This paper examines methodological and policy issues of interest to medical geographers who use diagnosis-related groups (DRGs) in their research. Methodological issues are studied in terms of the calculation of DRGs and variation in the utilization of surgical and medical DRGs. It is argued that a shift to a single DRG price system should first address the (i) regional disparities that currently exist and the need for large-scale indices of medical wages and labor costs; (ii) severity of illness measurements other than the present nominal ones; and (iii) wide variation among medical versus surgical procedures. The Department of Commerce's Economic Analysis Area is recommended to remedy the problem of geographic scale. Policy issues of interest to medical geographers center around the shift to greater hospital specialization which is likely to continue across the country. Inner-city, rural and teaching hospitals may continue to be inadequately reimbursed by DRGs, treat more medically indigent, or both. Medical geographers should be aware of the policy and methodological issues involved not only in DRGs, but in proposed prospective payment systems for ambulatory and long-term care.