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Introduction
Cost analysis is an economic evaluation technique that involves the systematic collection, categorization, and analysis of
  • program or intervention costs, and
  • cost of illness.
When Can We Use Cost Analysis?
Cost analysis can be used as a stand-alone evaluation method when
  • only one program is being assessed,
  • information about program effectiveness is not available, or
  • the interventions being assessed and compared are equally effective.
Cost analysis allows researchers to achieve cost minimization for the programs under consideration (with the goal to identify the least costly method to obtain a certain level of output).
Cost analysis can also be used together with effectiveness assessment techniques within the framework of three types of economic evaluation:
  • cost-effectiveness analysis,
  • cost-benefit analysis, or
  • cost-utility analysis.
Effectiveness assessment techniques vary, depending on whether cost-effectiveness analysis, cost-benefit analysis, or cost-utility analysis is used. Cost analysis techniques, however, are the same for all types of economic evaluations. The methods and skills presented in this self-study course can therefore be applied to cost-effectiveness analysis, cost-benefit analysis, or cost-utility analysis.
What are Costs?
Costs are the values of all the resources (e.g., labor, buildings, equipment, and supplies), tangible or intangible, used to produce a good or a service.
In everyday life we generally think of the financial or monetary cost of goods and services we consume. The "price tag" is what we refer to at the store. It is a convenient measure of cost: all the resources have readily available prices, and exchanges are based on monetary value.
Economists think of costs as consequences of choices. In the real world, resources are scarce. Because resources are limited, all necessary interventions cannot be implemented. When decisionmakers choose to implement a program, the resources expended will not be available for other possible uses.
For instance, the decision to allocate funds for a public health program renders these funds unavailable for education, housing, or defense spending.
Therefore, the true cost of a program is not just the amount of funds spent on it. It is also the value of benefits that would have been derived if the resources had been allocated to their next best use. Economists call it the opportunity cost of a resource or program.
Costs in Perfect Markets
Obtaining the opportunity cost of a resource is difficult. We have to identify the best alternative use of a resource and value the benefits foregone. In perfect markets, the market prices of resources reflect their opportunity costs. So we just have to collect market prices for goods traded in perfect markets to determine the opportunity costs.
Perfect market conditions exist when
  1. numerous buyers and sellers can enter and withdraw from the market at no cost,
  2. all buyers are identical,
  3. all buyers possess the same relevant information, and
  4. the goods and services traded are the same.
In reality, one or multiple conditions of perfect markets are violated in the majority of markets. Economists call them imperfect markets. Different methods are used to estimate the costs of resources when conditions for a perfect market are violated or the resources are not traded in the marketplace. Health-care markets do not meet the conditions for perfect markets for multiple reasons, among which are market power and asymmetric information.
Market power: The size and limited number of health insurance companies, the important participants in health-care markets who "buy" care from providers, gives them considerable market power to influence the prices of goods and services sold in that market. Health insurance companies representing multiple subscribers use their influence to negotiate discounts from hospitals and doctors (the "sellers"). Therefore, the prices paid to providers vary with the insurance status of patients and do not correspond to opportunity costs.
Asymmetric information: Consumers in health-care markets generally have limited information concerning the treatments that medical professionals offer them. Consumers are at a disadvantage to make fully informed choices. Economists refer to this difference in access to information between market participants as asymmetric information. Asymmetric information allows the sellers to charge prices for medical services that are higher than opportunity costs.
As a result, the charges for medical services rarely represent their true economic costs.
Methods of estimating true costs of medical services are considered below.
Costs in Imperfect Markets
The prices of tradable goods produced under perfect market conditions reflect their opportunity costs. We have to adjust the prices of goods purchased under imperfect market conditions to get correct estimates of their costs. The methods described below are different ways to derive true economic costs of resources in imperfect markets.
Using Cost-To-Charge Ratios (CCRs)
Market distortions (e.g., taxes and subsidies) are another reason for the discrepancies between the prices and economic costs.
The common method for estimating the true economic cost of medical services is to adjust the charges through the use of cost-to-charge ratios. Cost-to-charge ratios are coefficients developed by expert panels to convert charges for medical services to their true economic costs. Applying cost-to-charge ratios to medical service charges produces average estimates of true costs.
The Federal Register publishes Medicare cost-to-charge ratios every year, by state. The ratios are different for urban and rural areas.
