Danville, Ill., halfway down the state alongside the Indiana border, is a county seat whose 90,000 inhabitants have not been providing enough business for its two hospitals. On a typical day, there were fewer than 200 patients in the two facilities together, well below the combined capacity of 454.

By traditional antitrust analysis, the two competing institutions should not have been allowed to merge. But the Justice Department recently gave the green light to just such a deal.

Antitrust chief Charles F. Rule used Danville as an example of how his department analyzes the increasing number of merger proposals being floated by hospitals. It's a good example both of how hospitals are treated just like any other business and how they get special handling.

In the first place, to the antitrust specialists at both Justice and the Federal Trade Commission, the fact that a hospital is selling health care rather than widgets provides no insulation from antitrust laws.

"In hospital mergers, as in all other industries, the antitrust division applies the analysis of the 1984 Merger Guidelines," Rule told the National Health Lawyers Association last month. "Moreover, that analysis applies equally to mergers involving for-profit and not-for-profit hospitals. The tax and charitable status of hospitals, or any business for that matter, is not relevent to merger enforcement."

Except for the great national centers operating at the forefront of medical knowledge, however, hospitals serve a pretty well-defined local market. The bedrock of the antitrust philosophy is that competition will lead businesses to cut prices to the bone in order to woo more customers.

But while a furniture store may get buyers to drive 50 miles for a bargain, a hospital that offers bargain rates won't pull in that many more patients. In an emergency, they head for the nearest facility and, even without an emergency, it's deemed best to be in your hometown, near the doctors you know and family and friends who can visit.

This natural choice is amplified by the fact that many patients have health insurance that is going to pay the bill anyway -- or pocket the savings from a lower-priced facility. So while a merger of the only two furniture stores in a town might raise few antitrust problems (because customers can shop in other towns and new retailers can open up fairly easily if the merged store starts gouging customers), the concentration numbers tend to look very high in the hospital business.

Using the standard gauge, any time two hospitals in a town with five such facilities want to merge, the government would sue. Only in the biggest cities are there so many hospitals that competition looks vigorous.

Even under the benign attitude toward mergers that has characterized the Reagan administration, Justice and the FTC have sued, opposing hospital mergers in markets as diverse as Modesto, Calif., and Chattanooga, Tenn. In other cases, Rule said, pending deals have been called off when the antitrust people said they would oppose the merger.

But the amount of competition is not the whole story. A hospital probably needs at least 300 beds to operate efficienty; smaller facilities have to keep staff in place -- for emergency room admittances, for instance -- that is not likely to have enough to do to keep busy all the time. And a lot of smaller cities can't support more than one hospital of that size. Moreover, the approaches to the problem that might work in another industry to get a faltering concern back on its feet -- concentrating on certain lines of business and dropping others, finding ways to cut costs -- could be disastrous in health care.

"A market-directed struggle," Rule said, "could produce levels of care at the failing hospital that are inadequate from a health care perspective, but which might not be apparent to patients choosing a hospital." The Justice Department analysts feared that's what might happen in Danville if they refused to let the two hospitals merge.

But even in localities that can support more than one hospital, the antitrust staffers will let a merger go ahead if it promises to produce real efficiencies through specialization. If under joint ownership all obstetric patients, say, could be sent to one hospital and all psychiatric patients to the other, both programs could operate closer to full capacity and, therefore, at at lower per-patient cost.

A proposal to merge in order to gain efficiencies in operations like laundries and laboratories, however, won't impress the analysts. Without a merger, hospitals can work out joint ventures to achieve that kind of savings, Rule said.

Moskowitz covers legal affairs for McGraw-Hill World News.