Hospital price regulation and expenditure cap policy

In several European countries, governments have chosen to put a global budget cap on health care expenditure. This paper analyzes the strategies of the providers facing this policy and evaluates its effects on provider and patient surplus. We consider this policy when it is applied to local monopoly hospitals and when it is applied to hospitals playing as Cournot competitors. Using a two-stage model to characterize the optimal expenditure cap policy taking the hospitals' optimal responses as given, we prove that this policy induces a level of welfare lower than the first-best outcome. However, we show that a second-best outcome may be achieved under this policy when the number of hospitals becomes large.