Cost-Benefit Analysis for Alternative Products

Economic Analysis

Cost-benefit analysis is one among a family of economic analyses that may be applied in particular circumstances to guide the choice among alternatives. All require that the scope of costs and benefits be specified: for instance, is cost simply the dollar amount paid, or does it include societal considerations such as whether a choice will increase pollution in some part of the world? And do benefits refer only to the immediate benefits to an individual or clearly specified group, or are more diffused social benefits also considered?

A cost-minimization analysis is the simplest, because it assumes that the outputs, or benefits, would be the same under several different courses of action and therefore seeks to identify which would have the lowest cost. For instance, a university might choose between a number of suppliers for a given product according to which offered it at the lowest price (this assumes that the products in question are identical or equivalent and that there are no other considerations such as the green policies of the suppliers). A cost-effectiveness analysis may be used when the courses of action have not only different costs but also different effectiveness in producing the output: for instance, choosing to implement one diabetes intervention plan rather than another depending on which saves the greatest number of disability days per dollar invested. A cost-utility analysis adds the opportunity to incorporate a consideration of the value of the output: for instance, measuring the benefits of a program in terms of quality adjusted life years (QALYs), which incorporates societal valuations of the quality of life in different states of health (rather than simply counting the days).

Cost-benefit analysis allows for consideration of outputs that are not common to all alternatives (e.g., increasing employment in one town versus preserving a wilderness area near another), to place those outputs on a common scale, and to determine which choice of action has the greatest net social benefit for the least net social cost. The ideas of cost-benefit analysis are not new: they date back to the 19th century, and a well-known early application dates from the 1930s and the U.S Army Corps of Engineers. They developed a system for measuring the benefits and costs of their projects in order to evaluate projects, because in the Federal Navigation Act of 1936, they were charged with carrying out projects to improve the waterway system if the benefits (broadly defined) exceeded the costs. The principles of cost-benefit analysis were further refined by economists in the 1950s, and [Page 119]there are still areas of disagreement today due to the complex nature of the questions that must be considered.

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