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.

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. 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.

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. Methods of estimating true costs of medical services are considered below.

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.

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.

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:

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 Framing 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.

Please enter your answer to each question before you click on "Our Answer".

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
   Our Answer

   True
2. Cost analysis cannot be used to compare alternative interventions.
   True   False
   Our Answer

   False
3. Cost analysis cannot be used as a stand-alone technique; it must be combined with effectiveness assessment techniques.
   True   False
   Our Answer

   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   False
   Our Answer

   True
5. The goal of cost analysis is to evaluate the financial cost of a program or intervention.
   True   False
   Our Answer

   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.
   True   False
   Our Answer

   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   False
   Our Answer

   True
8. Cost analysis can be used to evaluate future costs on the basis of current levels of resource use.
   True   False
   Our Answer

   True
9. Cost analysis can be used to evaluate whether health resources are allocated equitably.
   True   False
   Our Answer

   True
10. Cost analysis can be used to demonstrate that a program has insufficient funding, given its caseload.
    True   False
    Our Answer

    True
11. Cost analysis can be used to demonstrate that funds have been spent as expected.
    True   False
    Our Answer

    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 Table in Appendix A, how would you adjust this charge for a truer estimate of resource costs associated with tuberculosis hospitalizations?
    Our Answer

    According to the Cost-To-Charge Ratio Table 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?
    Our Answer

    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?
    Our Answer

    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?
    Our Answer

    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.