PHARMACOECONOMICS –
CHAPTER 2
Lebanese International University
School of Pharmacy
Fall 2021-2022
Measuring and Estimating
Costs
Objectives • Define different costing terms
• Categorize types of costs
• Determine the perspective of a study
based on types of costs measured
• Understand when adjusting for timing
of costs is appropriate
• Calculate net present value
• Compare average costs with marginal
or incremental costs
• List common sources for obtaining cost
data
Costs • In business, costs may be defined as a
monetary valuation of efforts, material,
resources, time and utilities consumed, risks
incurred, and opportunity foregone in the
production and delivery of a good or service.
• All expenses in this case are cost components,
but not all costs are expenses.
• In economics, costs may include a wider
concept of resource, where no monetary
payment is made.
• Based on economic theory, the “True” cost of
a resource is its opportunity cost
Total Cost • Total cost (TC) = variable costs (VC) + fixed costs
Equation (FC)
• Variable costs are costs that change as the
quantity of the good or service that a business
produces changes i.e. they vary based on the level
of output.
• Examples: sales commissions, direct labor costs,
cost of raw materials used in production, and
utility costs ( electricity, phone bills…)
• Fixed costs are business expenses that are not
dependent on the level of goods or services
produced by the business. They tend to be time-
related.
• Examples: interest or rents being paid per month,
and are often referred to as overhead costs.
• Average Cost (AC): in economics,
Average average cost or unit cost is equal to total
Cost cost divided by the number of units of a
good produced.
• Average costs may be dependent on
the time period considered.
Marginal and • Marginal cost is the change in the total cost that
arises when the quantity produced is
Incremental incremented by one unit; that is, it is the cost of
Costs producing one more unit of a good.
• An incremental cost is the difference in total
costs as the result of a change in some activity.
Incremental costs are also referred to as the
differential costs and they may be the relevant
costs for certain short run decisions involving
two alternatives.
Exercise 1 • The following table represents the costs and
effectiveness of two antibiotics X and Y.
• Calculate the average cost effectiveness for each
alternative, then calculate the incremental cost
effectiveness ratio
Solution
Price • A price is the quantity of payment or
compensation given by one party to
another in return for one unit of goods or
services.
• A price is influenced by production costs,
supply of the desired item, and demand for
the product.
• In modern economies, prices are generally
expressed in units of currency.
• Price= cost + profit
Reimbursement • Reimbursement is money paid to an
employee or customer, or another
party, as repayment for a business
expense, insurance, taxes, or other
costs.
• A reimbursed amount is usually higher
than the cost of the hospital to provide
a service and lower than the standard
charge listed by the hospital
• Social security and tax refunds are
forms of reimbursement.
Costs’ One method of costs’ categorization
classifies costs into fur categories:
Categorization
• Direct medical costs
• Direct nonmedical costs
• Indirect costs
• Intangible costs
Direct • Direct medical costs include the cost of
a defined intervention and all follow-up
Medical costs for other medication and health
Costs care interventions in ambulatory,
inpatient, and nursing care.
• These costs are the most obvious to
measure.
• Examples include costs of medications,
lab tests, physician consultation,
hospitalization service.
Direct • Direct nonmedical costs are
patient/family expenditures associated
Nonmedical with an illness, but are not involved in
Costs the direct purchasing of medications or
medical services.
• These may include such expenditures
as travel, lodging, baby sitting and
home services (e.g., home health aide,
support bars in the bathtub).
Indirect • Indirect costs are not directly accountable to a cost object.
Costs • They involve the costs resulting from the loss of productivity
because of illness or death.
• When a person is sick and he/she cannot to work. A certain
amount of money would be deducted from his salary, or
he/she would be given their wages loss
• If this person has his/her own business, they may close it
until recovery or would not be able to resume normal
performance/opening hours... loss
• If family member will be taking care of the ill person, he/she
will not be able to g to work loss
• Thus indirect benefits occur when indirect costs are avoided.
Intangible • An intangible cost is a cost that can be
identified but cannot be quantified or
Costs accurately estimate.
• Intangible costs include the costs of
pain, suffering, anxiety, or fatigue that
occur because of an illness or the
treatment of an illness.
