1. 1 Cost-Effectiveness Analysis (CEA) Scott Matthews Courses: 12-706 and 73-359 Lecture 16 - 11/3/2003

2. 12-706 and 73-3592 Administrivia  PS 3 due next Monday  Presentation schedule check - Mon after thanksgiving instead?

3. 12-706 and 73-3593 Economic valuations of life  Miller (n=29) $3 M in 1999 USD, surveyed  Wage risk premium method  WTP for safety measures  Behavioral decisions (e.g. seat belt use)  Foregone future earnings  Contingent valuation

4. 12-706 and 73-3594 CEA - Another Type of Model  Last few lectures dealt with ‘solving’ problems with multiple (more than 2) “criteria”  Recall criteria could be cost, social values, …  Also dealt with formulating these problems  In simpler models, what happens when we cannot/will not monetize all aspects?  Example: what if we are evaluating options/policies with cost, a benefit is lives or injuries saved?  Do we place a value on these benefits?  Are there other ways to ‘solve’ this?

5. 12-706 and 73-3595 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’

6. 12-706 and 73-3596 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

7. 12-706 and 73-3597 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

8. 12-706 and 73-3598 An Obvious Example

9. 12-706 and 73-3599 Another Obvious One

10. 12-706 and 73-35910 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

11. 12-706 and 73-35911 Interesting Example Is “Lowest CE ratio” best decision rule?

12. 12-706 and 73-35912 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

13. 12-706 and 73-35913 Sample Applications  Cost-effectiveness of:  New drug/medical therapies  Pollution prevention  Safety regulations  CEA used frequently in biomed field  Helps show ‘better’ drugs

14. 12-706 and 73-35914 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.

15. 12-706 and 73-35915 Incremental CE  To find incremental cost-effectiveness :  Sort alternatives by ‘increasing effectiveness’  CE = (TAC k – TAC k-1 )/( PE k – PE k-1 )  CE = incremental cost-effectiveness of Option k  TAC = total annualized cost of compliance  PE = effectiveness (e.g. benefit measure)  Use zero values (if applicable) for base case

16. 12-706 and 73-35916 Incremental CE Example  ** 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”

17. 12-706 and 73-35917 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).

18. 12-706 and 73-35918 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’

19. 12-706 and 73-35919 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?

20. 12-706 and 73-35920 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