l Economics is the science of scarcity. The application of healtheconomics reflects a universal desire to obtain maximumvalue for money by ensuring not just the clinical effectiveness,but also the cost-effectiveness of healthcare provision.

l Achieving ‘value for money’ implies either a desire to achieve apredetermined objective at least cost or a desire to maximise thebenefit to the population of patients served from a limitedamount of resources. This requires services to be evaluated for‘cost-effectiveness’.

l An associated concept is that of efficiency, which measures howwell resources are used in order to achieve a desired outcome.

l Opportunity cost represents an invaluable mode of thoughtin health economics, as it makes clear the explicit trade-offs thatunderlie resource use in the health services. The true cost ofusing scarce healthcare resources in one manner is theirunavailability to fund alternative beneficial services.

l All economic evaluations have a common structure whichinvolves explicit measurement of inputs (‘costs’) and outcomes(‘benefits’).

l Health economics can help to inform and improve decision-making through the systematic and objective application of‘applied common sense’.

l Such ‘applied common sense’, which symmetrically balancescosts and benefits, represents a valuable mode of thinking fordecision-makers, irrespective of whether a formal economicevaluation is undertaken.

1

What is...? series Second edition Health economics

For further titles in the series, visit:www.whatisseries.co.uk

Alan Haycox BA MA

PhD Reader in HealthEconomics, Universityof LiverpoolManagement School

What ishealth economics?

Supported by sanofi-aventis

Date of preparation: April 2009 NPR09/1101

Economics is the science of scarcity. Itanalyses how choices are structured andprioritised to maximise welfare withinconstrained resources (Box 1). We all useeconomics on a daily basis (‘Do I buy thecheaper car, or pay a bit more for the nicerone?’) as we work within our own resourceconstraints (our desires say, ‘Buy the nicerone’; our resources say, ‘Buy the cheaperone’). By comparing the costs and benefitsarising from the purchase of the competingcars, we are able to optimise our decision-making. If we routinely use such economictechniques in our private lives, then surely itis not too great a ‘leap of faith’ to apply themin our lives as health professionals? This is thebasis of health economics.

It is universally acknowledged that thetechnical ability of healthcare systems toprovide care (the wide array of new andexpensive health technologies available) farexceeds the ability of any healthcare system toafford all such technologies. Once healthcaredecision-makers have accepted the need forchoice, they must inform that choice byprioritising competing interventions throughthe analysis of their costs and benefits.However, it is important to recognise thathealthcare exhibits a range of specialcharacteristics that will fundamentally affectsuch analyses. Health economics reflects auniversal desire to obtain maximum value formoney by ensuring not just the clinicaleffectiveness, but also the cost-effectiveness ofhealthcare provision.

Cost-effectivenessHealth economics is dominated by a simpletheoretical concept, that of cost-effectiveness(this is explored in greater detail in What iscost-effectiveness?).1 In general, the concept ofcost-effectiveness implies either a desire toachieve a predetermined objective at least costor a desire to maximise the benefit to thepopulation of patients served from a limitedamount of resources. To achieve this aim, weuse the tools of economic evaluation to selectthe most cost-effective options from a rangeof healthcare alternatives. An associatedconcept is that of efficiency.

EfficiencyEfficiency evaluates how well resources areused to achieve a desired outcome. It has anumber of different aspects.

Allocative efficiency measures theextent to which resources are allocated to thegroups or individuals who can benefit most.For example, the benefits of statin treatmentprovided to high-risk patients (for example,patients who have already had a heart attack)are far in excess of the benefits that arisewhen they are prescribed to low-risk patients.Allocative efficiency therefore requires thehigh-risk patients to be targeted as a priority(primary prevention), resulting in animproved level of health associated withstatin treatment.

Technical efficiency measures either theextent to which resources are combined toachieve maximum outcome, or alternativelythe minimum amounts of resources that arecombined to achieve a given outcome (forexample, identifying the least expensive wayto effectively heal a peptic ulcer). Theprescribing of unnecessarily long courses ofdrugs or unnecessarily expensive drugsimplies the existence of technical inefficiency.

Defining and measuring ‘healthoutcomes’Defining and measuring health outcomes isfraught with difficulties, but such measures arethe essential bedrock of health-economic

What is health economics?

