Cost–Benefit Analysis and Health Care Evaluations
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Cost–Benefit Analysis and Health Care Evaluations

Robert J. Brent

Cost–benefit analysis is the only method of economic evaluation which can effectively indicate whether a health care treatment or intervention is worthwhile. This book attempts to build a bridge between cost–benefit analysis, as developed by economists, and the health care evaluation literature which relies on other evaluation approaches such as cost-minimization, cost-effectiveness analysis and cost–utility analysis.
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Chapter 4: External Costs

Robert J. Brent


4.1 INTRODUCTION We have just seen one reason why market prices may not reflect costs, that is, because markets may be imperfect. When external effects exist, even perfect market prices may be incorrect indicators of social value. The competitive market equilibrium output with external effects could be under or over the level that is most desirable. We first define an external effect and explain how this drives a wedge between private and social evaluations. We next look at the relation between external effects and markets. Then we accommodate situations where external effects vary over time. The theory and the applications focus on the external costs involved with alcohol related driving accidents and the external benefits of preventing contagious diseases. 4.1.1 Defining an Externality External effects occur whenever someone other than the parties directly involved with a trade or transaction is affected. In the health care context, we can think of patients as the first party and the physicians and hospitals providing the care as the second party. Then third parties would be everyone else, i.e., the friends and families of the patients, other patients, other doctors and hospitals, and the rest of society. In developing countries, a very important external effect of female education is that women can read labels on medications and thus take only the appropriate tablets. Infant mortality rates decline significantly when mothers have had just one year’s education. External effects can be...

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