Click this link to see the Cost-To-Charge Ratio TableShow the Cost-To-Charge Ratio Table in a new window in Appendix A.
Micro-Costing
Micro-costing is a more precise method than is using cost-to-charge ratios but it is also more complex and time-consuming. Micro-costing involves identifying and determining a value for the resources actually consumed to produce the good or service.
For instance, instead of using a cost-to-charge ratio for a radiotherapy treatment session, we would have to estimate the cost of each component (e.g., medical consultant time, radiographer time, medical physics time, equipment, building and departmental overhead, and consumables).
Surveys
A survey can be used to estimate a person's willingness to pay (WTP) for a reduction in health risk or pain, or how much they would need to be paid to give up something.
The WTP approach is complex; a detailed discussion is presented in the Stated Preference MethodOpen this in a new window discussion in the Cost-Benefit Analysis tutorial.
Costs of Nontraded Goods and Services
Multiple health-care programs rely on nonmarket resources (e.g., volunteer time and donated goods and facilities), which do not require monetary compensation to secure their use. The estimated value of a nonmarket resource is called its shadow price. We discuss some common methods for estimating shadow prices below.
Using Market Prices for Similar Resources
Because nonmarket resources are not purchased in the marketplace, their costs are imputed based on the values of other resources.
Volunteer Time
Global substitute method: This method uses the wage rate of a paid worker that could be hired to do the job. It provides lower-end estimates.
Specialized substitute method: This approach uses the average wage of a specialist with appropriate skills for the task. This valuation technique takes into account the complexity of the task performed by volunteers, but problems might arise as it generates higher-end estimates.
Opportunity cost method: This approach uses the market wage that a volunteer is forgoing to perform the unpaid work. The opportunity cost method would yield a wider range of estimates depending on the skill and opportunity wage of the particular volunteer. This method allows volunteer work performed by a doctor to be imputed at a higher value than similar volunteer work performed by an unskilled worker.
Charity Goods
For other donated goods and services, we can use the market value of these inputs as the cost of the resources. For example, in the case of donated equipment or supplies, corresponding market prices can be found in catalogs or by contacting a supplier. The value of the physical space used by a program can be estimated from real estate listings for similar space in the area.
Using Similar Estimates from the Literature
One method for determining estimates might be to consult the published literature to assess how other researchers have handled the issue.
For example, a literature search might unearth previous studies in which values were assigned to volunteer time or to the pain and suffering associated with a medical condition.
Besides actual cost numbers, published studies often contain formulas which, if appropriate, can be replicated after some adjustments are made.
Discussing Qualitatively
Intangible costs are difficult to quantify, but they play an important role in patients' decisions. As a result, the majority of studies discuss the intangible costs qualitatively instead of attempting to estimate them by using sophisticated WTP methodology.
Note
Regardless of the nature of the resource or the method that is used to assess its value, be conscious of and consider all aspects of the true cost of a resource. For example:
  • Labor costs should include wages or salaries as well as benefits (e.g., paid vacations, health insurance, bonuses, and retirement fund contributions), and perquisites (e.g., the use of a car).
  • Supplies and equipment costs should include shipping charges, installation, and maintenance costs.
  • Transportation costs should include maintenance, gasoline, and insurance.
  • Whether or not sales taxes are included in the cost of a resource varies, depending on the study perspective. If the cost analysis is conducted from a societal perspective, taxes are considered a resource transfer and should not be included in the cost. If the cost analysis is conducted from any other perspective, sales taxes should be included, because they are part of the price paid to secure the use of that resource.
Why is Cost Analysis Important?
Cost analysis is an important component of all economic evaluation techniques. It is a useful tool for planning and self-assessment. Cost analysis is particularly useful for the following purposes:
Planning and Cost Projections
Cost analysis can be used as a tool for
  • developing and justifying budgets, and
  • determining the level of funding changes necessary to achieve a desired change in disease prevalence/incidence.
Assessing Efficiency
A program is considered efficient when the maximum amount of output (i.e., cases treated or persons screened) is produced from the given level of inputs (i.e., resources).
Cost analysis makes it possible to assess the efficiency of programs by
  • comparing cost profiles from equally effective programs, and
  • identifying cost categories for further efficiency studies.
For instance, tuberculosis-control programs can be compared by evaluating the disparity between unit cost per output: cost per tuberculosis case treated or cost per person screened.
