A Diagnosis-Related Group (DRG) is a statistical system of classifying any inpatient stay into different categories. The DRG system is used for determining prospective payment rates which serve as the basis of hospital reimbursement by Medicare. 
The DRG classification system divides possible diagnoses into more than 20 major body systems and subdivides them into almost 500 groups.
Factors used to determine the DRG payment amount include the diagnosis involved as well as the hospital resources necessary to treat the condition. The system is also used by a few states and many private health plans (usually non-HMO) for contracting purposes. Hospitals are paid a fixed rate for inpatient services corresponding to the DRG group assigned to a given patient. 
In 1983, amendments to the Social Security program contained a prospective payment plan for most Medicare inpatient services in the United States. This payment system is referred to as the inpatient prospective payment system (IPPS). Under the IPPS, each case is categorized into a diagnosis-related group (DRG). Each DRG has a payment weight assigned to it, based on the average resources used to treat Medicare patients in that DRG. 
The payment plan was intended to control rising health care costs by paying a fixed amount per patient. The program of DRG reimbursement was based on the premise that similar medical diagnoses would generate similar costs for hospitalization. Therefore, all patients admitted for a surgical procedure such as hernia repair would be charged the same amount regardless of actual cost to the hospital. If a patient's hospital bill should total less than the amount paid by Medicare, the hospital is allowed to keep the difference. If, however, a patient's bill is more than that reimbursed by Medicare for a specific diagnosis, the hospital must absorb the difference in cost. 
- Design and development of the Diagnosis Related Group (DRG), CMS
- Gillian I. Russell, Terminology, in Fundamentals of Health Law 1, 12 (American Health Lawyers Association 5th ed., 2011).
- Section 1886(d) of the Social Security Act
- Acute Inpatient PPS, CMS.gov (https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/AcuteInpatientPPS/index.html)
- Miller-Keane Encyclopedia and Dictionary of Medicine, Nursing, and Allied Health, Seventh Edition.