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This article examines factors accounting for higher costs in urban hospitals as well as their relative contribution to those costs. The costs of urban hospitals are influenced by case mix, wages, competition, the ratio of forecasted to actual admissions, teaching, and the percentage of patients admitted through the emergency room. The bulk of the higher costs in urban hospitals are linked to graduate medical education. Treatment of poor patients and the admission of patients through the emergency room also contribute to the higher costs. Higher inpatient costs stemming from outpatient activities pose distributional problems for hospitals when these costs are not accounted for in prospective (inpatient) rate-setting programs.