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Chapter 4: Economic Efficiency and Cost Benefit Analysis. Economic Efficiency Cost Benefit Analysis. Economic Efficiency.

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Chapter 4: Economic Efficiency and Cost Benefit Analysis

Economic Efficiency

Cost Benefit Analysis


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Economic Efficiency

  • Economic efficiency requires the maximization of total welfare, with the optimum quantity reflecting the sum of consumers’ and producers’ surplus.1. Consumer surplus (see Figure 4.1)2. Producer surplus (see Figure 4.2)

  • Figure 4.3 shows that the sum of surpluses (total welfare) is maximized at Q1 where demand equal supply

  • Example: inefficient (monopolist: too fee goods; polluters: too many goods)


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Cost-Benefit Analysis :Background

  • US Army Corps of engineersCongressional subcommittee (1950)The introduction of Medicare and Medicaid (1965)All federal regulation (1981)

  • Limitation: all shown in monetary term

  • Alternatives to CBA1.Cost-Efficiency Analysis (CEA): a way to quantify trade-offs between resources used and health outcomes achievement without having to value health outcomes in monetary terms2.Cost-Utility Analysis (CUA)-a special case of CEA with reflecting individual preference


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Cost-Benefit analysis: Basic Principle

  • CBA involves evaluation projects without decisions made in the market place

  • Project accepted if B>C

  • Best projects: B/C ratio ranked

  • Measuring cost-opportunity cost

  • Benefit- externality (e.g. flu immunization)


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  • Is equalizing risks program best?Viscusi (2000): no.

  • Marginal Analysis in CBA (Figure 4-4):Maximize Society’s net benefit=> Marginal Social benefit =Marginal social costs

  • The cost of saving lives [costs-Resources saving]: childhood immunization and prenatal care have negative net costs

  • Discounting: multi-periods projects

    Present value equation (4.1)Q1: should those living in the present so disregard future generation?

    Q2: market rate of interest rate=social discount rate?

    Q3: Inequalities in discounting rate?


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  • Risk adjustment: high risk=high interest rateStiglizt (1988): certainty equivalent (more risk=lower certainty equivalent)

  • Distributional Adjustment: stiglizt proposes more distributional weights to lower income group

  • Inflation: measure in real term


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Valuing Human life

  • Human capital approach: present value of future earnings

  • (1)Willingness to accept: labor economy of compensating differentials(2)Willingness to pay: consumer purchasing behavior for risk-reducing devices


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Cost-Effectiveness Analysis

  • CEA ration (4.2)=C1-C0/E1-E0 where cost as usual in dollar and output in health status measurement

  • Advantage: benefit measurement in non-monetary term


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Cost-utility Analysis

  • Quality-Adjusted Life Years (QALY) (4.3)

    where quality weight (q) denotes range from 1 (perfect health ) to 0 (death) =>individuals’ preference for health F is the probability of survival;

    d is discount rate


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The Ageism Critique of QALYs

  • Q: Is it fair for the elderly using QALY?

  • DALY: human tend to be depend on the middle age groups=> a “hump” shaped set of weights favoring the age groups in the middle


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