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Box 1. Scarcity, choice andprioritisation

Scarcity of resources requires individuals to

choose which goods and services they

consume. The basis for their choice is the

relative value that they place on each good

or service. The structure of these relative

values is the basis for their system of

prioritisation.

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What ishealth economics?

evaluations (Box 2). In addressing healthoutcomes, economists talk in terms of utility,which measures the strength of an individual’spreferences for specific outcomes (see What arehealth utilities?2 for further discussion).Outcomes are assessed in terms of enhancedsurvival (adding years to life) and enhancedquality of life (QoL) (adding life to years).There is a range of measures to assess theimpact of treatment on survival (lives saved,life-years gained or five-year survival rates), butincreasingly health services are focusing onimproving QoL (reduced pain, greater mobility,improved sensory function). Health-relatedQoL analyses measure the impact of treatmentson the social, emotional and physical aspectsof life from the patients’ perspective (see Whatis quality of life?3 for further discussion). Manytechniques have been developed to placevalues on various states of health which can beheld to be representative of the values ofsociety as a whole.4 These QoL ‘weights’ arethen integrated with survival data to produce asingle combined measure of the quantity and

quality of life generated by healthcareinterventions. Quality-adjusted life-years(QALYs) apply weights that reflect the QoLbeing experienced by the patient (perfecthealth is equivalent to 1, death is equivalent to0 and health states that may be regarded asworse than death have negative valuations). Itis important to recognise, however, that suchanalyses are still at an early stage of develop-ment and many methodological difficultiesremain to be resolved (see What is a QALY?5 forfurther technical discussion). An entertainingbut informative introduction to the debateconcerning the social value of the QALY can beread in an article by Brouwer et al.6

Defining and measuring ‘cost’A distinction must be made between financialand economic concepts of cost. Financialcosts relate to monetary payments associatedwith the price of a good or service traded inthe marketplace. Economic costs relate to thewider concept of resource consumption,irrespective of whether such resources aretraded in the marketplace (Box 3). Thus, thetime spent by patients and their families in ahospital waiting room represents a real cost tothem – despite the fact that no financialpayment arises.

The economic concept of cost is based onthe awareness that, when resources areconsumed in a certain way, those sameresources become unavailable for use indeveloping other services, and hence thebenefits which would have arisen have to beforegone. In economics, these outcomes thatare foregone are referred to as ‘opportunitycost’ (Box 4). Again, this is a concept familiarto all of us from our personal finances. If theresources at my disposal would allow me toeither buy a car or take a foreign holiday, in a

Date of preparation: April 2009 NPR09/1101

Box 2. Definition of health

Health has no generally accepted definition,

but has a wide range of physical, mental

and social characteristics. The breadth of

such characteristics and their essentially

subjective nature emphasises the difficulties

inherent in deriving an operational definition

for this concept.

Box 3. Resources

When we consider the resources available to

us, we normally think about financial

resources. The economists’ definition,

however, is far wider and encompasses the

time, energy and skills exhibited by the

individual, together with the buildings and

equipment that he or she may possess. A

resource may therefore be consumed (time

and effort expended in developing an idea)

even if there is no associated financial

payment.

Box 4. Opportunity cost

The economist perceives the true cost of any

good or service in relation to the resources

that are consumed to provide that good or

service. The cost of the resources consumed

is expressed as the value of the output that

would arise through their next best

alternative use.

very real sense, the true opportunity cost ofbuying the car is the foregone benefits oftaking the holiday.

In this manner, although the foregonebenefits are difficult to measure in practice,opportunity cost represents a very usefulmode of thought in health economics, as itemphasises the explicit trade-offs thatunderlie resource use in the health services.

Techniques of economic evaluationEconomic evaluation provides a systematicand objective framework for drawing up abalance sheet of costs and benefits which canassist decision-makers to make moreinformed choices. All economic evaluationshave a common structure which involvesexplicit measurement of inputs (‘costs’) andoutcomes (‘benefits’). The four main methodsof economic evaluation vary in terms of theirevaluation of health outcomes. Each methodis described briefly in Table 1. The appropriateanalytical tool to choose in any givencircumstance depends upon three mainissues. First, what is the context in which theanalysis is being undertaken? Second, what isthe focus of the economic evaluation beingundertaken. Third, what is the nature of thecomparative outcome arising from the

competing therapeutic options? Knowledge ofthese three issues will provide a guide to theappropriate economic tool to be employed forany particular analysis.

