We performed a two-year cost of illness study of 240 AIDS patients (55 percent of all Massachusetts cases) diagnosed and treated at five hospitals from March 1984 through February 1986. Sociodemographic and clinical data as well as information on medical utilization were obtained from review of inpatient and outpatient hospital records. The yearly inpatient cost per patient decreased by 28 percent from $38,369 in year one to $27,714 in year two. These changes were related to shorter lengths of stay (from 20.6 days to 16.8 days per hospitalization, mean difference of 3.8 days, 95% CI of the difference -.2, 7.8), and less costly hospitalizations (from $12,463 to $9,957, mean difference of $2,506, 95% CI of the difference $135, $4,877). The probability of hospitalization, however, was similar in both years. These patterns of care were still evident after controlling for transmission category, race, site, mortality, insurance, age, gender, number and type of opportunistic diseases and time since diagnosis. Although the cost per patient per year decreased between years one and two, median survival increased by 70 percent (from 10 to 17 months). Hence overall estimated lifetime costs increased by 24 percent.