If a variation in cost per unit output is observed, we might decide to study further to determine the possible reasons.
If we do not find a justification for higher costs per unit (e.g., a higher rate of MDR-tuberculosis rate in the target population) we might need to reassess the program structure and methods to improve efficiency.
Assessing Priorities
Cost analysis provides information on health resource allocation. We can use this information to
  • examine how resource use reflects national, state, and local health priorities, and
  • examine how expenditure profiles of similar programs vary from one another. Cost patterns from a cost analysis might indicate that previous priorities need to be reassessed by giving consideration to emerging trends.
Accountability
Cost analysis involves tracking expenses, which allows us to know how the funds are spent and whether they are spent as intended.
Assessing Equity
Cost analysis can help us to assess how health resources are distributed among various population groups.
For instance, cost analysis can indicate whether a program spends more resources per capita in urban areas than in rural areas and whether the difference is the result of allocation mechanisms or of differences in need.
Framing a Cost Analysis
When you are conducting a cost analysis, the first step is to determine a detailed research strategy or framework that will later guide the data collection and analysis efforts. This stage is referred to as study framing.
We discussed study framing in detail for all types of economic evaluation in the FramingOpen this in a new window tutorial. Next, we will see how the concepts and steps in that tutorial are applied for framing a cost analysis.
We follow seven steps to frame a cost analysis.
1. Defining the Problem
Conducting a study involves considerable expenditure of resources; therefore, research dollars must be allocated efficiently. In the first step of framing a cost analysis, we need to identify the problem and the reasons that justify expending the limited resources on the study. We have to consider the following questions:
  • What is the problem to be analyzed?
  • Why is it important?
  • What aspects of the problem need to be explained?
  • What questions need to be answered?
Example: Antigua's Health Education and Condom Distribution (HECD) Program
This cost analysis was conducted in 1992 in the Caribbean's leeward island.
  • What was the problem to be analyzed?
    • To determine the cost of the HECD program.
  • Why was it important?
    • Funding for an AIDS prevention program among persons at high-risk was coming to an end. Without adequate funding, the program would be shut down. As a result, human immunodeficiency virus (HIV) infection rates could increase.
  • What aspects of the problem needed to be explained?
    • Cost data were needed to evaluate the program and identify resources to continue its operation.
  • What questions needed to be answered?
    • What was the annual cost of running the HECD program?
    • What resources are needed to continue the program?
2. Defining the Options
To obtain estimates that are as accurate as possible, all relevant organizational and technological aspects of available options/interventions must be considered, which includes defining the items below.
Interventions The nature of the intervention(s).
Comparisons What will this program be compared with? Current practice can always be used as a baseline for comparison. (Can we do better than what we are currently doing?).
Target population What are the populations that the intervention is designed to reach?
Delivery site Where will the intervention take place?
Personnel Who will deliver the services? Several categories of personnel (e.g., physicians and public health nurses [PHNs]) could be involved.
Technology Laboratory tests and surgical operations, for example.
Timing The beginning of the school year or of the calendar year, for example.
Example: Antigua's Program Options
Interventions Health education and condom distribution.
Comparisons Implications of program termination.
Target population Commercial sex workers from the Dominican Republic.
Delivery site 19 locations (bars, brothels, boarding houses, and truck stops).
Personnel Two outreach workers.
Technology Condoms and printed materials.
Timing On an ongoing basis during January 1990–September 1991.
3. Defining the Audience
The structure of the analysis depends on who will be using the results of the cost analysis. We have to consider the following questions:
  • Who will be using the results of the analysis?
  • What are the information needs of the audience?
  • How will the results be used?
Example: Antigua's Program Audience
Who was the audience for the cost analysis?
  • Ministry of Health of Antigua
  • Caribbean Epidemiological Center (CAREC)
  • Family Health International/AIDSTECH
What were the information needs of the audience?
  • How much does the program cost?
  • Is it sustainable?
How would the audience use the results?
  • To compare with other projects
  • To measure the involvement of the different funding agencies
4. Defining the Perspective
The study perspective determines which costs are relevant and should be included in the cost analysis. The perspective takes into account who bears the costs and who gains from available interventions. A cost analysis can be conducted from any or all of the perspectives indicated below, from the narrowest to the broadest.
Costs incurred by patient/family are considered.
Costs related to providing the health services are considered (e.g., clinics and hospitals).
