Economic evaluation of health programmes Department of Epidemiology, Biostatistics and Occupational Health Class no. 4: Measuring costs - Part 1 Sept 15, 2008

Plan of class  Finish review of Mark et al; review Weisbrod et al. using checklist from chapter 3.  Average, marginal, fixed, variable, total costs  Calculating unit costs without overhead costs to allocate between different clinical activity centres  Calculating unit costs when overhead or joint costs need to be allocated

Checklist summary (1)  Does the question correspond to the economic evaluation of a health program?  Was a comprehensive description of the alternatives given?  Was the effectiveness of the program or intervention or treatment well established?  Were all important and relevant costs and consequences for each alternative identified?  Were costs and consequences measured accurately in appropriate physical units?

Checklist summary (2)  Were costs and consequences valued credibly?  Were costs and consequences adjusted for differential timing?  Was an incremental analysis of costs and consequences of alternatives performed?  Was allowance made for uncertainty in the estimates of costs and consequences?  Did the presentation of study results include all issues of concern to users?

Question  How does the viewpoint of the analysis influence the conclusion in Weisbrod et al.’s analysis? Does the E treatment produce a net benefit from the point of view of the health and social care system?

Total, average, marginal, fixed and variable costs

HYPOTHETICAL TOTAL, AVERAGE, AND MARGINAL COSTS OF AN ORTHOPAEDIC SURGEON SPECIALIZED IN HIP REPLACEMENTS Surgeries per week Total cost (dollars) Marginal cost (dollars) Average cost (dollars)

TOTAL, AVERAGE AND MARGINAL COSTS - GRAPHICALLY $ TOTAL COSTAVERAGE COST Surgeries MARGINAL COST

FIXED AND VARIABLE COSTS Another important way of classifying costs is between fixed and variable. Fixed costs are those that are incurred in a fixed way (do not change) whatever the level of production. All other costs, which vary with the level of production, are called variable costs. Thus we have the relation: TC = TFC + TVC (total costs = total fixed costs + total variable costs)

What goes into the marginal cost, for a hospital, of an additional X- ray? How does it compare to the average cost of an X-ray? How about the variable cost of an X- ray?

HYPOTHETICAL FIXED COSTS OF AN ORTHOPAEDIC SURGEON SPECIALIZED IN HIP REPLACEMENTS Surgeries per week Total fixed cost (dollars) Marginal fixed cost (dollars) Average fixed cost (dollars)

TOTAL, AVERAGE AND MARGINAL FIXED COSTS - GRAPHICALLY $ TOTAL FIXED COST AVERAGE FIXED COST Surgeries MARGINAL FIXED COST Total fixed costs do not change once production has begun. Average fixed costs will keep declining, but without ever reaching 0. Marginal fixed cost starts at 5000 with the first unit, then goes to 0. All this follows from the definition of fixed costs.

REVISITING TOTAL, AVERAGE AND MARGINAL COSTS $ TOTAL COSTAVERAGE COST Surgeries MARGINAL COST The total cost function can never be decreasing. If the marginal cost curve intersects the one for average cost, at that point average cost reaches a minimum and then begins to rise. Can you see why?

LONG-RUN VERSUS SHORT- RUN COSTS The cost to a hospital or other organization of changing its output level is very much dependent on the time horizon for the change. Given enough time, a hospital can change many of its inputs so as to be able to more efficiently produce the greater quantity. For example, robotic equipment can be purchased to automate a surgical procedure. The long run is a period of time long enough for all the hospital’s commitments to come to an end. The short run is a shorter period of time than the long run, such that some, but not all, of its commitments will have come to an end. In the long run, virtually all fixed costs become variable.

LONG-RUN VERSUS SHORT-RUN AVERAGE COST CURVES Short-run AC curves Long-run AC curve In the short run, the producer is “stuck” with one production method or another, each associated with one of the short-run AC curves. But in the long run, depending on the desired level of output, the producer can choose the production method leading to the lowest AC.

Cost = q x p Price of one pill = $25 Price of three pills = 3 x $25 = $75 To cost resources we need to : (a) count numbers or frequencies; then (b) multiply them by a unit cost

Note: ignore minor costs or costs that won’t change the answer  Some costs far into the future, because of discounting…  Costs that are small compared to the others and perhaps difficult to measure  Ex: Legal costs for certain populations of people with severe mental illness

In theory, what should the unit cost represent?  Short-run or long-run opportunity cost of using the resource?  Usual practice: estimate average cost, as an approximation to the long-run marginal cost  Exception: when comparing two programs that have the same overhead costs

Need for caution in using average costs  The case of Info-Santé

So how do we find a unit cost?

Easy if we live in England… Unit Costs of Health and Social Care 2007 Personal Social Services Research Unit (PSSRU), University of Kent at Canterbury pdf

But what if we live in Canada?  No current, comprehensive set of unit costs  Would vary significantly by province  Price, when it exists, is usually a good approximation  In U.S., hospital prices can be very misleading  In the Québec health care system, what services have a price?

Why market price may not be good  Under what conditions does market price reflect the cost of production?

Volunteer time  Common practice: ignore it, or report it separately as time  If valued:  Wage rate of someone who could be hired to do the job  Average wage rate for age and sex  Which seems best to you?

No joint costs to allocate (1)  Uncommon in health care: an organization that produces only one output Nursing home with one level of care

No joint costs to allocate (2)  Divide total cost by number of units produced  Ex: Total cost in : $5,000,000 (including estimate of opportunity cost of land and building)  Number of bed-days: 40,000  Cost per bed-day: $125

Allocating joint costs: the problem Cost of Hospital’s central administration: $2M 35,000 bed- days 150,000 Outpatient visits ??

No simple solution!  Allocation method depends on objective – no « true » or absolutely « correct » way to do it  For us: look for reasonable method  Consider Tables 4.2 to 4.8