Title: Chapter 3: Cost and Benefit Analysis
1Chapter 3 Cost and Benefit Analysis
2Cost Identification Analysis
- Cost Identification Analysis measures the total
economic cost of a given medical condition or
type of adverse health behavior. - Examples Cost of asthma or Alzheimers disease.
Cost of cigarette smoking or excessive alcohol
consumption.
3Three Types of Costs
- Direct medical costs all costs incurred by
medical care providers when treating the
condition. - Direct nonmedical costs monetary costs imposed
on any nonmedical care personnel, including
patients and their relatives. - Indirect costs opportunity cost of the time
influenced by the illness or health behavior such
as lost productivity because of sickness, injury,
or loss of life.
4Examples of Cost Identification Analysis
- Fanslow et al. (1997) Social Science and Medicine
- Cost of Homicides in New Zealand
- Total cost slightly more than 53 million in
1992 - Total cost for homicide victims 24 million
(direct medical 800,000 and indirect costs
23 million). - Total cost for perpetrators almost 30 million
(24 million direct medical costs and 6 million
indirect costs).
5Example - continued
- Weiss, Gergen, and Hodgson (1992), New England
Journal of Medicine - Total annual cost of asthma in the U.S. gt 6.2
million in 1990 - Direct medical costs gt 3.6 million
- Indirect costs gt 2.5 million
- Lost school days 900 million
- Lost work due to illness 800 million
- Lost work because of worker death 800 million
6Value of Cost Identification Analysis
- While valuable because it sheds light on the
economic impact of illnesses and adverse health
behaviors, cost identification analysis does not
provide information on the wastefulness of
various medical interventions or the best or
efficient way of saving lives. - Cost-Benefit Analysis and Cost-Effectiveness
Analysis do offer this type of information.
7(No Transcript)
8Cost-Benefit Analysis
- The Theory of Cost-Benefit Analysis
- Suppose an all-knowing and benevolent
Surgeon-General (SG) is responsible for
maximizing the social utility or happiness of the
population in an area. - The SG achieves the objective by maximizing the
total net social benefit received from each and
every good in society.
9The Surgeon General of the US
Vice Admiral Richard H. Carmona was sworn in as
the 17th Surgeon General of the United States
Public Health Service on August 5, 2002, and
assumed the role of Acting Assistant Secretary
for Health on February 9, 2003.
10Theory of Cost-Benefit Analysis - continued
- For medical services, the SG faces the following
objective - Max TNSB(Q) TSB(Q) TSC(Q)
- Where Q identifies the decision variable- how
many medical services to produce and TSB and
TSC reflect the total social benefit and total
social cost associated with consuming and
producing medical services, respectively. Total
net social benefit (TNSB) represents the
difference between the two.
11TSB and TSC
- Total social benefit can be treated as the money
value of the satisfaction generated from
consuming different amounts of medical services.
TSB increases at a decreasing rate reflecting the
law of diminishing marginal utility. - Total social cost can be looked at as the money
value of all the resources used in the producing
the different amount of medical services. TSB
increasing at an increasing rate indicating the
law of diminishing marginal productivity.
12Determination of the Efficient Level
of Medical Services
TSC
TSB
A
B
Quantity of Medical Services Q
Q0
Q0 represents the efficient level of medical
services because TNSB, the vertical difference
between TCB and TSC, is the greatest.
13MSB and MSC
- Marginal social benefit
- (MSB) ?TSB/?Q or slope of TSB curve
- Marginal social cost
- (MSC) ?TSC/?Q or slope of TSC curve
- Geometric principle the distance between two
curves is maximized when slopes are equal.
14A Marginal Perspective of the Efficient Level
MSC
A
G
E
C
F
H
MSB
B
Q0
QL
QR
Quantity of Medical Services
Q
The amount of medical services at Q0 is efficient
because MSB MSC. QL reflects underprovision beca
use MSB gt MSC and QR indicates overprovision
because MSC gt MSB. Triangular areas ECF and GCH
reflect the deadweight losses associated with
inefficient outcomes.
15The Net Benefit Calculus - revisited
- The SGs task can be restated as setting the net
marginal social benefit (NMSB) of each and every
good equal to zero, or - NMSB(Q) MSB(Q) MSC(Q) 0
- If NMSB(Q) gt 0 produce more.
