Chapter 3: Types of Costs and their Measurement
3.1 INTRODUCTION We continue our analysis of costs within the context of CM and focus on how to measure these costs. We know that ‘cost’ means opportunity cost; but this cost comes in many forms, in particular, marginal, average, overhead, sunk and joint. It is MC cost that is most useful for evaluation purposes. However, often we have information only on AC. Worse still, we are usually faced with hospital or physician charges that may not even reﬂect AC. After presenting the main cost concepts, we examine the link between markets and costs. Market prices are often used to value resource inputs in health care. We shall see that only competitive market prices can be used for this valuation purpose. The next section examines in detail the relation between charges and costs, highlighting the use and misuse of the hospital cost-to-charge ratio. The applications cover the two main cost components in health care: hospital and physician services. 3.1.1 Marginal versus Average Cost MC refers to the cost of one more or less unit, while AC looks at all the units produced and divides the total cost by the number of units. The basic problem with using AC is that some of the units produced in the past incur ‘sunk costs’, i.e., costs that cannot be recovered. Often a machine installed for one particular use may not be used for anything else. By deﬁnition its opportunity cost is zero (if it has no scrap value). If to produce the...
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