Alternative • An alternative method of costs’
categorization was developed due to a
Method of conflict about the definition of indirect costs,
Costs’ which refers to the costs of overhead in
accounting.
Categorization
• This method categorized costs into the four
following categories:
• Health care sector costs
• Costs to other sectors
• Patient and family costs (direct medical and/
or nonmedical)
• Productivity costs (instead of indirect cost)
Health Care • The actual costs of providing services related to
the delivery of health care, including the costs
Sector Costs of procedures, therapies, and medications.
• It is differentiated from HEALTH
EXPENDITURES, which refers to the amount of
money paid for the services, and from fees,
which refers to the amount charged, regardless
of cost.
• Healthcare costs are usually subdivided as
follows:
• Variable costs: (e.g. drug acquisition costs,
costs of other consumables such as needles and
syringes)
• Fixed costs: (e.g. capital costs of building or
equipment; staff salaries)
Benefits • Benefits are the advantage or profit gained from
something.
• Direct benefits arise from receiving the
intervention being studied. They represent the
potential savings resulting from the avoidance of
use of health resources.
• Indirect benefits represent the potential increased
earnings or productivity gains that would not have
been possible without the particular health
program.
• Intangible benefits are derived from avoiding the
pain and suffering. However, it is difficult to
quantify them.
Measurement • Costs are usually measured in monetary
units.
of Costs and
Benefits • Benefits might be measured in the
following ways:
• Natural Units (like in CEA)
• Utility Units (Like in CUA)
• Associated Economic Benefits
Perspective • Perspective is the point of view from
which the study is conducted.
• From whose point of view are the costs
and consequences being evaluated.
• There are four types of perspectives in
pharmacoeconomics.
Types • Hospital Perspective : is the perspective of the institution
of
or provider such as hospital or clinic. It is primarily
concerned with direct medical costs that specifically
Perspectives affects its budget.
• Payer Perspective: may include the costs to the third-
party plan, patient and family, or a combination of the
patient copayments, lost wages, transportations etc.
• Patient perspective
• Societal Perspective is the most appropriate and
comprehensive perspective according o the economic
theory. Where societal costs include costs to the:
insurance company, patient, other sector costs and
indirect costs.
Timing • When costs are estimated from
information collected for more than 1
Adjustment year before the study, adjustment of
For Costs costs is needed.
Methods:
• Standardization
• Discounting
Standardization • Standardization of costs means
bringing past costs to the present.
• When retrospective data are used to
assess resources used over a number of
years back, adjustment of costs should
be made; that is the monetary values
should be valued at one point in time.
• Because the value of money does not
remain the same over time, and thus
the cost of a treatment in 1990 will not
have the same monetary value as its
cost in 2020. (inflation!)
Standardization • First method
Methods • Is done by calculating the number of
units(doses) used per case and
multiplying this number by the current
unit cost for each medication.
• Second method
• Multiply by an Inflation Rate (medical
inflation rate)
Standardization Example using the number of
units
Use the given number of units and multiply them by the present price of each (or the price
that refers to the year of interest).
Standardization Using CPI
Discounting • Discounting stands for bringing future
costs (benefits) to the present.
• Discounting is a technique used to
reflect the present value of a cost or
health benefit that will occur at some
future date.
• The discount rate for health care
interventions is between 3% and 6%.
Discounting • future
costs and benefits are translated
into their equivalent net present value
(NPV).
• NPV =
• A: cost or benefit accrued after time (n)
• r: discount rate
• n: number of years with the present
time being 0
Discounting • When the costs are assessed at the
beginning of each year the first year will
have a (n) value of equal to 0.
• When costs are assessed at the end of
each year the same formula applies but
with year 1 having a (t) or (n) value of 1
Exercise 2 • Calculate the NPV for therapy X, given that
costs are assessed at:
• A) the beginning of each year with a
discount rate of 5%
• B) the end of each year with a discount rate
of 5%.
Solution A
Solution B
Resources for • Sources of estimates for four types of
common direct medical cost categories
Cost are addressed:
Estimations
• Medications
• Medical services
• Personnel costs
• Hospitalizations
• Sometimes the cost estimations are
collected retrospectively from medical
records and reimbursement claims data.
