Information vs advertising in the market for hospital care

Recent health care reforms have introduced prospective payments and have allowed patients to choose their preferred providers. The expected outcome is efficiency in production and an increase in the quality level. The former objective should be obtained by the prospective payment scheme; the latter by the demand mechanism, through the competition between providers. Unfortunately, because of asymmetry of information, patients are unable to observe the true quality and the demand for health care services depends on a perceived quality as influenced by the hospital advertising. Inefficiency in the resource allocation and social welfare loss are the two likely effects. In this paper we show how the purchaser can implement effective policies to overcome these undesired effects.