• economies of scale;
  • activity based funding;
  • diagnosis related groups;
  • multilevel model;
  • public hospitals
  • H51;
  • F12

Under a new national agreement, public hospitals in Australia will be funded on activities. This article seeks to determine whether economies of scale exist in public hospitals and, if so, to develop a possible funding adjustment for the differences. Scatter diagrams, data transformation and a multilevel model were used to describe the phenomenon. Ray scale elasticity was used to assess the overall economies of scale. The results demonstrate the existence of substantial scale economies in public hospitals and a clear negative log-linear association between average cost and activity. A 10-fold increase in hospitalisations may result in a 10 per cent decrease in average costs.