Chapter 4: Economic Efficiency and Cost Benefit Analysis 1.Economic Efficiency 2.Cost Benefit Analysis

Economic Efficiency Economic efficiency requires the maximization of total welfare, with the optimum quantity reflecting the sum of consumers’ and producers’ surplus. 1. Consumer surplus (see Figure 4.1) 2. Producer surplus (see Figure 4.2) Figure 4.3 shows that the sum of surpluses (total welfare) is maximized at Q1 where demand equal supply Example: inefficient (monopolist: too fee goods; polluters: too many goods)

Cost-Benefit Analysis :Background US Army Corps of engineers Congressional subcommittee (1950) The introduction of Medicare and Medicaid (1965) All federal regulation (1981) Limitation: all shown in monetary term Alternatives to CBA 1.Cost-Efficiency Analysis (CEA): a way to quantify trade-offs between resources used and health outcomes achievement without having to value health outcomes in monetary terms 2.Cost-Utility Analysis (CUA)-a special case of CEA with reflecting individual preference

Cost-Benefit analysis: Basic Principle CBA involves evaluation projects without decisions made in the market place Project accepted if B>C Best projects: B/C ratio ranked Measuring cost-opportunity cost Benefit- externality (e.g. flu immunization)

Is equalizing risks program best? Viscusi (2000): no. Marginal Analysis in CBA (Figure 4-4): Maximize Society’s net benefit=> Marginal Social benefit =Marginal social costs The cost of saving lives [costs-Resources saving]: childhood immunization and prenatal care have negative net costs Discounting: multi-periods projects Present value equation (4.1) Q1: should those living in the present so disregard future generation? Q2: market rate of interest rate=social discount rate? Q3: Inequalities in discounting rate?

Risk adjustment: high risk=high interest rate Stiglizt (1988): certainty equivalent (more risk=lower certainty equivalent) Distributional Adjustment: stiglizt proposes more distributional weights to lower income group Inflation: measure in real term

Valuing Human life Human capital approach: present value of future earnings (1)Willingness to accept: labor economy of compensating differentials (2)Willingness to pay: consumer purchasing behavior for risk-reducing devices

Cost-Effectiveness Analysis CEA ration (4.2)=C1-C0/E1-E0 where cost as usual in dollar and output in health status measurement Advantage: benefit measurement in non- monetary term

Cost-utility Analysis Quality-Adjusted Life Years (QALY) (4.3) where quality weight (q) denotes range from 1 (perfect health ) to 0 (death) =>individuals’ preference for health F is the probability of survival; d is discount rate

The Ageism Critique of QALYs Q: Is it fair for the elderly using QALY? DALY: human tend to be depend on the middle age groups => a “hump” shaped set of weights favoring the age groups in the middle