Review of the Last Lecture

Review of the Last Lecture • Finished our discussion of information asymmetry as a source of market failure in the healthcare market • today begin our discussion of economic evaluation of healthcare programs.

Evaluating the Economic Viability of Healthcare Programs: Section VI of the Course outline • Will look at three methods of analyzing healthcare programs • - cost-benefit analysis • - cost-effectiveness analysis • - cost-utility analysis • discuss - how to conduct each type of analysis • - issues that need to be addressed in conducting the analysis • - strengths and weaknesses of each method of analysis ///

Cost-Benefit Analysis: CBA • CBA is a method for assessing the economic viability of a project. • A project generates a flow of: annual costs: C1, C2, C3, …,CT • annual benefits: B1, B2, B3, …,BT • the C’s and B’s must be expressed in dollars • in CBA these flows are expressed as present values of the costs and of the benefits => need a discount rate r • r is the rate at which we discount a dollar to be received(spent) one year from now, e.g., if r = 0.05 a dollar one year from now is worth 1/(1.05) = $0.952 today, a dollar two years from now is worth 1/(1.05)2 = $0.907 today, etc. • in general, the present value of a dollar of costs(benefits) incurred(received) n years from now is 1/(1+ r)n today.

The Present Value of the Benefits and of the Costs, and the NPV • compute the present value of the benefits (in $s): • PVB = B1/(1+r) + B2/(1+r)2 +…+ BT/(1+r)T • = t Bt/(1+r)t t = 1, …, T • compute the present value of the costs (in $s): • PVC = C1/(1+r) + C2/(1+r)2 +…+ CT/(1+r)T • = t Ct/(1+r)t t = 1, …, T • compute the net present value  NPV = PVB – PVC ///

The Net Present Value Criterion • if NPV > 0 project is economically feasible • if NPV = 0 indifferent • if NPV < 0 project is not economically feasible • if funds are limitless  implement all projects that are economically feasible • if funds are limited  implement the set of projects that maximizes NPV for the available funds. ///

Cost-Benefit Analysis in HC • Steps in cost-benefit analysis in HC: • Specify the comparator (best alternative to the project being considered) • Best Supportive Care is minimally the comparator • benefits are then measured in terms of the incremental benefits (the additional benefits that the proposed project will yield compared to the benefits yielded by the comparator e.g. benefits from the new drug benefits vs the best available current drug) • costs are then measured in terms of the incremental costs

The Incremental Net Present Value • compute the incremental net present value as: • INPV = PVB - PVC • Where : PVB = t (Bnew – Bcomp)t/(1+r)t t = 1, …, T • PVC = t (Cnew – Ccomp)t /(1+r)t t = 1, …, T • Where Bnew = monetary benefit in year t from the proposed project • Where Cnew = monetary cost in year t for the proposed project • Where Bcomp = monetary benefit in year t from the comparator • Where Ccomp = monetary cost in year t for the comparator • Project is viable if INPV ≥ 0

The Discount Rate • computing a present value requires a discount rate (some interest rate) • use a real interest rate, r, (no inflation premium ) if projected benefits and costs are measured in constant dollars (no inflation allowed for) • use a nominal interest rate, i, (includes an inflation premium) if projected benefits and costs are measured in current dollars (prices are increased over time for expected inflation) • rule of thumb  r = i –  ( = Δp/p = rate of inflation) • this is an approximation, the correct formula is:r = (i – )/(1 + )

Viewpoints in Cost- benefit Analysis • incremental benefits and costs often exist from a variety of viewpoints, e.g.: - Patients • - family/friends • - hospital • - taxpayer • could conduct C/B analysis from any of these viewpoints  would include only costs/benefits relevant to that viewpoint. • most comprehensive viewpoint societal viewpoint  includes all B & C, from all viewpoints ///

Computing the annual Benefits in Dollars • Four steps: • First, identify all the real benefits (e.g. reduced pain, better mobility, life years gained) generated in each year of the project’s life => bikt = quantity of the ith real benefit accruing to the kth viewpoint in year t, i = 1, …, n, n = number of real benefits, t = 1, …, T, T = project’s lifespan • second, identify (or measure) the unit value for each type of real benefit e.g., $/(life year saved), $ per unit of improved mobility, etc. • third, convert the real benefits into dollar values using the unit values from step two • Fourth, for each year, sum the dollar values calculated in step three.

Unit Dollar Values for the Real Benefits • pikt = dollar value of one unit of real benefits of type i, accruing to viewpoint k, in period t. • pikt values may vary from different viewpoints e.g., a life year saved likely has a different value for the person whose life year was saved than for family and friends, or for society at large. • PROBLEM: there are no observable values for many of the real benefits created by healthcare  need shadow prices (see below) ///

Computing the annual Cost in Dollars • Four steps: • First, identify all the real costs (e.g. labour, plant, equipment, supplies) incurred in each year of the project’s life => cjkt = quantity of the jth real cost accruing to the kth viewpoint in year t, j = 1, …, m, m = number of real costs • second, identify (or measure) the unit value for each type of real cost (market prices are often available) • third, convert the real costs into dollar values using the unit values from step two • Fourth, for each year, sum the expenditures calculated in step three

Unit Dollar Values for the Real Costs • vjkt = dollar value of one unit of real costs of type j, imposed on viewpoint k, in period t. • for many real costs there are observable unit values from the market place, e.g., for an hour of labour, piece of equipment, services, supplies, etc. • from the private point of view  market prices are the opportunity costs for producing the healthcare good or service • however, from the public point of view  must always ask  do market prices capture the true opportunity cost to society for producing the HC good or service? ///

Calculating the $ values of the Benefits and Costs • formula for Bt ($ value of all the benefits in year t) Bt = i,k pikt bikt • t =time index, k = viewpoint index, i = benefit index • B1, B2, B3, …, Bn where the B’s are the dollar values of the total benefits in year 1, 2, 3, …, n respectively. • formula for Ct (the $ value of all costs in year t) Ct = j,k vjkt cjkt • t =time index, k = viewpoint index, j = cost index • C1, C2, C3, …, Cm where the C’s are the dollar values of the total costs in year 1, 2, 3, …, m respectively. • ///

Review of the Last Lecture