LECTURE 8:

HEALTH ECONOMICS
Joanne Gray, Associate Professor Health Economics

Joanne3.gray@northumbria.ac.uk
Lecture Overview
Intro and Background
1. Brief overview of NHS England structure to highlight structures
involved.
2. Introduction to the role of economics and economic principles in
addressing and managing scarcity.
The application of economic principles to managing scarcity within the
NHS and elsewhere using Economic Evaluation.
3. Economic Evaluation
4. Measuring (Health Related) Quality of Life
5. Cost-Benefit Analysis
6. Summary of Evaluation Techniques
7. Concluding Remarks
1. Overview of health and social care structures in
the Health and Social Care Bill, April 2013.
1.1 Decision Making
•Changing •Budgets
Demographics •Funding Model
•Evolving •etc
Technologies
• etc

Demand Costs

Health
Policy
Outcomes
•Equity •Specific goals
•Prevention •Health in General
•etc

Health Economics provides a framework to formally incorporate some of

these into the decision making framework.
 2.1 Scarcity in Healthcare
• Universally, healthcare
systems are faced with a fixed
Resources Outcomes
funding envelope.
• There are limited resources
available (time, HR, money) to
meet all need/demands/wants.
• Decisions have to be made
about what can be spent on
what.
Increasing pressure to achieve
productivity gains.
By 2015 By 2021
£20 £30 billion
billion more
NHS England estimates of a funding gap
Nicholson challenge for productivity gains
 2.1 In a ideal world economists can study how
markets can work:
• In a perfect market we can
S
simplify in terms of the graph
Price to the left:
D
• SS shows the level of outputs a
supplier will be willing to sell as
the price goes up
• DD show the demand falls as
price rises.
• Where the two meet is the
‘market price’ where buyers
and seller meet. Both making
S
D best use of their scarce
resources.
• Key to this simplification is
buyers and sellers know what
else they could get for their
money.
Quantity
2.3 Why Health Economics?
• Health Economics really began as a discipline in the 1960s.

• Kenneth Arrow published a paper called "Uncertainty and the

welfare economics of medical care“ in the American Economic
Review. In this paper he pointed out key differences between
the market for health care and the markets for other goods:

• People consume healthcare because they want health.

• There is uncertainty in the link between the two.
• The role of physicians, in acting as agents for patients.
• Key insight: Markets cannot ‘work’ in health care (as shown on
previous slide), so we need non market institutions to achieve the
goals of optimising outcomes that occur elsewhere without
intervention.
2.4 A (health) economic approach to managing
scarcity: The fundamental principles.
Resources are scarce. Every choice over the use of scarce resources has
associated benefits and associated (2.4.1) Opportunity costs

• The objectives of any healthcare system are to maximise benefits and

minimise the opportunity costs to society. Therefore resources should be
deployed in such as way as to ensure (2.4.2) Efficiency in the choices made

• This means the costs and benefits of choices should be measured at (2.4.3)
The margin

• Analysis at the margin accounts for opportunity costs and also the fact that
benefits realised from the additional input of resources tend to increase at an
ever decreasing rate according to the (2.4.4) law of diminishing marginal
returns
2.4.1 Opportunity Cost
Opportunity cost = forgone benefits of the next best
alternative use of resources
• In allocating resources to one option, some benefit will be lost because
resources were not allocated to the forgone option.

• For example, the opportunity cost of a therapist led extended

rehabilitation programme for stroke patients might be the benefits
forgone from not being able to run an exercise programme for the frail
elderly.

• They are different from financial costs, but are sometimes measured in
financial terms. More on this later.
2.4.2 Efficiency
• The goal in any health care market can be defined as:
maximising benefits whilst minimising costs.. Therefore, in
allocating resources we can achieve efficiency by
ensuring resources are deployed to maximise health
gains to society. We can look at this two ways:

• Technical Efficiency - decisions to achieve certain objectives are taken

as given; the problem is how best to achieve them. i.e. cheapest way to
provide a screening service, or screen the most people with a given
budget

• Allocative Efficiency - all objectives have to fight with each other; the
problem is about whether (or how many) resources will be ALLOCATED
to achieving each objective. One group of people will lose resources so
that another gains. But we would have the biggest overall benefit. More
on this later
2.4.3 The Margin
• A very important concept in economics:
• marginal cost = cost of one more unit of output
• marginal benefit = benefit from one more unit of output

• In allocating resources it is important to analyse the costs

and benefits of any changes at the margin = marginal
analysis.
• Numerous examples in health care usually to do with screening.
e.g. Neuhauser D, Lewicki AM. “What do we gain from the sixth
stool guaiac?”. N Engl J Med. 1975 Jul 31;293(5):226-8.
• The marginal cost of the sixth test may be up to 20,000 times the
average cost of the tests.
2.4.4 Law of diminishing marginal returns
Each extra unit of input yields less and less additional
output:
The marginal benefits realised from additional units of input will diminish.

