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					Cost-Effectiveness Analysis

     Scott Matthews
     Courses: 12-706 and 73-359
     Lecture 18 - 11/3/2004


PS 3 due next Wednesday
Presentation schedule check - Mon after
 thanksgiving instead of Dec 1?

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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

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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?

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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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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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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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An Obvious Example
     Values      Alternatives
              A       B       C
    Cost    $10 M $10 M $10 M
    # Lives   5       10      15
    CE      $2 M $1 M $0.67
    ratio                     M
    EC       0.5    1 life 1.5
    ratio    life           lives
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Another Obvious One

    Values         Alternatives
                A       B       C
 Cost          $5 M $10 M $15 M
 # Lives Saved 10       10      10
 CE ratio      $0.5     $1    $1.5
 EC ratio        2      1     0.66
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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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Interesting Example

                          A        B
        Cost             $1 M $100 M
        # Lives            4      200
        CE ratio         $250k $500k
        EC ratio         4 lives 2 lives
 Is “Lowest CE ratio” best decision rule?
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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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Sample Applications

Cost-effectiveness of:
  New drug/medical therapies
  Pollution prevention
  Safety regulations
CEA used frequently in biomed field
  Helps show „better‟ drugs

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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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Incremental CE

To find incremental cost-effectiveness :
Sort alternatives by „increasing effectiveness‟
CE = (TACk – TACk-1)/( PEk – PEk-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

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  Incremental CE Example
Control Option Name Costs          Removals          Cost-          Incremental
                                   (pounds)      Effectiveness           CE

Metals 2          $8,853,173        369,112          $24             $24
Metals 4          $1,843,303        372,040           $5         -$2394.08**
Metals 3          $9,179,935        379,571          $24            $974
Oils 8             $313,523         13,943           $22             $22
Oils 9             $313,523         14,811           $21              $0
Organics 4         $150,694            —
Organics 3         $275,074         27,055           $10               $10

   ** 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
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    Standards for the Centralized Waste Treatment Industry”
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

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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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Gray Areas

How to measure cost-effectiveness when there
 is a single project cost but multiple effectiveness
  E.g. fatalities and injuries, CO2 and SO2
  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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Another CEA Example

Automated defribillators in community
  What would costs be?
  What is effectiveness?

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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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