The cost of a day of hospital care has increased 600 per cent in the past 20 years while the general consumer price index rose only 100 percent. The current paper explains the rising cost of hospital care with the aid of an econometric model. the essence of the explanation is that the explosion of hospital cost reflects a rapid change in the quality and style of hospital care and not an increasing cost of providing the same product. The dramatic change in the quality of care is primarily due to the increased demand caused by the growth of private and public insurance. The paper presents an analytic of the hospital industry in which quality affectsthe demand for hospital services and in which the purchase or private insurance is endogenous. Estimates of key equations of the model based on a cross-section of time series for the individual states for the years 1958 through 1973 are presented. The price adjustment process and dynamic multipliers are discussed.