Cost-minimisation analysis

Cost-minimisation analysis is restricted tosituations in which the health benefits ofhealthcare treatments have been proven to beidentical. An example would be a decision toprescribe a generic drug instead of a brand-name drug, achieving the same outcome atless cost. Frequently, therefore, this techniqueis perceived as being the easiest to apply, butsuch a perception is misleading. Cost-minimisation analysis does not ignore healthoutcomes, but actually requires proof thatoutcomes are clinically equivalent tolegitimise the use of this technique. Thisopens up a new and complex array of issuesthat need to be addressed prior to utilisingthis technique. What do we mean by ‘clinicalequivalence’ and what evidence is required tosupport such equivalence (non-inferioritytrials, equivalence trials or real-world auditdata). Such theoretical considerations need tobe addressed if cost-minimisation analysis isto be appropriately employed as a validtechnique of economic evaluation. What is

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Method Outcome measure Application/interpretation

Cost-minimisation analysis Evidence is available that outcomes for Given the evidence of output equivalencecompeting therapies are equivalent (and only when such evidence is available),

the cheapest therapy is preferred

Cost-effectiveness analysis Health benefits are measured in natural How much more does it cost (incrementalunits, reflecting a dominant common cost) to achieve an additional unit therapeutic goal for competing therapies (incremental effectiveness) of the common

therapeutic good (incremental cost-effectiveness ratio)?

Cost–utility analysis In the absence of a common therapeutic The quality-adjusted life-year measures the goal, outcome is measured through the number of additional life years weighted effect of any intervention on mortality by the quality of life (value) of the(quantity of life) and morbidity (quality health state experienced in each yearof life)

Cost–benefit analysis Both costs and benefits are measured in An intervention should be undertaken ifthe same unit – money – with the financial the (financial) value of the benefits value of the costs being compared with the exceeds the (financial) value of the costs.financial value of the benefits If only one intervention can be funded,

choose the activity with the highest excess financial benefit over costs

Table 1. Structures of economic evaluation

clear, however, is that it is highlyinappropriate to simply assume clinicalequivalence between competing therapies as ajustification for the use of cost-minimisationanalysis. For further discussion, see What iscost-minimisation analysis?7

Cost-effectiveness analysis

The term ‘cost-effectiveness analysis’ properlyrefers to an evaluation where the outcomesare one-dimensional. Cost-effectivenessanalysis is therefore used in health economicsto compare the financial costs of therapieswhose outcomes can be measured purely interms of health effect (for example, years oflife saved, ulcers healed). For instance, if wewanted to compare the use of a proton pumpinhibitor to relieve severe reflux oesophagitiswith the use of H2 blockers to achieve thesame end, we could calculate the costs perpatient relieved of symptoms for eachtherapy. Cost-effectiveness analysis is themost commonly applied form of economicanalysis in the heath economics literature,and is frequently used in drug therapy.However, it does not allow comparisons to bemade between courses of action that havecompletely different therapeutic outcomes(see What is cost-effectiveness?1 for furtherdiscussion).

Cost–utility analysis

Cost–utility analysis is similar to cost-effectiveness analysis in that there is a definedoutcome, and the cost to achieve thatoutcome is measured in money. However, incost–utility analysis the outcome is measuredin terms of survival and QoL (for example,using QALYs) (Box 5). Since the endpoint maynot be directly dependent on the disease state,cost–utility analysis can, in theory, comparecourses of action in different areas ofmedicine. In practice, this is not so easy, sinceQALYs remain subject to much philosophicaland technical criticism (see What is cost–utilityanalysis?8 for a more detailed discussion).