In resource allocation terms:

Resources should be moved from programmes producing less marginal benefit
per unit of cost to programmes producing more as the total benefit from the
resources available would thus increase this should continue until the marginal
benefits per unit of cost produced by each programme are equal.
OR
You should always fund the programme with the highest marginal benefit, until
that marginal benefit drops below that of an alternative programme.
3. What is economic evaluation?
• An important sub discipline of health
economics. Some times referred to as Health
Technology Assessment (HTA)
• A lot of time and money spent on economic
evaluation.
• Can be thought of as the evidence that helps
decision makers (commissioners) decide
whether or not to fund a programme.
• Scarcity implies the need to make choices and
to be efficient with available resources.
3.1 The place of economic evaluation in the
wider ‘evaluation cycle’
1. Can it work (Efficacy)?
– For example, does a new drug have an impact
on the condition in question?
2. Does it work (Effectiveness)?
– Is it a meaningful effect, are symptoms reduced?
3. Is it worth doing (efficiency)?
– What are the marginal costs and marginal
benefits compared to other treatments for the
same condition?
3.1.1 Characteristics of most common form

ConsequencesA
Programme A
CostsA

Choice
e.g. patient randomised

CostsB
Comparator B
ConsequencesB

A comparison of two or more programmes in terms of their costs

and outcomes.
 3.2 Family of evaluations
Are both costs (inputs) and consequences (outputs) examined?
2. Are at least 2 alternatives compared?

NO YES

Examines only Examines only

consequences costs
2 PARTIAL EVALUATION
NO 1A PARTIAL EVALUATION 1B
• Outcome • Cost • Cost-outcome description.
description. description.
3A PARTIAL EVALUATION 3B4 FULL ECONOMIC EVALUATION
• Efficacy or • Cost analysis.
effectiveness • Cost-minimisation analysis.
YES evaluation. • Cost-effectiveness analysis.
• Cost-utility analysis.
• Cost-benefit analysis.

Of most use to decision makers

3.2.2 Interpreting Full Economic Evaluations

More Costly

Decision depends
Do not use new
on how much we
technology
are willing to pay?

Less Effective More Effective

Decision
depends on how Use New
much we are technology
willing to accept?

Less Costly
3.2.3 Three main types of full economic evaluation

• Cost Effectiveness Analysis

• Cost Utility Analysis

• Cost Benefit Analysis

Which technique?

Depends on the question being asked.

3.2.4 ‘Type 1’ Questions
A fixed amount of resources have been allocated to treat a
particular condition, how do we best use those resources
to maximise benefits?

This question relates to Technical efficiency (Slide 2.4.2)

Achieving a set goal using the least possible amount
resources or maximising (health) output from a given set
of resources

e.g. What is the most efficient way of providing dialysis for

patients with chronic renal failure – hospital based or at
the patient’s home?
3.2.5 ‘Type 2’ Questions

• Should we allocate more/fewer resources to a particular

intervention?
• e.g. Should we expand the provision of hospital haemodialysis?

• Should we provide a particular intervention at all?

• e.g. Should we introduce screening for prostate cancer in men
aged over 55 years?

Refers to the issue of ‘Allocative efficiency’ (Slide 2.4.2)

Achieving maximum output (health gain) from resources as
a whole.
3.2.6 Cost Effectiveness Analyses (CEA).

Addresses questions of Technical Efficiency

Effects/benefits are one dimensional and measured in

physical units e.g. life years gained, deaths prevented

Interventions are compared in terms of cost effectiveness

i.e. the ratios of cost to unit of effect
costs/life years gained

Intervention with the lower/lowest cost-effectiveness ratio is

the most efficient e.g cost per emergency attendance
avoided.
3.2.6.1 Hypothetical CEA
Two alternative treatments for knee injury:

1. Existing – anti-inflammatory drugs

2. New – physiotherapy

Measure of outcome is disability days avoided (DDA)

Fixed budget of £500,000 per annum.

Drugs – produces 2,500 DDA per annum

CE ratio = 500,000 / 2,500 = £200 / DDA

Physiotherapy – produces 5,000 DDA per annum

CE ratio = 500,000 / 5,000 = £100 / DDA
3.2.6.2 Pros and Cons of CEA

Pros:
• Relatively simple.

Cons:
• Uses a limited definition of benefits
• Comparisons with cost-effectiveness of other treatment areas
is limited.
• Also: Assume a new third option for our knee injury example –
surgery:
• Total cost of surgery programme = £2,000,000
• Outputs: DDA per annum = 25,000
• CE ratio surgery = 2,000,000 / 25,000 = £80 / DDA (drugs were £200 /
DDA and physiotherapy was £100 / DDA)
3.2.7.1 A Solution ?

• Do we seek to extend budget to £2 million to

provide a more expensive but a more effective
treatment option?

• What would happen if we spent £2 million on

drugs or phsyiotherapy instead?

• Do we have a decision rule?

