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Cost benefit analysis is the most comprehensive and theoretically sound form of economic evaluation and it has been used as an aid to decision making in many different areas of economic and social policy in the public sector for more than fifty years.

Cost-Benefit analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. These projects may be dams and highways or can be training programmes and health care systems.

The main difference between cost-benefit analysis and other methods of economic evaluation that were discussed earlier in this series is that it seeks to place monetary values on both the inputs (costs) and outcomes (benefits) of health care. Among other things, this enables the monetary returns on investments in health to be compared with the returns obtainable from investments in other areas of the economy. Within the health sector itself; the attachment of monetary values to outcomes makes it possible to say whether a particular procedure or program offers an overall net gain to society in the sense that its total benefits exceed its total costs. Cost-effectiveness and cost-utility analysis do not do this because they measure costs and benefits in different units. CBA requires programme consequences to be valued in

monetary units, thus, enabling the analyst to make a direct comparison of the programmes incremental cost with its incremental consequences in commensurate units of measurement, be they Birr, dollars, or pounds.

CBA compares the discounted future streams of incremental programme benefits with incremental programmes costs; the difference between these two streams being the net social benefit of the programme. In simple terms, the goal of analysis is to identify whether a programme’s benefits exceed its costs, a positive net social benefit indicating that a programme is worthwhile. CBA is a full economic evaluation because programme outputs must be measured and valued. In many respects CBA is broader in scope than CEA/CUA. Because CBA converts all costs and benefits to money, it is not restricted to comparing programmes within health care, but can be used (although not without problems) to inform resource allocation decisions both within and between sectors of the economy. CBA is broader in scope and able to inform questions of allocative efficiency, because it assigns relative values to health and non-health related goals to determine which goals are worth achieving, given the alternative uses of resources, and thereby determining which programmes are worthwhile.

 Both costs and benefits are assigned a monetary value. The benefits of any intervention can then be compared directly with any costs incurred.

 If the value of benefits exceeds the costs of any intervention, then it is potentially worthwhile to carry that intervention out.

 If society funds projects for a given budget, then it can maximise the benefits generated by social spending.

 It is concerned with allocative efficiency.

 It is concerned with the question, is a particular goal worthwhile. Potentially it can answer questions such as should extra money be used for heart transplants or improving housing.

 Method requires that all resources and benefit generated by an intervention need to be assigned a monetary value. Therefore, needs to cost things which have no market value, i.e, changes in health, quality of life, length of life, pain, etc.

 Methods of valuing

 Willingness to pay (WTP)

 Human Capital Approach

The net welfare gain or net value of a project X (NVX) is equal to

NVX = WTPX – WTY

Where y refers to the next best alternative project. If the latter is not or can not be defined

NVX = WTPX – WTPXi

Where WTPXi refers to society while WTP is for the inputs used alternatively in the economy at large.

If NVX is positive then, project X may be undertaken. When several projects compete with each other, it is evident that the one with the highest NV needs to be selected in order to maximize welfare.

This shows the CBA for projects that have benefits or costs in the current period. It is evident that projects may also entail future benefits and future costs. Some modifications in the calculation of net value will be required in this case. Note that individuals prefer a net value of 1$ received now to 1$ in the future.

It follows that one cannot simply add up benefits or costs that are related to different points in time. A social discount rate, denoted as r, will enable use to add up a steam of net benefits. Namely, 1$ in year one will be worth (1tr) $ in year two, (1tr) 2 in year three etc.; conversely, 1$ in year two is worth (1/1tr) $ in year one, 1$ in year three is worth (1/1tr)2 $ in year one etc. The value in year one of a $received or paid in the future is called the present value of that dollar.

Making use of the social discount rate r, we can calculate the net present value (NPV) of a project.

Where ‘B’ and ‘C’ refer to benefits and costs respectively, with ‘t’ is the time index. In fact, ‘Bt’ is equal to the WTP for the nth project at time ‘t’, while ‘Ct’ has to be understood as the benefits forgone in period ‘t’. Note that if NPV >0 society’s welfare will increase; hence the project can be adopted. If several projects are competing with each other the one with the highest NPV should be chosen.

The following case study shows how cost-benefit analysis may be used in practice.

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A cost-benefit study – Occupational Health Services Background.: Most large organizations choose to provide an occupational health service (OHS) beyond that which is required by law. Whilst the input costs (labour, capital, etc) of OHS are very clearly identifiable the outputs are not always directly observable since benefits may be multidimensional and sometimes inherently intangible. Consequently, it is unclear whether the benefits of these activities outweigh their costs. In an environment of competition for resources lack of evidence on cost-effectiveness is likely to be regarded the same as activities demonstrated not to be cost-effective, whereas those activities that can demonstrate cost- effectiveness will be supported.

Study objective: To quantify the value added by OHS for a specific organization.

Study Methods: OHS was conceptualized as a form of insurance policy, which individual managers chose to purchase at different levels of cover. Under this model, OHS is purchased in order to reduce the risk and impact of negative events whose cost, timing and frequency is uncertain. The contingent valuation methodology was used to elicit monetary valuations of benefits from these managers. It is based on “stated” rather than “revealed” preferences. In a market, preferences are revealed by individual’s actions the survey- based contingent valuation methodology (CVM) requires individuals to state values for a particular good or service. By asking for stated preferences, CVM allows for a monetary valuation of a particular ‘project’s’ benefits. Contingent valuation has two types of question to elicit values, ‘willingness-to-pay’ (WTP) and ‘Willingness-to-accept’ (WTA) questions. OH cost data are then compared with benefit valuations generated by the contingent valuation survey in order to construct a cost-benefit analysis.

Results: The maximum amount respondents are ‘willing to pay (WTP)’ for the benefits provided by OHS is ₤300 per employee per year (medial value). The minimum amount respondents are ‘willing to accept (WTA)’ as compensation for a withdrawal of OHS is ₤400 per employee per year (median value). The aspect of OHS valued most highly is the ability to enhance workplace safety. The aspect valued least is the possible impact on reducing medico-legal costs. Cost-benefit analysis shows that OHS generates a positive value added range. Sensitivity analysis shows that WTP and WTA values would have to be considerably lower before the overall economic result is reversed.

Comment: In the absence of data on the benefits of OHS, WTP and WTA techniques provided a means of quantifying and moreover valuing the multidimensional consequences’ of engaging in this activity. These results were then used in a simple cost-benefit equation, to measure net economic impact.

Review Questions

1. Discuss the difference between opportunity cost and outlay costs and show their practical implication.

2. Costs are incurred in all economic activities – why? 3. Explain the cost implications of ill health.

4. Define cost benefit analysis and explain its difference from cost effectiveness analysis.

Bibliography

1. Bowling, A. (1997) Measuring Health: A review of quality of life measurement scales, second edition, Open University Press, Buckingham.

2. Briggs, AH. , Gray, AM. Handling Uncertainty When Performing economic evaluation of health care interventions: Health Technology Assessment 1999;3(2). 3. Drummond, M., Stoddart, G. , O’Brien, B. , and Torrance,

G. (1997) Methods for the Economic Evaluation of Health Care Programmes, second edition, Oxford Medical Publications; Oxford.

4. Johansson, P.O. (1991) An Introduction to Modern Welfare Economics, Cambridge: CUP.

5. Kobelt, G. (2002) Health Economics: An Introduction to Economic Evaluation, second edition, Office of Health Economics; London.

6. Mills,Anne and et.al. (1992), Health Economics for developing countries: A Survival KitLondon.

7. Robinson, R. What does it mean? BMJ Vol. 307, 11th September 1993, PP. 670-673.