Costs incurred by persons or entities responsible for financial costs of health services are considered (e.g., insurance companies, employees, and employers).
The costs related to providing health care, including all categories of providers, are considered.
All costs, regardless of who incurs them, are considered.
Example: Antigua's Program Perspective
The cost analysis was conducted from the payer/funding entity perspective.
The choice of a perspective was driven by the audience for the analysis.
5. Defining the Time Frame
The time frame must be long enough to capture the full extent of the program costs (the costs of the intervention itself) and of the side effects. The time frame must be long enough to account for
  • program start-up and maintenance costs,
  • seasonal variations, and
  • cost of intervention, including side effects.
Example: Antigua's Program Time Frame
The time frame for the cost analysis was 1 year.
Reason: All agencies involved in the program allocate funds on a yearly basis.
6. Defining the Analytic Horizon
Following are examples of conditions when the length of the analytic horizon is not apparent and careful consideration is required to determine it.
  • The costs and benefits derived from an intervention occur at different times, as is the case with prevention strategies (costs now, benefits later).
    A horizon that is too short will underestimate the value of the intervention, and the impact could be life-long.
  • Interventions with different timelines are to be compared.
We have to choose an analytic horizon that is:
  • long enough to capture the full costs and effects of programs with an impact that occurs at different times, and
  • short enough that future costs and benefits are not uncertain.
The time frame and analytic horizon diagram below illustrates a time frame with a much longer analytic horizon.
Time frame and analytic horizon
A time frame with a much longer analytic horizon
7. Choosing a Format
Depending on the availability of data and resources, we can choose to use one of three formats:
  1. Retrospective analyses: Can be conducted when the intervention of interest is already in place or has been carried out previously. When the analysis starts, the costs have already been incurred.
  2. Prospective analyses: Costs have not yet been incurred when the study starts. We will therefore track the costs as they occur.
  3. Models: Costs are based on estimated values from other studies.
Example: Antigua's Program — Retrospective
The cost analysis followed a retrospective format:
Retrospective time line.
Example: Antigua's Program — Prospective
A possible prospective format:
Prospective time line.
Example Summary: Antigua's HECD Program
Antigua's Health Education
and Condom Distribution (HECD) Program
The research design was as follows:
Intervention  
Nature Health education and condom distribution
Target population Commercial sex workers from the Dominican Republic
Delivery site 19 sites: STD clinic, brothels, truck stops, bars, and boarding houses
Personnel 2 outreach workers, 1 supervisor, and 1 administrative assistant
Technology Condoms and printed materials
Timing Ongoing
Audience Program payers
Perspective Program payers
Scope The analysis included program costs for both program components:
health education and condom distribution
Study time frame 1 year
Study format Retrospective
Outcome measures Costs,
Number of condoms distributed, and
Number of persons reached with health education talks
Summary measures Cost per condom distributed and
Cost per person reached with health education talks
Test Your Understanding
Please answer the questions before you look at the "Our Answers" section.
  1. Cost analysis is an economic evaluation technique that involves the systematic collection, categorization, and analysis of program costs and costs of illness.
    True   False
  2. Cost analysis cannot be used to compare alternative interventions.
    True   False
  3. Cost analysis cannot be used as a stand-alone technique; it must be combined with effectiveness assessment techniques.
    True   False
  4. Costs are the value of the resources used to produce a good or a service.
    True   False
  5. The goal of cost analysis is to evaluate the financial cost of a program or intervention.
    True   False
  6. The next best use of a resource is its next most effective use.
    True   False
  7. The opportunity cost of a program is the value of the benefits that would have been derived from allocating its corresponding resources to their next best use.
    True   False
  8. Cost analysis can be used to evaluate future costs on the basis of current levels of resource use.
    True   False
  9. Cost analysis can be used to evaluate whether health resources are allocated equitably.
    True   False
  10. Cost analysis can be used to demonstrate that a program has insufficient funding, given its caseload.
    True   False
  11. Cost analysis can be used to demonstrate that funds have been spent as expected.
    True   False
  12. Assume that you are conducting a cost analysis of tuberculosis treatment in New York City. Your data indicate that the average hospital charge for a patient diagnosed with tuberculosis in New York City was $11,000.
    Using the Cost-To-Charge Ratio TableShow the Cost-To-Charge Ratio Table in a new window in Appendix A, how would you adjust this charge for a truer estimate of resource costs associated with tuberculosis hospitalizations?