- If NMSB(Q) lt 0 produce less
16Practical Side of C/B Analysis
- Several steps must be taken to implement C/B
analysis in practice. - Enumerate and quantify the benefits of the
program or intervention, e.g., - Medical costs diverted because an illness is
prevented - Monetary value of any gains in productivity
because death is postponed or illnesses prevented - The monetary value associated with the utility of
being in a state of good health
17C/B in practice - continued
- Costs must be enumerated and quantified, e.g.,
- Opportunity cost of each and every resource
involved in the program or intervention. - Should capture both the money (explicit) and time
(implicit) cost of resources.
18Discounting Costs and Benefits
- Discounting considers the time value of goods and
services. In general, people prefer receiving
goods and services today than in the future. - Stated in financial terms, a dollar received
today is worth more than a dollar received
tomorrow.
19Discounting Costs and Benefits - continued
- Since a medical intervention typically yields a
stream of future benefits and costs, discounting
of values is necessary to state all values in
present day terms for comparability. For example,
the present value of 1 received at the end of
the year when the discount rate is 5 is - PV 1/(1.05) .95
20Discounting Costs and Benefits - continued
- In general, if there are N periods for which the
medical intervention generates benefits and/or
cost and the discount rate is represented by r,
we can write - PV B1-C1 B2-C2 . . . BN-CN
- (1r)1 (1r)2 (1r)N
- N
- Or PV ? Bi-Ci
- i (1r)i
21Discounting Costs and Benefits - continued
- Careful consideration must be given to the choice
of the discount rate. The discount rate should
reflect societys time preference for goods and
services. - If the chosen rate is higher than the true rate,
short-term interventions will be chosen over
long-term interventions. - The T-bill rate is often used and studies
normally examine the sensitivity of the results
to different discount rates.
22The Value of a Human Life
- To properly estimate the benefits of a medical
intervention, it is often necessary to put a
value on a human life. Two approaches. - Human Capital Approach equate the value of a
persons life to the market value, in present
value terms, of the output produced by an
individual over the remaining years of that
persons life. - For example, suppose a life-saving treatment, if
implemented today, provides an estimated 2
additional years of life for an estimated 10,000
adult males, each with his human capital worth
1,500 for those 2 years. The benefit, in terms
of the value of life years saved, would be 15
million.
23Human Capital Approach - continued
- Although widely accepted and used, human capital
values may be understated because of gender and
racial discrimination in the labor market. - Additionally, the human capital approach would
assign a zero value of life for someone who is
chronically unemployed.
24Willingness to Pay Approach
- Willingness to pay approach assigns a value of
life based upon someones willingness to pay for
a small reduction in the probability of dying. - This kind of information is revealed when people
purchase safety equipment or are compensated for
working in risky environments, for example.
25Willingness to Pay Approach - continued
- To understand the logic, consider a person who is
deciding to purchase a device that can reduce the
probability of dying by Pr. Using the
cost-benefit principle, the person with a value
of life equal to V would be indifferent about
buying the device of cost, C, if - Pr V C (or marginal benefit equals marginal
cost.)
26Willingness to Pay - continued
- Rewriting
- V C/Pr
- Thus, if society is willing to pay 100 per
person per year for some device that improves
environmental quality by reducing the probability
of dying by 1 in 10,000, the imputed value of a
life equals at least 1 million (100 divided by
1/10,000
27Willingness to Pay Approach - continued
- For figures based on various types of regulations
see Table 7-2 in text. - Viscusi (1993) JEL found willingness to pay
estimates to range between 3 million and
7million in 1990 based on labor market studies
where workers must be compensated for undertaking
risky jobs. Note the figure for wage premiums for
dangerous factory jobs in Table 7-2. - Viscusi and others point out the willingness to
pay numbers greatly exceed human capital
estimates by a sizeable margin.
28Willingness to Pay Approach - continued
- Advantage measures the total value of life,
both job market value and leisure time.. - Disadvantage difficult to develop precise,
reliable data about how much people value safety.
29The Game of Life
30Determining the Value of Your Life
- We begin with a pool of 10,000 people.
- Each person is asked to play a game, if willing.
- Each person must determine the fee that he or she
will accept or be paid to participate in the
game. - The fee is based on each persons own values and
the expected level of competition. - One thousand of the 10,000 lucky people with the
lowest fees will be chosen to play the game. The
assumption is that competition among the 1,000
individuals will keep fees close to actual
willingness to play the game.
31Determining the Value of Your Life
- One of the 1,000 players will be selected at
random and executed. - The rest will receive their fees and are allowed
to withdraw from the game. - How much will you charge to play the game?
