This paper examines the implications of regulatory change for input mix and technology choices of regulated industries. We study the increase in the relative price of labor faced by U.S. hospitals that resulted from the move from full cost to partial cost reimbursement under the Medicare Prospective Payment System (PPS) reform. Using the interaction of hospitals’ pre‐PPS Medicare share of patient days with the introduction of PPS, we document substantial increases in capital‐labor ratios and declines in labor inputs following PPS. Most interestingly, we find that PPS seems to have encouraged the adoption of a range of new medical technologies.