  13. What other alternative(s) are available to you to assess the true cost of a tuberculosis hospitalization?
  14. You have been asked to conduct a cost analysis of a nutrition and health-education program for middle school students.
    Your client tells you that he or she expects the results to indicate that the program has a substantially low cost, because all of the materials used are donated and the sessions are conducted by students from a nearby university on a volunteer basis.
    Do you agree?
  15. If you conducted a cost analysis of the Girl Scouts' annual cookie sale, what monetary value would you assign to the labor provided by the scouts and their parents?
Our Answers
  1. Cost analysis is an economic evaluation technique that involves the systematic collection, categorization, and analysis of program costs and costs of illness.
    True
  2. Cost analysis cannot be used to compare alternative interventions.
    False
  3. Cost analysis cannot be used as a stand-alone technique; it must be combined with effectiveness assessment techniques.
    False. Cost analysis can be used as a stand-alone technique.
  4. Costs are the value of the resources used to produce a good or a service.
    True
  5. The goal of cost analysis is to evaluate the financial cost of a program or intervention.
    False. Cost analysis attempts to evaluate the opportunity cost of a program or intervention.
  6. The next best use of a resource is its next most effective use.
    False. The next best use of a resource is the one that generates the highest value of benefits, as determined by the person or authority considering the alternative uses of resources.
  7. The opportunity cost of a program is the value of the benefits that would have been derived from allocating its corresponding resources to their next best use.
    True
  8. Cost analysis can be used to evaluate future costs on the basis of current levels of resource use.
    True
  9. Cost analysis can be used to evaluate whether health resources are allocated equitably.
    True
  10. Cost analysis can be used to demonstrate that a program has insufficient funding, given its caseload.
    True
  11. Cost analysis can be used to demonstrate that funds have been spent as expected.
    True. Cost analysis can indeed be used to demonstrate that funds have been spent as expected.
  12. Assume that you are conducting a cost analysis of tuberculosis treatment in New York City. Your data indicate that the average hospital charge for a patient diagnosed with tuberculosis in New York City was $11,000.
    Using the Cost-To-Charge Ratio TableShow the Cost-To-Charge Ratio Table in a new window in Appendix A, how would you adjust this charge for a truer estimate of resource costs associated with tuberculosis hospitalizations?
    According to the Cost-To-Charge Ratio TableShow the Cost-To-Charge Ratio Table in a new window in Appendix A, the average cost-to-charge ratio for urban hospitals in New York State was 0.529 in 2000.
    This means that for every dollar charged by a hospital, actual resources used accounted for 52.9 cents.
    Therefore, the true resource use associated with a tuberculosis hospitalization is
    $11,000 x 0.529 = $5,819
  13. What other alternative(s) are available to you to assess the true cost of a tuberculosis hospitalization?
    Micro-costing can also be used to estimate the cost of a tuberculosis hospitalization.
    Micro-costing involves assessing the resources actually used in the course of a hospitalization and taking into account the
    • type of personnel involved,
    • length of stay,
    • diagnostic tests and treatment procedures performed,
    • drugs provided, and
    • supplies used.
  14. You have been asked to conduct a cost analysis of a nutrition and health-education program for middle school students.
    Your client tells you that he or she expects the results to indicate that the program has a substantially low cost, because all of the materials used are donated and the sessions are conducted by students from a nearby university on a volunteer basis.
    Do you agree?
    The answer depends on the perspective of the study.
    If the study is conducted from the program's perspective, the costs of donated materials and voluntary labor will not need to be included in the analysis.
    However, if the study adopts a societal perspective, these resources will need to be considered.
  15. If you conducted a cost analysis of the Girl Scouts' annual cookie sale, what monetary value would you assign to the labor provided by the scouts and their parents?
    Volunteer labor is best valued by using the specialized substitute method.
    By applying this method to the case of the Girl Scouts' annual cookie sale, the hours of labor volunteered by scouts and their parents are valued according to the cost to pay someone to sell cookies door-to-door, in offices, or at the local grocery stores.
 Cost of the Intervention or ProgramJump to page 2.
 Cost of IllnessJump to page 3.
 Adjusting CostsJump to page 4.
 AppendicesJump to page Appendices.
 Glossary — Cost AnalysisJump to page Glossary.
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Based on earlier, paper-based Framing &
Cost Analysis self-study guides by
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Contacts
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