The demand side of the model is built up from individual consumers' choices of hospital, which depend on hospital price, distance from the patient's residence to the hospital, observed patient specific factors such as diagnosis, age, sex, and race, and unobserved consumer preferences and hospital characteristics. Assessments of hospital quality are permitted to be correlated across consumers, causing price to be endogenous in the demand equations. The supply side of the model comes from hospitals' optimizing their objective functions in price, taking account of conjectural variations. This supply side specification gives us pricing equations. The structure of the model leads directly to exclusion restrictions which identify it.
Price is endogenous in the demand equation.
The supply side pricing equation is identified by cost and demand shifters. Our estimation sample contains 374 hospitals and approximately 3 million discharges. Our preliminary results reveal that demand for hospital services is sharply negatively sloped in price in 1995. On average, these results indicate a price elasticity of demand of -6.23. In addition, we find a distance elasticity of demand of approximately -2.4.