Health Economics- Lecture Ch04

Embed Size (px)

Citation preview

  • 8/3/2019 Health Economics- Lecture Ch04

    1/29

    Economic Efficiency

    And

    Cost Benefit Analysis

    Dr. Katherine Sauer

    Metropolitan State College of Denver

    Health Economics

  • 8/3/2019 Health Economics- Lecture Ch04

    2/29

    Outline

    I. Economic Efficiency

    II. Cost-Benefit AnalysisIII. Cost-Effectiveness Analysis

    IV. Cost-Utility Analysis

  • 8/3/2019 Health Economics- Lecture Ch04

    3/29

    Health policy requires that we frequently and

    systematically evaluate alternatives.

    e.g. preventative care vs acute care vs R&D

    I. Economic Efficiency- maximizing the economys total surplus

    Consumer benefits from good X can be measured by

    their willingness to pay for good X.

    The opportunity cost to society of producing good X

    can be measured by the marginal cost of production.

  • 8/3/2019 Health Economics- Lecture Ch04

    4/29

    D

    Q

    P

    Demand represents

    willingness to pay.

    Suppose price is P1.

    - in total, consumers

    would buy Q1

    - the total benefit toconsumers is area

    A + B

    - the total amount

    paid by consumers isarea B

    - area A is consumer

    surplus

    P1

    Q1

    A

    B

  • 8/3/2019 Health Economics- Lecture Ch04

    5/29

    S

    Q

    P

    Supply represents the

    marginal costs of

    production.

    Suppose price is P1.

    - in total, producers

    would be willing tosell Q1

    - the total benefit to

    producers is area

    F + E- the total production

    cost is area E

    - area F is producers

    surplus

    P1

    Q1

    F

    E

  • 8/3/2019 Health Economics- Lecture Ch04

    6/29

    D

    Q

    P

    The market is in equilibrium

    at a price of P*.

    - total benefit toconsumers is area

    X + Y + Z

    - consumers pay

    Y + Z to producers- producers use Z

    to cover costs

    - consumers are left

    with X as surplus- producers are left

    with Y as surplus

    - total surplus is

    X + Y

    P*

    Q*

    X

    S

    Y

    Z

  • 8/3/2019 Health Economics- Lecture Ch04

    7/29

    D

    Q

    P

    The market is efficientbecause total surplus is maximized.

    In contrast, a monopoly is not efficient

    P*

    Q*

    S

    MR

    (MC )Pm

    Qm

    x1

    x2

    x3

    y1 y2

    y3

    In a competitivemarket, consumer

    surplus is x1+x2+x3.

    Under a monopoly,

    they have x1+x2.

    In a competitive

    market, producer

    surplus is y1+y2+y3.Under a monopoly,

    the firm has y1.

    x3 + y3 are DWL

  • 8/3/2019 Health Economics- Lecture Ch04

    8/29

    II. Cost Benefit Analysis

    In a competitive market, supply and demand provide theefficient quantities of the good to the market.

    Many goods do not have market signals available:

    - clean air- bridges

    - stop signs

    Cost-Benefit Analysis (CBA) is a method for evaluating

    public projects.

    [ justify public works projects in depression era]

    [ mandatory since 1981]

  • 8/3/2019 Health Economics- Lecture Ch04

    9/29

    CBA measures benefits and costs in money terms.

    - need to place dollar values on human life

    CBA based on the idea that a project/policy will

    improve social welfare if the benefits (B) exceed the

    costs (C).

    worthwhile project if B C >0

    When alternative projects are being evaluated, their

    benefit cost ratio will be looked at.

    (B/C) project with highest ratio gets funded

  • 8/3/2019 Health Economics- Lecture Ch04

    10/29

    Some Basic Principles:

    A. Measuring Costs and Benefits

    - costs must include opportunity costs

    - public project opportunity costs often dont have a

    market value- a dam to prevent flooding may destroy a

    historical landmark

    - benefits may not have market value either

    - the dam results in a lake which can be used asa public recreation area

  • 8/3/2019 Health Economics- Lecture Ch04

    11/29

    B. Equal Risk vs Equal Marginal Cost per Life Saved

    Should society distribute resources so that each person

    faces the same health risk?

    - impossible

    Should society distribute resources so that the marginal

    cost of saving a life is equal across publicly funded

    programs?- nutshell: each next dollar spent should go where

    it does the most good

  • 8/3/2019 Health Economics- Lecture Ch04

    12/29

    C. Marginal Analysis

    MSC

    MSB

    $

    MC,

    MB

    Percentage reduction in discharge

    100

    %

    Q1

    Societys net benefit from a

    project will be maximized

    when MSC is equal toMSB.

    - reduce discharge by Q1%

    What about a policy toreduce discharge by only

    Q2%?

    - at Q2, MSB > MSC

    so society would gainby increasing the

    reduction in discharge

    How about 100%

    reduction?

    Q2

  • 8/3/2019 Health Economics- Lecture Ch04

    13/29

    MSC

    MSB

    $

    MC,

    MB

    Percentage reduction in discharge

    100

    %

    Q1

    Suppose the current project

    is reducing discharge by

    Q2%.

    A project which increases

    the reduction in discharge

    from Q2% to Q1% wouldcreate a net benefit to

    society of area A.

    Q2

    A

  • 8/3/2019 Health Economics- Lecture Ch04

    14/29

    D. Discounting

    - many projects have benefits or costs lasting

    into the future- use present value calculations

    Each periods costs and benefits are divided by a

    discount factor (1+d).- societys discount rate (d)

    !

