Using data from 1985 and 1986, we examine how New York state's prospective payment system affected nursing homes. The system, called Resource Utilization Group (RUG-II), aimed to limit nursing home cost growth and improve access to nursing homes by "heavy-care" patients. As in Medicare's prospective hospital reimbursement system, payments to nursing homes were based on a "price," rather than facility-specific rates. With respect to cost growth, we observed considerable diversity among homes. Specifically, those nursing homes most financially constrained by the RUG-II methodology exhibited the slowest rates of cost growth; we observed higher cost growth among the homes least constrained. This higher rate of cost growth raises a question about the desirability of using a pricing methodology to determine nursing home payment rates. In addition to moderating cost growth, we also observed a significant change in the mix of patients admitted to nursing homes. During the first year of the RUG-II program, nursing homes admitted more heavy-care patients and reduced days of care to lighter-care patients. Thus, through 1986, the RUG-II program appeared to satisfy at least one of its major policy objectives.