Cost-benefit analysis

Cost-benefit analysis is used to evaluate projects that generate non-financial costs and benefits by taking account of the preferences of those affected. It has applications to the provision of public goods for which preferences are not reflected in market prices. Although its quantitative results are necessarily approximate, it can sometimes provide a persuasive guide to a choice among alternatives. It is claimed that, by taking account of the strengths of preferences, cost-benefit analysis can provide a better guide to choice than can be obtained from voting.

Introduction

The problem that is tackled by cost-benefit analysis is that of making a decision on behalf of others. The objective of the decision-maker is taken to be the achievement of an outcome that those affected would have chosen in preference to all of the feasible alternatives. That objective cannot be fully achieved because the decision-maker cannot be fully aware of the preferences of others. In the pursuit of his objective, the decision-maker is nevertheless under an obligation to take account in his decision of all of the available information about those preferences.

The following paragraphs outline the methods by which that problem is normally tackled, provide examples of their application, and include an account of their limitations.

Methodology

The basic method

The customary ("consequentialist") decision criterion of a cost-benefit analysis uses the summation of the effects of the expected consequences of a decision on the well-being of people within its scope. To make a summation possible, a monetary cost or benefit is assigned to each of those effects. (The term "cost-effectiveness" is a applied to an analysis in which only the costs are monetised.) The summation normally used is then the of the costs and benefits of each effect, weighted by their estimated probability of occurrence, and discounted using the estimated time preference rates of those affected. The acceptance criterion for a single project is a positive value of the resulting net present expected value of the excess of benefits over costs, and the acceptance criterion for the acceptance of one among several alternatives is that it should be the one with the highest net present expected value.

The alternative ("deontologist") decision criterion takes account of the views of those affected concerning the need to conform to predetermined rules (such as the sacredness of human life or permissibility of interest-paying debt). Monetisation under that criterion is based upon the costs of socially-agreed practices that conform to the relevant rules.

Scope

The scope of an analysis is normally determined by the requirements of its prospective users. The evaluation of a medical procedure might, for example, be concerned solely with its effects on patients and their families, or it might also encompass effects on the hospital or on the public at large. An evaluation of migration commissioned by a European government might or might not be required to include effects upon migrants and their families, but an evaluation commissioned by the European Union might be expected to require the inclusion of effects upon all of its inhabitants. Some users require the coverage of a longer timescale than others, and environmental studies may even be required to encompass effects on future generations.

Reports that do not specify the scope of a quoted cost-benefit analysis are open to misinterpretation.

Valuation

The outcomes whose valuations typically figure in cost-benefit analysis, include benefits such as the saving of time and the relief of suffering, and non-financial costs in the form of unwelcome experiences such as injury and exposure to noise. The monetary value to a person of such an outcome is taken to be the amount that he would be willing to pay in order to enjoy its benefits or avoid its costs. The preferred way of estimating that amount is the revealed preference method, which depends upon the observation of the subject's conduct in making free and well-informed choices. The collective valuation of an outcome can be reliably estimated from the price that is determined by choices made in an efficient market, a reasonable approximation to which is often provided by organised markets for products and services (and estimates of the value of time are often derived from the wage rates ruling in the labour market). Relevant observations of the results of such choices are not always available, however, and other observed choices provide a less reliable basis for valuation. For example, it appears that estimates of the value of life derived from the payments or other benefits that are commonly accepted in return for conduct involving the risk of death, may be seriously distorted by probability blindness.

Metrics used in cost-benefit analyses

• Cost per year of life saved The definition of an acceptable cost per year of life saves ranges from $50,000 to $200,000.
• Cost of Preventing an Event (COPE). For example, to prevent a major vascular event n a high-risk adult , the number needed to treat is 19, the number of years of treatment are 5, and the daily cost of the generic drug is 68 cents. The COPE is 19 * 5 * ( 365 * .68) which equals $23,579 in the United States.
• Years (or months or days) of life saved. "A gain in life expectancy of a month from a preventive intervention targeted at populations at average risk and a gain of a year from a preventive intervention targeted at populations at elevated risk can both be considered large."

Standards in conducting a cost-benefit analysis

Standards have been developed for the conduct of cost-benefit analyses and for systematic reviews of cost-benefit analyses.

The two most common problems in publications of cost-benefit analyses are not stating the study perspective (e.g. is the cost born by the patient, health case system, or society) and not disclosing the funding source.

Difficulties in cost-benefit analyses

The costs saved by successful treatment of one disease may be offset by greater longevity leading to increased costs from other disease.

Recommendations have bee published on how to read and interpret a cost-benefit analysis.