Cost-Benefit Analysis and Cost-Effectiveness Analysis: The basics

Disclaimer: This article is primarily intended for my students. However, others may find the same useful as well.

Background Information:

Economics is the science of scarcity.

Health Economics: When economics is applied to health, it is termed health economics.

Resources: Economists have a wide definition of what is a resource: money, time, energy and skills displayed by an individual, the movable and immovable assets (s)he may possess, etc. Therefore, a resource may be consumed (like the time and effort spent in developing an idea) even if there is no associated financial payment.

Opportunity cost: The true cost of any good or service is determined in relation to the resources that are consumed to provide that good or service. Since resources are scarce, choosing to use a resource for one good/service may make it unavailable for use elsewhere. The potential benefits that may have arisen from using the resource elsewhere have to be foregone. These foregone outcomes/ benefits are referred to as ‘opportunity cost’ and represent missed opportunity.


You have saved enough money to repay your loans. Around the same time your friends invite you to accompany them on a long overseas holiday that will cost the same as your savings. If you decide to go on the holiday, the true cost of that holiday is the financial freedom you would have gained by repaying your loans instead.

Direct costs: These are the costs incurred as direct result of an intervention, and may include

  • Direct medical costs: Cost of drugs, investigations, consultation, procedures, etc.
  • Direct non-medical/ patient costs: Cost of transport, out-of pocket expenditure, etc.

Indirect/ Productivity costs: These are costs incurred as an indirect consequence of an intervention, and may include loss of production, loss of wages (when someone misses work to stay with a sick person, for instance), etc.

Incommensurable items: These are costs and benefits that cannot be measured in terms of money- like patients’ satisfaction, happiness, pain, and suffering, etc.

Intangibles: These are costs and benefits that may be known or suspected by cannot be quantified at all- like a sense of independence.

Both incommensurable and intangible items are context specific, and refer to problems of measurement, not to the item itself.

Willingness to pay: A concept proposed by Dupuit (who developed Cost-Benefit Analysis) to determine the societal benefits of a good/service/ intervention. He proposed that the perceived benefit of something is the sum of how much members of society are willing to pay to realise those benefits.

Example: Every monsoon a village gets cut off from the rest of the country by floods. A bridge would solve the problem, but there is no money to construct a bridge. It is proposed that the cost of the bridge would be recovered from the villagers (through a user fee, for instance). A survey is conducted in the village and each member is asked how much they are willing to pay for a bridge. The sum of the amounts thus obtained indicates the perceived benefit from the bridge.

People may also be willing to pay to avoid unpleasant consequences- paying to receive vaccination to avoid vaccine-preventable diseases, for instance.

All economic evaluations involve an explicit measurement of inputs (costs) and outcomes (benefits). The various methods for economic evaluation differ in terms of their evaluation of health outcomes, but essentially aim to assist in decision-making. Generally, comparisons are made between the existing system/ intervention and an alternative intervention to determine if change is economically desirable.

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