Cost–benefit analysis

In cost–benefit analysis the benefit ismeasured as the associated economic benefitof an intervention, and hence both costs andbenefits are expressed in money. Cost–benefitanalysis may ignore many intangible but very

important benefits that are difficult tomeasure in monetary terms (for example,relief of anxiety). It could also be seen todiscriminate against those for whom a returnto productive employment is unlikely (forexample, the elderly or the unemployed).However, the virtue of this analysis is that itenables comparisons to be made betweenschemes in very different areas of healthcare,and even with schemes outside the field ofmedicine. For example, using cost–benefitanalysis, the costs and benefits of expandinguniversity education (the benefits ofimproved education and hence productivity)can be compared with establishing a backpain service (enhancing productivity byreturning patients to work). This approach isnot widely accepted for use in healtheconomics.

Marginal analysis – a little bit more,a little bit lessMarginal costs measure the additional costincreases or savings arising as a consequenceof small output changes within a healthcareprogramme. For instance, if a new treatmentenables patients to be discharged fromhospital a day earlier, it would be tempting(but wrong) to apply the average cost per bed-day as the associated saving of resources. Thisis because, unfortunately, all the fixed-costelements (laboratories, kitchens and buildingmaintenance) will be largely unaffected, withthe only altered costs being those associatedwith the physical occupation of the bed(patients’ meals and other ‘hotel’ costs).These are the marginal costs, where resource

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What ishealth economics?

Date of preparation: April 2009 NPR09/1101

Box 5. Quality-adjusted life-years

The concept of the quality-adjusted life-year

(QALY) is based on the belief that the aim of

any health service intervention can be

dichotomised between improving survival

(increasing the quantity of life) and

improving the ability to enjoy life (enhancing

quality of life). By applying ‘quality weights’

to each additional year of life experienced

after treatment, the QALY attempts to

incorporate both of these elements into a

single measure (see What is a QALY?).5

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use is directly related to a change in the scaleof service provision – the additional resourcerequired to treat one additional patient, orconversely, the level of resource directly savedby treating one fewer patient.

The importance of perspectiveA key point to consider in planning aneconomic evaluation is the point of viewfrom which the study should be conducted:from that of the health service, in which caseonly direct costs are considered; or from asocietal viewpoint, in which case indirectcosts (for example, productivity losses arisingfrom ill health) should also be included. Ingeneral, the societal perspective is preferred,as it reduces the likelihood that importantcosts will be excluded from the analysissimply because they fall outside the focus ofthe study. However, a healthcare managerfaced with a limited budget has an obviousincentive to concentrate entirely on costs thathave an immediate impact on his ownbudget.

Employing a societal perspective alsoincorporates the costs and benefits directlyexperienced by the patient. For example, thedevelopment of an insulin delivery systemthat reduced the total number of injections orprovided greater flexibility of the timing ofinjections, would be likely to reduce the costsexperienced by a diabetes patient, by reducingthe pain and inconvenience associated withtheir ill health and providing them withgreater control and, hence, an improvedability to plan and structure their lives. Theseprivately-borne costs might be overlookedfrom a solely health service perspective, butthey represent a vital component of theeconomic analysis: their reduction is likely tobe a fundamental determinant of patientcompliance, which in turn would lead toimproved glycaemic control and a reductionin the health and financial burden associatedwith poorly controlled diabetes. For thisreason, economic analyses should take thewidest possible perspective in order tomaximise their value as a basis for healthcaredecision-making.

DiscountingThere is often a significant time lag betweenthe investment of health service resources and

the arrival of the associated health gain. Ingeneral, we prefer to receive benefits now andpay costs in the future. To reflect this ineconomic evaluation, both costs and benefitsare discounted. The rate currently set by the UKTreasury to discount streams of future costsand benefits to their net present value is 3.5%.9

UncertaintyEconomics operates in the realm of thebehavioural sciences and, as such, is beset byuncertainty concerning the exact values ofestimates of costs and benefits. To minimisesuch uncertainty, it is necessary to reflectaccurately the balance of scientific evidenceon clinical and cost-effectiveness through theapplication of evidence-based medicine (seeWhat is evidence-based medicine?10 for furtherdiscussion). Great care must be taken to utilisea balanced and impartial summary of theevidence with regard to anticipated treatmentoutcomes, ideally in the form of a systematicreview (see What is a systematic review?11 forfurther discussion). Where possible, a meta-analysis should be used to obtain a precisequantitative estimate of treatment effect (seeWhat is meta-analysis?12 for furtherdiscussion).

