Cost Benefit Analysis Introduce the concept of costbenefit
Cost Benefit Analysis
Introduce the concept of cost-benefit analysis. CBA: Learning Objectives When should we use CBA and when we should not use CBA? Problems of measuring health benefits in money terms. Methods of measuring health benefits.
CBA vs Other Economic Evaluation Methods CUA and CEA tell us the cost per unit of life years gained, deaths prevented or QALY gained. It can not tell us whether such a goal is worthwhile to pursue. For decision making on adopting the intervention, we need some external criteria of acceptance or rejection.
To decide about a project, we need to assign values to the outputs or health outcomes obtained. Decision Making Often, we do not explicitly mention values for the outputs derived. In decision making, some implicit values are assigned. The planners must decide how valuable it is to save a “statistical” life?
Also referred as benefits-cost analysis Systematic process for calculating and comparing costs and benefits associated with intervention: Cost-Benefit Analysis to determine if it is a sound investment (justification/feasibility) to see how it compares with alternate interventions (ranking/priority assignment) In cost-benefit analysis, the consequences of healthcare programs (outcomes, outputs) are measured in money terms.
In CBA, all costs and benefits are measured in dollar values and so it can compare very dissimilar projects. CBA is Broader in Scope In sectors other than health care, the CBA is the most widely used form of economic evaluation (environment, industry, agriculture, etc. ) CBA can inform us about allocative efficiency; other approaches of economic evaluation can not. A point when there is an optimal distribution of goods and services
CEA and CUA techniques are narrowly client-focus. e. g. , we consider the expected health outcome of the person being treated. Wider Focus of CBA CEA and CUA can not capture the spill-over effects. The effects on other individuals not directly related with the treatment. CBA can quantify these effects. e. g. , total social benefits of a new treatment program is the benefits obtained by the individuals being treated as well as the value others assign to the intervention.
… CBA Works by 1) 2) defining the intervention alternatives/policy scenarios/investment options identifying, measuring, and valuing the costs and benefits of each. Standardizes all costs and benefits in monetary terms. Lists all costs and benefits over time. Can have different time lines for costs and benefits. Can include direct and indirect benefits.
The “gold standard” of economic evaluation. Most commonly used for public decision making policy proposals, programs, and projects, e. g. , dams, bridges, traffic circles, riverfront parks, libraries, drunk driving laws, and anything else the government might fund. CBA EXAMPLES Building a wider bridge New water conservation facility/technology New production/processing equipment Allowing commercial development on Jekyll Island, GA CBA can be used to rank alternative projects as well as evaluating the social value of one particular project.
Benefit-cost ratio: (B/C) Very popular with stakeholders. “For every dollar spent on X, you will save Y dollars. ” Implement if B/C ratio > 1. Often misleading. Easy to manipulate costs to get higher ratios. CBA Measures Benefits: Gains - losses Net benefit: (B – C) Implement if net benefit > 0. Less easily manipulated. Also, Net Present Value Payback period How long it takes for B ≥ C?
In deciding whether to implement a program. If Net Benefit > 0, implement. When choosing among competing options. Implement program with highest net benefit. When trying to maximize the return on investment, Decision Rule Choose program with positive net benefits and the highest benefit to cost ratio If you have a budget constraint, Start with the program with the highest net benefit (if it fits in the budget), and so on and so forth Also, look at the next highest net benefits and their costs. You may get more combined benefits by choosing multiple programs instead of just a single program. For setting priorities when facing limited budgets.
CBA For PRIVATE decisions, such as taking martial arts classes or going to a movie on Saturday night, we are often not aware of any internal process of consideration of costs and benefits, but behave as though we do. An individual will choose an action if: Benefits (B) > Costs (C) or Net Benefits (NB) = B - C > 0
Bill will smoke if B > C. For Bill Benefits are: taste/oral satisfaction, relaxation, diet control, and improved work performance. CBA Costs are: expense, health consequences, value of time spent, discomfort/inconvenience of “smoking-allowed areas”, and disapproval of others. For the continuous choice of how many cigarettes to smoke, Bill will smoke the number of cigarettes which yield the greatest net benefits.
