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1 Cost-Utility Analysis Cost-Effectiveness Analysis Scott Matthews Courses: 12-706 / 73-359 / 19-702 Lecture 21 - 11/9/2005
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12-706 and 73-3592 Utility Last time: eliciting and using individual utility functions to make decisions Is there a similar concept to help us make decisions at the social level?
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12-706 and 73-3593 Specifics on Saving Lives Cost-Utility Analysis Quantity and quality of lives important Just like discounting, lives are not equal Back to the developing/developed example But also: YEARS are not equal Young lives “more important” than old Cutting short a year of life for us vs Cutting short a year of life for 85-year-old Often look at ‘life years’ rather than ‘lives’ saved.. These values also get discounted
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12-706 and 73-3594 Contingent Valuation Analysis method used when there is no observable market Example: water quality at national parks Asks questions to population Is a last resort option! Called ‘contingent’ since you never really pay Valuing use non-controversial Valuing ‘non-use’ VERY controversial
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12-706 and 73-3595 Example Asked for valuations of a certain good Then estimate overall WTP for it - similar to travel time demand functions Extrapolated to entire population Assumes random sample!
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12-706 and 73-3596 Criticisms of CV Extrapolation of ‘all CV studies’ to average consumer would take over their budget Normal statistical problems (sampling, non-response, biases, etc.) Surveying opinions is imprecise Problems tend to be complicated
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12-706 and 73-3597 WTP versus WTA Economics implies that WTP should be equal to ‘willingness to accept’ loss Turns out people want MUCH MORE in compensation for losing something WTA is factor of 4-15 higher than WTP! Also see discrepancy shrink with experience WTP formats should be used in CVs Only can compare amongst individuals
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12-706 and 73-3598 Measuring Lives Saved Life years (prevented fatalities) not equal Qualitative and quantitative issue Need to consider tradeoffs Simple example from Boardman Status quo: no newborns survive a condition Alt. A: 5 live, but with permanent disability Alt. B: 2 live, but with low levels of disability Which option (SQ, A, B) is preferable? Assume Y increasing, H increasing Equal costs, no relevant uncertainty
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12-706 and 73-3599 Simple Example
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12-706 and 73-35910 The Quality/Quantity Game Assume “preference” for Increased number of years lived Increased level of health Would your preferences be the same? If so, SQ “dominated” by A and B Note different horizontal/vertical preference But which of A or B is better? We all understand difference in years Need an index of health status
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12-706 and 73-35911 Health Status Index Death 0 Severely Disabled Minimally Disabled HealthModerately Disabled 0.150.470.921 Measures utility, derived from experts But this says nothing about tradeoff! Can perform tradeoff survey Value of “shorter Y, higher H” vs. opposite
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12-706 and 73-35912 Methods Health Rating method (see above) Time tradeoff method Standard gamble method Discounting life years Can/should we discount them? Unlike cash values, we can’t make a decision to trade 1 year today for 10 yrs from now
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12-706 and 73-35913 Cost-Effectiveness Testing Generally, use when: Considering externality effects or damages Could be environmental, safety, etc. Benefits able to be reduced to one dimension Alternatives give same result - e.g. ‘reduced x’ Benefit-Cost Analysis otherwise difficult/impossible Instead of finding NB, find “cheapest” Want greatest bang for the buck Find cost “per unit benefit” (e.g. lives saved) Allows us to NOT include ‘social costs’
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12-706 and 73-35914 Why CEA instead of CBA? Similar to comments on MCDM Constraints may limit ability to perform Monetizing maybe difficult or controversial Easy to find lives saved, hard to judge value Monetizing can’t capture total social value or distorts its value
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12-706 and 73-35915 The CEA ratios CE = C/E Equals cost “per unit of effectiveness” e.g. $ per lives saved, tons CO2 reduced Want to minimize CE (cheapest is best) EC = E/C Effectiveness per unit cost e.g. Lives saved per dollar Want to maximize EC No practical difference between 2 ratios
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12-706 and 73-35916 An Obvious Example
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12-706 and 73-35917 Another Obvious One
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12-706 and 73-35918 Comments on Obvious Examples Each had 2 dominated alternatives Could easily identify best CE/EC option Also had fixed scale Fixed cost scale in first Fixed effectiveness in second
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12-706 and 73-35919 Interesting Example
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12-706 and 73-35920 Lessons Learned Ratios still tend to hide results Do not take into account scale issues CBA might have shown Option B to be better (more lives saved) Tend to only consider budgetary costs CEA used with constraints? Minimize C s.t. E > E* Min. effectiveness level (prev slide) Find least costly way to achieve it Minimize CE s.t. E > E* Generally -> higher levels of C and E! Can have similar rules to constrain cost
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12-706 and 73-35921 Sample Applications Cost-effectiveness of: New drug/medical therapies* very popular Pollution prevention Safety regulations
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12-706 and 73-35922 Definitions Overall cost-effectiveness is the ratio of the annualized cost to the quantity of effectiveness benefit. Incremental cost-effectiveness is the difference in costs divided by the difference in effectiveness that results from comparing one option to another, or to a benchmark measure.
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12-706 and 73-35923 Incremental CE To find incremental cost-effectiveness : Sort alternatives by ‘increasing effectiveness’ TAC = total annualized cost of compliance PE = effectiveness (e.g. benefit measure) CE = (TAC k – TAC k-1 )/( PE k – PE k-1 ) CE = incremental cost-effectiveness of Option k Use zero values (if applicable) for base case
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12-706 and 73-35924 Incremental CE Example Inc CE here only relevant within control categories (metals v. oils v. org’s) ** Negative CE means option has more removals at lower cost Source: US EPA Office of Water EPA 821-R-98-018, “Cost Effectiveness Analysis of Effluent Limitations Guidelines and Standards for the Centralized Waste Treatment Industry”
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12-706 and 73-35925 Definitions (2) Marginal cost-effectiveness refers to the change in costs and benefits from a one- unit expansion or contraction of service from a particular intervention (e.g. an extra pound of emissions, an extra fatality avoided).
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12-706 and 73-35926 Why is CEA so relevant for public policy analysis? Limited resources! Opportunity cost of public spending i.e. if we spend $100 M with agency A, its $100 M we cannot spend elsewhere There is no federal rule saying ‘each million dollars spent must save x lives’
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12-706 and 73-35927 Gray Areas How to measure cost-effectiveness when there is a single project cost but multiple effectiveness categories E.g. fatalities and injuries, CO 2 and SO 2 Alternatives: Keep same cost, divide by each benefit Overstates costs for each Keep same cost, divide by ‘sum of benefits’ Allocate cost, divide by each benefit separately Weight the costs and/or benefits
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12-706 and 73-35928 Another CEA Example Automated defribillators in community http://www.early-defib.org/03_06_09.html http://www.early-defib.org/03_06_09.html What would costs be? What is effectiveness?
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