    !T

    tt

    tt

    d

    CBPV

    1 1

    - T is the number of time periods

    - t = 0 in the present

  • 8/3/2019 Health Economics- Lecture Ch04

    15/29

    Often it is assumed that d is equal to the market interest

    rate.

    - rate at which willing to give up currentconsumption for future consumption

    - rate of return on investment

    As t gets larger, the PV falls.-This assumes we discount the distant future

    more heavily.

    - Is this fair to future generations?

    Some argue for setting d lower than the current market

    interest rate.

    (smaller d means greater emphasis on the future)

  • 8/3/2019 Health Economics- Lecture Ch04

    16/29

    E. Adjustments

    i. Risk Adjustments

    Some projects are riskier than others.

    Public projects represent the public at large.- public at larges view of risk might be hard to

    discern

    - Stiglitz recommends using a lower discount

    rate to reflect the publics role.- certainty equivalent

  • 8/3/2019 Health Economics- Lecture Ch04

    17/29

    ii. Distributional Adjustments

    Government projects often result in a change in the

    distribution of income.

    - often concentrated benefits with diffuse costs

    After projects are ranked by their benefit-cost ratio,

    rankings can be subjectively altered to reflect their

    effect on income distribution.

    - many favor higher rankings for projects forlow income people

  • 8/3/2019 Health Economics- Lecture Ch04

    18/29

    F. Inflation

    Inflation estimates are often wrong so use the real

    discount rate (not nominal rate) for the present value

    calculations.

    G. Valuing Human Life

    It is difficult but necessary to put a value on human life.

    3 main approaches:

    human capital approach

    willingness to accept approach

    contingent valuation approach

  • 8/3/2019 Health Economics- Lecture Ch04

    19/29

    i . Human Capital Approach:

    - estimates the present value of an individuals

    future earnings- popular for legal applications

    - measures the loss of national output from

    mortality/morbidityor

    measures the production gains from saving or

    extending a life

    - does not take into account an individuals

    willingness to pay to avoid injury/death

  • 8/3/2019 Health Economics- Lecture Ch04

    20/29

    ii. Willingness to Accept Approach:- the flip side of willingness to pay

    - the compensation you would require to accept

    an additional risk to life/limb

    - derived from labor economic theory

    (compensating differentials)

    - theoretically no limit on WTA

  • 8/3/2019 Health Economics- Lecture Ch04

    21/29

    iii. Contingent Valuation: elicits individuals valuation

    of alternative contingent risks.

    - poses sets of questions like:

    If you faced an X high risk of heart attack, how

    much would you be willing to pay for a medical

    procedure that would reduce your risk to Y?

  • 8/3/2019 Health Economics- Lecture Ch04

    22/29

    Dollar value of a life:

  • 8/3/2019 Health Economics- Lecture Ch04

    23/29

    III. Cost-Effectiveness Analysis

    CEA may be more practical than CBA.

    CEA compares the costs of achieving a particular

    objective. (e.g. # of lives saved)

    Assumption: the objective is desirable (even if it hasnt

    been measured in monetary terms)

    - now we dont have to worry about trying to

    quantify the benefits- still need to quantify costs

  • 8/3/2019 Health Economics- Lecture Ch04

    24/29

    The CEA ratio:

    01

    01

    EE

    CCCEAR

    !

    - compares incremental costs to incremental output- costs are measured in dollars

    - output is the chosen health status measure

    - to compare across projects, the output measures mustbe the same

  • 8/3/2019 Health Economics- Lecture Ch04

    25/29

    IV. Cost-Utility Analysis

    - practical variation of CEA

    A. QALY (quality adjusted life years)

    Each project is evaluated on the basis of its incremental

    costs per extra QALY.

    QALY assigns a value q to represent the quality of life

    for each year.

    0 = death1 = perfect health

  • 8/3/2019 Health Economics- Lecture Ch04

    26/29

    !

    !duration

    ii

    ii

    d

    qFQALY

    max

    1 )1(

    Fi = probability that the person is alive at age i

    qi = quality weight between 0 and 1

    d = time discount factor

  • 8/3/2019 Health Economics- Lecture Ch04

    27/29

    Ex: Treatment has a probability of 90% for extending

    life by one year, a probability of 50% for extending life

    by two years, and a probability of 0% for extendinglife by three years.

    The quality weights are 0.8 for year one and 0.6 for

    year two.

    The discount rate is 0.05 each year.

    96.0)05.01(

    )0)(0()05.01()6.0)(5.0(

    )05.01()8.0)(9.0(

    321!

    !QALY

    This QALY could be used in the denominator of the

    CEA ratio.

  • 8/3/2019 Health Economics- Lecture Ch04

    28/29

    B. Praise for QALYs

    Provides another technique for judging public projects.

    Accounts for the notion that each person is entitled to a

    life in which he or she can use a basic set of capabilities

    to achieve personal goals in life.

    Importantly, these capabilities would include basic

    health and functioning.

  • 8/3/2019 Health Economics- Lecture Ch04

    29/29

    C. Critique of QALYs

    They are not consistent with standard Pareto basedwelfare economics.

    A developing criticism of CUA with QALYs focuses on

    the methods linear valuation of medical interventions asthe simple sum of quality gains times life-years saved

    times the number of people treated.

    It has long been pointed out that QALYs tend to place areduced value on older people when evaluating a medical

    intervention.