Pertussis vaccination in children: Cost component is the actual cost of vaccination including the cost of the vaccine, the treatment of complications resulting from the vaccine and treatment of cases that resulted despite being vaccinated. CBA Example Benefits: savings in medical care costs by preventing the disease. Benefits/costs = ($1, 866, 153/$720, 862)= 2. 6 This approach is enriched by accounting for health consequences, rather than only cost savings. WHY?
In mid-1960 s, almost all individuals were at risk to measles (if not immune). 1 in 10, 000 cases in US resulted in death 3 in 10, 000 cases had permanent brain damage requiring long-term care. CBA Immunization Example For the rest, loss of school and work time and discomfort associated with the illness. In mid-1960 s, US cost of immunizing children against measles was $108 million. Did not consider the cost of dealing with the adverse reactions of immunization or those who became sick despite immunization.
BENEFITS 1) CBA Immunization Example Medical care cost savings due to reduction in measles cases in US: $77 million 2) Life-time care of mentally retarded individuals (after discounting): $201 million 3) Present value of earnings of the people not killed or disabled by the disease: $216 million 4) $37 million in work-time lost. 5) TOTAL BENEFITS: $531 MILLION
Net-benefit of immunization: Benefits - costs = 531 - 108 = $423 million CBA Immunization Example Benefit cost ratio: = total benefit/total cost = 531/108 = 4. 92 Benefit cost ratio: if we use resource savings as cost offsets, net cost should be lowered by the amount of money saved for not treating cases. = total benefit/net cost= (201+216+37)/(108 -77)=14. 64
Even if CBA is not explicit, any decision, public or private, reveals a C-B calculus consistent with the observed choice. Example: Ashenfelter, Orley and Michael Greenstone. “Using Mandated Speed Limits to Measure the Value of a Statistical Life. ” CBA Other Examples National Bureau of Economic Research Working Paper w 9094, August 2002 (http: www. nber. org/papers/w 9094). Raising the max speed limit from 55 to 65 increased travel speed by about 2 mph (people often exceed posted speed). Results: Savings: 45 million hours travel time per year Inducing about 360 deaths per year (125, 000 hours of life). Our collective decision to drive faster infers that 45 million hours of travel time is worth more that 360 deaths. Our decisions lead to changes in benefits and costs regardless of whether we make them explicit.
Example: Knee Injury v Playing soccer, you injure your knee. v Do you go to the emergency room (ER)? v CBA usually takes the form of an explicit and formal presentation of a balance sheet, i. e. , is it worth taking 3 hours and possibly $80 to go to the ER so that a doctor can alleviate pain and check for serious damage?
Time lost - opportunity cost of time commonly measured by the wage, e. g. , $7/hour. Example: Knee Injury Value of athletic image - what you are willing to pay to preserve your image, e. g. , $40 for crutches Value of stopping pain with certainty - the highest amount you would pay to stop the pain for 10 days, e. g. , by buying painkillers. Expected value of stopping pain by going to the ER = probability that the ER visit will result in stopping the pain times the value of stopping the pain with certainty.
EXPECTED VALUE When values of costs or benefits are not known with certainty, but are known with probability, expected values are used. Example: Knee Injury Expected value of a benefit is: E(B) = ∑i prob(B=bi) × bi , where prob(B=bi) is the probability that the benefit is worth $ bi.