Medications • The Average Wholesale Price (AWP): is the
national average price assigned to a vaccine or
drug by its manufacturer, and is compiled by
various vendors.
• AWP is considered as the “list price” or “sticker
price” (the cost of the drug) plus (depending on
the vendor) a 20-25 percent mark-up and excise
tax.
• AWP is often used when calculating the cost of
pharmaceutical products in the US.
• Average Manufacturer’s Price (AMP):is the
average price paid to the manufacturer for the
drug by wholesalers for drugs distributed to
retail community pharmacies after all discounts
are made.
Medical • Frequently included under Direct
Medical Cost estimates
Services
• Includes clinic visits, lab or surgery
procedures
• Providers have a “list price” but payers
usually pay less than that price
Personnel • To estimate these costs, the amount of
time spent in the activity would be
multiplied by the salary plus fringe
benefits of pharmacists .
• Time spent doing procedure can be
monitored.
• The number of patients covered per
units of time can be measured.
• When analyzing the personnel cost the
perspective is that of the provider of the
healthcare service.
Hospitalizations • Studies that include hospital costs vary
in precision from gross or macro-costing
to the more precise micro-costing.
• The methods adopted to estimate
hospital costs:
• Per diem
• Disease-specific per diem
• Diagnosis-Related Group (DRG)
• Micro-costing
Hospitalizations The level of accuracy used depends on:
• The importance of the cost at study
• The perspective of the study
• The availability of cost data
• The availability of resources (more
precision means more resources)
Per Diem • The least precise method where an
average cost per day is used as a
multiplier for all types of
hospitalizations
• If the average cost reimbursement per
day of hospitalizations of all patients is
$2000, then the cost for a 3-day stay for
a cardiac bypass or an appendicitis
would be $6000
Disease- • Uses estimated costs per day for a
specific disease, which is more precise
specific Per
Diem • 3-day stay for appendicitis would be
$4500 while that of a bypass case would
be $30,000
Diagnosis- • This method is used to classify clinically
cohesive diagnoses and procedures that
related used similar resources.
Group (DRG)
Micro- • Micro-costing involves collecting
information on resource use for each
costing component of an intervention to
estimate and compare alternative
interventions.
• The most accurate method where
information
• For example we would go through the
patients’ hospital records to determine
the used services/medications and
assign a cost to each
Final
Thought • Costs categorization and adjustment
are involved in the left hand side of the
pharmaco-economic equation.
• The right hand side will be discussed in
the following chapters.
Practice • A pharmacist need to invest in a clinic.
Our costs for the coming three years
Problem 1 varied.
• Year 1 expenses: 8000
• Year 2 expenses: 6000
• Year 3 expenses: 7000
• Considering that the costs are assessed
at the end of each year and the discount
rate is 3% fill in the table on the next
slide.
Solution
Year Cost($) Adjusted Cost Results ($) Savings($)
1 8000 8000/(1+0.03) 7766 234
2 6000 6000/(1+0.03)² 5665 335
3 7000 7000/(1+0.03)³ 6598 402
Total 21000 20029 971
Practice • A retrospective study is being applied
by an agency to evaluate the costs of its
Problem 2 services going back to 2016.
• Variations were as follows:
• 2016 to 2017 it is 3%
• 2017 to 2018 it is 3.5%
• 2018 to 2019it is 3.5%
• What is the present 2018 value in $ of
the services?
Solution • $20,000 x 1.03= 20,600 x 1.03=21,218 x
1.03= $21,854
• $20,000 x 1.035=20,700 x 1.035 =$ 21,424
• $15,000 x 1.035=15,525
• 10,000
• Total=
21,854+21424+15525+10,000=68,803
Practice • What is the perspective & type of cost?
Problem 3 • An out-patient clinic evaluating the effect of a new
pain medication:
• Provider(Hospital), Direct medical cost
• The cost of illness analysis of various Migraine
treatments:
• societal(Hospital, insurance, non healthcare
Public)
• Analyzing the difference between the amount
charged by the hospital and that paid by third party
payers for two therapies to determine which
approach recommends fewer copayments by the
patient:
• Payer(Patient) Cost=Direct Medical