However, there will inevitably remaincertain areas where clinical evidence is eitherlimited or entirely missing, and hence itbecomes necessary to make assumptions tosupplement the structure of evidenceobtained from clinical trials and othersources. All pharmacoeconomic analysesmust therefore include a detailed sensitivityanalysis to assess the robustness of the studyresults in relation to variations in theunderlying assumptions. The economicappraisal can be said to be robust if the resultsare not influenced to any great extent byfeasible variations in the value of any of thekey underlying assumptions. If feasiblevariations in key assumptions lead to adifferent underlying conclusion, then theeconomic analysis is not robust. This isdiscussed in more detail in What areconfidence intervals and p-values?13

ConclusionHealth economics represents a valuable toolfor improving the information base uponwhich healthcare decisions are made. It can

What ishealth economics?

Date of preparation: April 2009 NPR09/1101

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help to inform and improve decision-making,as a systematic and objective system ofthought. The very process of identifyingalternative options to meet prespecifiedobjectives and balancing resources andbenefits represents a valuable mode ofthinking for decision-making, irrespective of whether formal economic evaluation isundertaken.

References1. Phillips C. What is cost-effectiveness? London: HaywardMedical Communications, 2009.2. Tolley K. What are health utilities? London: HaywardMedical Communications, 2009.3. Fallowfield L. What is quality of life? London: HaywardMedical Communications, 2009.4. www.euroqol.org/home.html (last accessed 24 March2009)5. Phillips C. What is a QALY? London: Hayward MedicalCommunications, 2009.6. Brouwer W, van Exel J, Baker R, Donaldson C. The newmyth: the social value of the QALY. Pharmacoeconomics2008; 26: 1–4.7. Haycox A. What is cost-minimisation analysis? London:Hayward Medical Communications, 2009.8. McCabe C. What is cost–utility analysis? London:

Hayward Medical Communications, 2009.9. HM Treasury. The Green Book. Appraisal and Evaluationin Central Government. Treasury Guidance. www.hm-treasury.gov.uk/d/2(4).pdf (last accessed 30 October2008)10. Belsey J. What is evidence-based medicine? London:Hayward Medical Communications, 2009.11. Hemmingway P, Brereton N. What is a systematicreview? London: Hayward Medical Communications,2009.12. Davies HTO, Crombie IK. What is meta-analysis?London: Hayward Medical Communications, 2009.13. Davies HTO, Crombie IK. What are confidenceintervals and p-values? London: Hayward MedicalCommunications, 2009.

Further reading1. Walley T, Haycox A, Boland A (eds).Pharmacoeconomics. Edinburgh: Churchill Livingstone,2003.2. Eddy DM. Clinical decision-making: from theory topractice. Applying cost-effectiveness analysis. The insidestory. JAMA 1992; 268: 2575–2582.3. Eddy DM. Clinical decision-making: from theory topractice. Cost-effectiveness analysis. Will it be accepted?JAMA 1992; 268: 132–136.4. Eddy DM. Clinical decision-making: from theory topractice. Cost-effectiveness analysis. Is it up to the task?JAMA 1992; 267: 3342–3348.5. Eddy DM. Clinical decision-making: from theory topractice. Cost-effectiveness analysis. A conversation withmy father. JAMA 1992; 267: 1669–1675.

What ishealth economics?

Date of preparation: April 2009 NPR09/1101

Supported by sanofi-aventis

What ishealth economics?

Published by Hayward MedicalCommunications, a division ofHayward Group Ltd.

Copyright © 2009 Hayward Group Ltd.All rights reserved.

8

What is...? series

First edition published 2003Authors: Alan Haycox and Euan Noble

This publication, along withthe others in the series, isavailable on the internet atwww.whatisseries.co.ukThe data, opinions and statementsappearing in the article(s) hereinare those of the contributor(s)concerned. Accordingly, thesponsor and publisher, and theirrespective employees, officersand agents, accept no liabilityfor the consequences of any suchinaccurate or misleading data,opinion or statement.

Date of preparation: April 2009 NPR09/1101