This article examines the influence of excess demand on nursing home costs. Previous work indicates that excess demand, reflected in a pervasive shortage of nursing home beds, constrains market competition and patient care expenditures. According to this view, nursing homes located in underbedded markets can reduce costs and quality with impunity because there is no pressure to compete for residents. Predictions based on the excess demand argument were tested using 1989 data from a sample of 179 Kentucky nursing homes. Overall, the results provide partial support for the excess demand argument. Factors that may counteract the influence of excess demand are considered. Finally, the role of competition in nursing home markets and difficulties associated with making it operational are discussed.