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Marginal Cost Pricing

In: Business and Management

Submitted By eboniivori04
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In economics the marginal cost of an item is the cost of providing one additional unit of output, whether that output is a product or service. For example, suppose that a hospital currently provides 40,000 patient days of care. Its marginal cost, based on inpatient day as the unit of output, is the cost of providing the 40,001st day of care. In this situation, it is likely that fixed costs, both direct and overhead, have already been covered by reimbursements associated with the existing patient base (the 40,000 patient days), so the marginal cost that must be covered consists solely of the variable costs associated with an additional one-day stay. In most situations, no additional labor costs would be involved; additional personnel would not be hired nor overtime required. The marginal cost, therefore, consists of variable costs such as laundry, food and expendable supplies, and nay additional utility services consumed during that day. Many proponents of government programs such as Medicare and Medicaid argue that payments to providers should be made on the basis of marginal rather than full costs. By implication, nongovernmental payers would cover all base costs. However, what would happen if all payers for a particular provider set reimbursement rates based on marginal costs? If such a situation occurred, the organization would not recover its total costs and would ultimately fail. For prices to be equitable, all payers should pay their fair share in covering providers’ total costs. Furthermore, if marginal cost pricing should be adopted, which payer(s) should receive its benefits by being charged lower prices? Should it be the government because it is taxpayer funded, or should it be the last payer to contract with the provider? There are no good answers to these questions, so the easy way out, at least conceptually, is to require all payers to...

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