HERC: Opportunity Costs
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Opportunity Costs

Overview

Most items that we purchase regularly, such as gasoline, vary a little in price.  The market price (or range of prices) for gasoline is determined through the interaction of supply and demand forces, under the right conditions. Buyers who are fully informed about the products, a uniform product across sellers, and a sufficiently large number of both sellers and buyers are some of those conditions. These market conditions do not hold in health care (Arrow 1963) and the methods and presentation of cost-effectiveness analyses should reflect this reality.

Consider how prices are set in a highly competitive market, such as for gasoline. Naturally, people buy gasoline because they need it. If people act rationally, however, there is another requirement: the benefits of spending money on gasoline outweigh the benefits of alternative uses of the money. The alternative with the greatest value to the consumer is the next best use of the money, and the benefit it brings (in dollars) is the opportunity cost of gasoline. As long as people act rationally, then we know that they value gasoline at least as much as its opportunity cost. Consequently, opportunity cost is the gold standard for defining costs in economic analyses.

Rarely can one estimate opportunity costs in health care. Researchers must instead rely on accounting costs or charges. The accounting cost (or production cost) is the combined value of resources used to produce the good. The charge is the amount listed on an invoice or bill.

Not always are accounting and economic costs similar. Take the cost of a no-show. Accounting systems often set the value of a no-show at some small amount, such as $10. However, if the health care system plans accordingly, then it can still operate without downtime. In this case, the only cost of the no-show is the administrative time to reschedule the patient.  On the other hand, if a no-show causes health care providers to wait for their next patient, then the cost of a no-show could be quite large.

Differences between accounting and economic costs might also reflect incentives. Sometimes hospitals will bill a patient $10 for missing an appointment. This cost is an incentive-- it increases the likelihood that the patient will show. It is important to keep in mind the implicit incentives when deciding whether to use cost estimates, charges or payments.


References

Arrow, KJ. 1963. Uncertainty and the welfare economics of medical care. American Economic Review 53 (5):941-973.