1. 317_L25, Mar 12 2008 J. Schaafsma 1 Review of the Last Lecture Have discussed three methods for shadow pricing life and limb for CBA: human capital method, Revealed Preference, RP, (WTA, WTP), contingent valuation, CV, (WTA, WTP) Human Capital Method: ethically offensive, theoretically flawed noted that the two alternatives (RP and CV) are also flawed: valuing at the margin and wealth still matters Then begin our discussion of two alternatives to CBA that don’t require shadow pricing of non-market goods (life and limb): i) Cost effectiveness analysis (CEA), ii) Cost Utility Analysis (CUA)

2. 317_L25, Mar 12 2008 J. Schaafsma 2 First Alternative to CBA: Cost Effective Analysis without credible shadow prices for life and limb  can’t convert HC benefits into $s  can’t use CBA one alternative  Cost-effectiveness analysis  CEA here measure the output of a HC program in real units, e.g. lives saved, disability days prevented, pain eliminated suppose there are n HC projects that save lives  for each project compute ($cost/(life saved)  rank projects by $/(life saved). the most cost-effective project is the one with the lowest $/(life saved). ///

3. 317_L25, Mar 12 2008 J. Schaafsma 3 Applying the CEA Criterion for a given budget constraint: maximize the number of lives saved for the amount of money available  implement the projects with the lowest cost per life saved N.B. funding level implicitly assigns a value to human life!! WHY?  not all life-saving projects funded, only where the cost/life is implicitly less than some value, this value is determined by the point at which the budget is used up. if a target output level is specified e.g. x lives to be saved: minimizes the cost of achieving target output  pick the most cost- effective projects ///

4. 317_L25, Mar 12 2008 J. Schaafsma 4 Two Advantages of CEA avoids the need for shadow pricing (however, a $ value is still implicitly placed on life & limb, see preceding slide) theoretical parallel with theory of maximizing output for a given budget constraint, or minimizing cost for a given output level ///

5. 317_L25, Mar 12 2008 J. Schaafsma 5 Applying CEA to other Units of HC Output can use CEA in many different contexts  life years saved, disability days prevented, improved mobility, etc. then calculate $/life years saved; $/disability day prevented switching from lives saved to life years saved will have a big impact on resource allocation  redirect resource use from elderly to young PROBLEM: can’t compare cost-effectiveness of programs with outputs measured in different units, e.g., can’t compare $/(life year saved) with $/(disability day prevented). ///

6. 317_L25, Mar 12 2008 J. Schaafsma 6 CEA results compared with CBA results using Human Capital Based Shadow Prices HC priorities will be quite different if HC spending guided by CEA results rather than by CBA results that incorporate shadow prices based on the human capital method in CEA based on $/(life year saved)  - value of life of elderly doesn’t drop to 0 - a child’s life weighs much more heavily - earning power is irrelevant ///

7. 317_L25, Mar 12 2008 J. Schaafsma 7 Future HC Costs and CEA suppose two programs cost the same and each saves 20 life years However, for program A  lifetime follow-up costs = $10,000 (annual check-up plus prescription costs for a subset of patients) for program B  follow-up costs = llifetime follow-up costs $300,000 (e.g expensive anti-rejection drugs for an organ transplant) society not indifferent between these two outcomes. BASIC RULE: subsequent HC costs that are a direct consequence of the initial program should be included in the CEA DON’T include future HC costs not associated with the program ///

8. 317_L25, Mar 12 2008 J. Schaafsma 8 Two Fundamental Problems with CEA can’t compare cost-effectiveness across projects with different outputs  different units! quality of life is ignored in life years saved (would expect that 10 life years saved in full health is preferred to 10 life years saved in poor health). SOLUTION TO BOTH PROBLEMS: Cost-utility analysis  CUA ///