• Or is there another, more appropriate economic

evaluation technique we could use?
3.2.7.2 Cost Utility Analyses (CEA)

Addresses questions of Technical efficiency (Can also answer

allocative efficiency questions strictly within the health care
sector)

Measure of effect is multi-dimensional – typically the quality

adjusted life year (QALY) as favoured by National Institute of
Care Excellence (NICE)

Interventions compared in terms of cost utility ratios cost of

intervention/QALYs gained
 3.2.7.3 QALYs in practice

No operation:
• Current health state has utility value 0.5
• Current life expectancy is 2 years at a
1.0 constant health state
• QALYs = 2 x 0.5 = 1
0.9
QALYs gained Operation:
QoL
0.5 • Health state has utility value 0.9
• Life expectancy is 5 years at a constant
health state
0 • QALYs = 5 x 0.9 = 4.5
2 5
Duration (years)
QALY gain from operation = 4.5 - 1 = 3.5
3.2.7.4 Pros and Cons of QALYs

Pros:
• Broader measure of benefit
• Wider range of comparisons possible

Cons:
• Measurement of Health
• Outcomes beyond health
• Still need decision rules e.g. £20,000
per QALY
4.1 How do we measure Health Related Quality of Life
(HRQoL)?

• Most commonly used is the EQ-5D. I categorises health

into one of a finite set of stated. In the case of 3L – 243.
This has population values for each of the 243 health
states it captures.
• Questions about sensitivity, has led to EQ-5D-5L with has 3,125
states.
• Quite burdensome valuing each state (see next slide)
• and whose values of the states should we use? (this is important,
the arguments for using population values not patient values are
strongest in publicly funded systems)

• We can value the health states ourselves, working with

patients or the general public.
EQ-5D

EQ-5D TM is a
trade mark of
the EuroQol
Group
4.2.1.3 Valuing the states
• Variety of ways to value the states. We chose one called
Time Trade-off.
• Time trade-off asks people to ask how much length of life
out of five years they would forsake in one of the states to
live in in full health. E.g. rather live in full health for four
years than with a good outcome of CRT.
• Obviously this technique works best with more serious
conditions.
5. Cost Benefit Analyses (CBA)
Allocative efficiency (Type 2 questions)

Costs and benefits measured in commensurate units –

money

Decision rule: Are benefits greater or less than costs?

Can be applied to all or nothing changes (e.g. should we

provide IVF on the NHS?) or changes to existing provision
(e.g. should we lower the age at which breast cancer
screening is routinely offered to women?)
5.1 Pros and Cons of CBA

Pros:
• Possible to rank all CBAs and fund from top
• Potential to value a wider range of benefits

Cons:
• Difficulties in assigning monetary values to
benefits
5.2 People do do it!

Age Male Female

20-24 $170,707 $133,328
30-34 $205,062 $130,044
40-44 $180,352 $111,647
50-54 $124,989 $ 86,286
60-64 $ 45,169 $ 53,426
70-74 $ 9,718 $ 29,189
80-84 $ 2,820 $ 16,787
>=85 $ 943 $ 5,705

Source: Avorn J. (1984). Benefit and cost analysis in geriatric care;

turning age discrimination into health policy. New England Journal of
Medicine, 1294-1300.
6. Summary of Evaluation Techniques
Evaluative technique Benefits Unit of measurement

Cost-effectiveness Quantity of life Life years gained

analysis OR
Natural units e.g.
Health gain
- Pain reduction
- Cases detected
- Activities of daily living
- Cholesterol reduction

Cost-utility analysis Quantity & quality of life - QALYs (generic or

condition-specific)
- HYEs
Cost-benefit analysis Quantity & quality of life Money e.g.
(possibly including some - Human capital
non-health aspects) - Willingness to pay
7. Conclusions

• Health Economics provides a set of tools and techniques that can be

used to make better, more informed, decisions about how scarce
resources can be allocated.

• It is still for decision makers to weigh up the health economic evidence

alongside other information to make decisions.

• Different healthcare models may use and view health economic

evidence differently.
7.1 NICE in the UK

• Intended to provide “authoritative, robust and reliable

guidance on current best practice”

• Remit to produce national guidance on

• Individual technologies, appraisal
• Management of specific conditions, clinical guidance
• Clinical audit

• Criteria for making decisions

• clinical priorities
• clinical need
• “broad balance of benefits and costs”
• guidance on resources likely to be available
7.2 Global Picture
World Health Organisation’s 2015 Global Survey on Health Technology
Assessment by National Authorities: http://www.who.int/entity/health-
technology-assessment/MD_HTA_oct2015_final_web2.pdf?ua=1
• “Most countries reported having a formal process for compiling, analysing
and synthesizing relevant information and scientific evidence
systematically to support health care policy decision making”
• “All low-income countries and 85% of middle-income countries surveyed
said they used HTA for planning and budgeting. Only 64% of high-income
countries reported using HTA for this purpose. High-income countries were
much more likely than low-income countries to use HTA for determining
reimbursement or to decide what to include in a package of benefits.”
• “Findings from HTA-related organization(s) played an advisory, rather than
mandatory, role for policy decisions in a majority of the responding
countries.”