1. Introduction The theoretical framework relating to the production of health services by hospitals is similar to that of any other firm. Economists are concerned with much the same issues in the measurement of output in the health sector as in other spheres of production. Foremost among these is the shape of the production function that underlies the transformation of inputs into outputs since it determines the optimal size and structure of the production unit, in this case hospitals. Based on a 12-year panel of all short-term hospitals in Quebec covering 1981 through 1992, this research examines the health care production process. The approach is new in that it examines hospitals in a noncompetitive, socialized framework and relies on a very complete hospital sector data set. To avoid biases often present in previous work, all quasi-fixed inputs (physicians, equipment, and buildings), all variable inputs (labor, drugs, food for inpatients, supplies, energy, and an aggregate of other inputs), and all outputs (inpatient care, outpatient care, food, and laundry services sold to the public, laboratory services to outpatients or under contract, and teaching) are included in the estimation. Determining the optimality of the hospital industry structure in Quebec is important for at least two reasons. First, hospital investment decisions in Quebec are centralized. Planners can determine the optimal hospital structure only if they have knowledge of the hospital production process. Second, the absence of a competitive market precludes the usual adjustments driven by competitive pressures from taking place. Diseconomies of scope or scale, highly unlikely in a competitive market, might be present, large, and persistent in a nonmarket structure. In Quebec, hospitals are most often private not-for-profit institutions. However, the Quebec government that controls the national health insurance system is their only payer except for very small revenues from hospital private foundations or uninsured services such as cosmetic surgery, some laboratory tests, etc. These private payments to hospitals represent negligible amounts. As a result, the system operates very much as if hospitals were in fact public entities. Collective bargaining occurs with the government, reimbursement rates are determined by the government, and major investment or merger decisions, equipment purchase, or new construction are approved by the government. The present analysis provides a framework to gather information valuable to planners in any publicly funded system as they restructure hospital health services delivery. In Quebec, the government could also better respond to changes in relative input prices through changes in relative input use, review of its reliance on private laboratory analysis services, or toughening of its medical school admissions policies. In the early 1990s, and without the benefit of an analysis such as this one, the Quebec government froze health care spending, closed a number of hospitals, changed hospitals' role (from short-term care to long-term care), and decentralized its structure through regional boards (Regies regionales). Some of the unintended consequences included crowding in hospitals, a near breakdown of emergency care during the first months of each year since, and few, if any, gains in efficiency. Our analysis provides an exploration of the structure of hospital production in a nonmarket environment. In anticipation of unavoidable restructuring of the industry in the years to come, it also suggests a management tool for planners to direct the industry toward greater economic performance through changes in hospitals' relative budgets, changes in the scope of services offered, or mergers between establishments. This article examines the optimality of size, diversification, capitalization levels, and technological change as well as the flexibility in the choice of inputs and outputs. It identifies the hospital and delivery structure characteristics associated with greater performance. …