32Calculations
- Fee probability of dying times value of life
(i.e., MB MC) - Value of life Fee/probability of dying
- Value of Life 1000 X Fee
- Major Point The value of our lives is revealed
by our acceptance or avoidance of risk.
33End of Game
34Reconciling the Human Capital and Willingness to
Pay Approaches
- Keeler (2001) JHE
- Points out that standard economic models of labor
supply assume that the value of leisure time at
the margin is equal to the marginal wage rate
(i.e., marginal cost equals marginal benefit of
working). - If we assume the value of all time is equal to
the wage rate (no diminishing returns due to
leisure if so a lower bound estimate), we can
calculate the value of life by multiplying the
wage rate by total discounted hours of life time
remaining.
35Reconciliation - continued
- Makes these assumptions
- Workers stay employed for 5 years after we first
observe them working. - After the initial period they revert to the 1990
participation rates 92 of 25-54 year old mean
remain employed 70 of men 55-64 16 of men 65
and over 75 of 25-54 year old women 46 of
women 55-64 9 of women 65 and older. - Hour wage rate given by the 1990 median weekly
earnings for full-time wage and salary workers in
their age-sex category divided by 40. - Workers work 2000 hours per week, if employed.
- Workers live up to age 40 and then follow average
US 1992 mortality rates. - Discount rate is 3.
36Value of life based on value of work and leisure
time
Keeler, 2001, JHE
37Reconciliation - continued
- Keeler concludes by writing (p. 142)
- Neither the estimates of value of life in the
literature nor these estimates of value of
lifetime remaining are very precise, but it is
amusing that they are so close to each other.
Maybe people really do make these calculations
implicitly in choosing a job, or answering a
survey.
38C/B Analysis some applications
- See page 191 in text and surrounding discussion
concerning Vaccination of College Students
against Meningococcal Disease. - Cutler and McClellan (2001) Health Affairs, Is
Technological Change in Medicine Worth It?
39Cutler and McClellan
- Point out that most agree that technological
change has accounted for the bulk of medical care
cost increases over time. But do the benefits
outweigh the added costs? - Also point out that the average newborn could
expect to spend 8,000 in present value terms on
medical care over his or her lifetime. An infant
born in 1990 had a life expectancy that was 7
years greater than one born in 1950 and lower
disability but faced costs of 45,000 on medical
care during his or her lifetime. Do the benefits
outweigh the costs?
40Cutler and McClellan
- Cutler and McClellan focus on the costs and
benefits of medical technology improvements at
the disease level to get more precise estimates.
Focus on - Heart Attacks
- Low-birthweight infants
- Depression
- Cataracts
- Breast Cancer
41Cutler and McClellan
- Authors point out that new technologies have a
treatment substitution effect and a treatment
expansion effect. - Authors assume a 3 discount rate and the value
of a year of life in the absence of disease at
100,000.
42(No Transcript)
43Cutler and McClellan - continued
- Authors conclude
- The benefits from lower infant mortality and
better treatment of heart attacks have been
sufficiently great that they alone are about
equal to the rise in medical care costs over
time. Recognizing other benefits, medical
spending is clearly worth the costs. - Quality adjusted medical prices may actually have
declined over time in contrast to standard
figures showing rising prices for medical
services.
44Cost Effectiveness Analysis
- Instead of measuring if various medical
intervention are wasteful or not, CEA seeks to
answer the question What is the least cost way
of achieving a given objective? - Objective may be number of life years saved or
reduced cholesterol levels or blood pressure, for
example.
45CEA Analysis - continued
- Cost of a life year saved
- Cost of Intervention
- Number of life years saved
- Costs would include both direct medical costs and
direct nonmedical costs. The number of life years
saved may also be multiplied by a quality of life
index ranging from zero (death) to one (perfect
health) to measure quality-adjusted live years
saved.
46- Lifesaving Costs
- Median cost of a year of life saved by various
interventions -
COST - Childhood immunizations Less than
zero - Prenatal care Less than
zero - Flu shots
600 - Water chlorination
4,000 - Pneumonia vaccination
12,000 - Breast cancer screening
17,000 - Construction safety rules
38,000 - Home radon control
141,000 - Asbestos controls 1.9 million
- Radiation controls 27.4 million
- Source Harvard Lifesaving Study
Health Prevention may be costlier than a cure
Wall Street Journal New York Jul 6, 1994
Stipp, David
47THE END!!