This paper studies factor substitution in one important sector: the nursing home industry. Specifically, we measure the extent to which nursing homes substitute materials for labor when labor becomes relatively more expensive. From a policy perspective, factor substitution in this market is important because materials-intensive methods of care are associated with greater risks of morbidity and mortality among nursing home residents. Studying longitudinal data from 1991 to 2000 on nearly every nursing home in the United States, we use the method of instrumental variables (IV) to address measurement error in nursing home wages. The results from the IV models yield evidence of factor substitution: higher nursing home wages are associated with greater use of psychoactive drugs and lower quality.