Estimating a Non-Minimum Cost Function for Hospitals

A hybrid translog nonminimum cost function and 3 share equations are estimated for 331 US short-term hospitals for the period 1975-1976. Data on total observed cost and input cost shares are taken from the American Hospital Association's annual survey of US hospitals. The estimated cost function fits the data quite well. The results indicate that hospitals tend to overemploy capital and underemploy physicians' services. Allocative inefficiency is indicated to be 4%-5% of total cost. The cost function estimates suggest the possibility of substitution between all pairs of inputs except capital and materials. Estimated input concepts are found to be sensitive to model specification, along both the conditional efficiency branch and the restrictive technologies branch of models nested within the nonminimum cost function. On the other hand, output concepts are generally insensitive to model specification. In addition, the estimated differences between shadow and observed marginal costs, output cost inelasticities, and overall economies of scale are small.