A reconsideration of economies of scale in the health care field.

The Health Care Financing Administration has demonstrated an interest in the economies of scale phenomenon as it might apply to reimbursement methodologies. This paper provides a critical evaluation of the economies of scale research methodology and a critical review of both the analytical (LRAC estimates) and the implied economies of scale (spreading fixed costs) literature. Given that estimates of Minimum Optimum Scale are based on individual coefficients generated by a regression model, this work illustrates the danger inherent in this approach and examines the volatility of the coefficient values and their dependence upon model specification. The ambiguity present in the literature addressing the LRAC estimates is thereby explained. An evaluation of the implied economies of scale literature reveals that average fixed costs decrease with increasing levels of output. This should not be a surprise to anyone. The notion of economies of scale is implied in this literature but never addressed. It is suggested in this work that the means to better standardize the output of the hospital industry, the sine qua non of economies of scale research, is now available in various methodologies of patient grouping.