Cost of visit to ER=$50, $100 or more; expected value = $80 Example: Knee Injury $80 is a weighted average, where the weights are the probabilities that alternative cost values will occur. That is, if $50 will occur with probability 0. 6, $100 will occur with probability 0. 2, and $150 will occur with probability 0. 2, then E(C)=0. 6×($50)+0. 2×($100)+0. 2×($150)= $80
Example: Economic Impact of Treatment of HIV-Positive Pregnant Women and their Newborns with Zidovudine: Implications for HIV Screening
Probability of maternal-to-fetal transmission when the mother is HIV-positive No Treatment With Zidovudine Treatment Example: HIV screening = 25. 5% = 8. 3% Lifetime cost of treatment of an infected child from birth = $98, 915 Expected value of cost of a lifetime pediatric HIV infection = (probability of transmission) × (lifetime treatment costs) No Treatment = 0. 255 × 98, 915 = $25, 223 With Treatment = 0. 083 × 98, 915 = $ 8, 210
Expected benefits of treatment = Expected costs averted by treatment = 25, 223 - 8, 210 = $17, 013 Cost of Zidovudine treatment = $1, 045 Example: HIV screening Expected Net Benefits = 17, 013 - 1, 045 = $15, 968 per HIV-positive pregnant woman If medical expenses are paid privately, the woman will opt for the treatment. If the child will be on public assistance for medical care (e. g. , Medicaid), it benefits society to treat the mother with Zidovudine.
EXAMPLE: building a tunnel Direct benefits: Fees collected from new tunnel for the local budget. Benefits Indirect benefits: Cost savings to trucking companies due to shorter and higher speed route through the tunnel. Intangible benefits: Less congestion in the nearby community due to detouring. Cleaner air in the town, less noise.
Joint Certain costs could be the same whether the projects are built together or individually. e. g. an infrastructure investment that supports more than one project (unrelated). Hence, cost allocation is needed. Costs Sunk past investments that do not materially influence the present and future impacts of project alternatives. e. g. existing infrastructure to support a project/alternative
Impossible to eliminate. So, minimize it! Example Uncertainty Number of patients Probabilities Number of passengers riding the proposed rail line Discount factor Yield Solution Use a range of estimates rather than a single value e. g. estimate costs for high, low and optimistic scenarios Will help with sensitivity analysis too.
Choose the level of output of a good or service to maximize net social benefits (NSB) Public Policy Objective NSB = TSB – TSC where TSB = total social benefits TSC = total social costs
Marginal Social Benefit (MSB) = additional social benefits from one more unit of output MSB = ΔTSB/ ΔQ Q = quantity of a publicly provided good or service Public Policy Objective Marginal Social Cost (MSC) = additional social costs of producing one more unit of output MSC = ΔTSC/ ΔQ NSB are max when MSB = MSC Social Decision Rule: Choose Q for which MSB = MSC
Future, as well as present, benefits and costs must be included in the analysis. But costs and benefits that accrue in the future are worth less than costs and benefits today. Present Value Economic agents and society as a whole will maximize the present value of expected net benefits.
Costs and benefits may occur over different periods of time, e. g. , costs for a hospital built today may be spent primarily during the initial period of the project, but benefits will accrue over the lifetime of the hospital. To account for all costs and benefits in the same units across time periods, we calculate the present value of net benefits: Decision Rules
What value of r should be used? r = rate of discount of future consumption or rate of time preference The higher the social discount rate, the higher the social value of consumption today relative to consumption tomorrow. Discount Rate Conventional to use 3 -5% or the T-Bill interest rate since it represents the cost of borrowing at virtually no risk. Results can be sensitive to the discount rate chosen. Sensitivity analysis will allow to see how sensitive the results are to changes in assumptions about the discount rate, costs, and benefits.
Sometimes hard to assess the value of the underlying good/service Health outcome View of Grand Canyon Limitations CBA does not make decisions. It facilitates decision making process where other factors may be considered as well. Ethical considerations
Value of Human Life One of the most sensitive and controversial issues in economic evaluation business. Mostly used in public heath field where it is often needed to put a value on the human life in order to estimate benefits associated with public health interventions.
Human capital Value of life based on the loss of human capital resulting from the death of that human being. Monetizing Health Outcomes Revealed preferences Based on individual preferences regarding the value of increased or decreased health risk as a trade-off against increased or decreased income. Contingent valuation States preferences of WTP
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