Opportunity cost

This is the sixth in a series of occasional notes on economics

The concept of opportunity cost is fundamental to the economist's view of costs. Since resources are scarce relative to needs,1 the use of resources in one way prevents their use in other ways. The opportunity cost of investing in a healthcare intervention is best measured by the health benefits (life years saved, quality adjusted life years (QALYs) gained) that could have been achieved had the money been spent on the next best alternative intervention or healthcare programme.2

Opportunity cost can be assessed directly with cost effectiveness or cost utility studies. When two or more interventions are compared cost utility effectiveness analysis makes the opportunity cost of the alternative uses of resources explicit. Cost effectiveness ratios, that is the £/outcome of different interventions, enable opportunity costs of each intervention to be compared.

Although the concept of opportunity cost is fundamental, incorrect conclusions can result from difficulties in applying the concept. Firstly, the study perspective (societal, patient, etc) is critical since it determines which costs and effects to include in the evaluation.3 A societal perspective incorporates all the costs and benefits regardless of who incurs or obtains them. More restricted perspectives may mask the fact that costs are simply being shifted to another sector rather than being saved.

Secondly, the choice of comparisons can play a crucial part in cost effectiveness analysis, affecting the measurement of opportunity cost. Ideally an intervention should be compared with all relevant interventions, including doing nothing. Without a “do nothing” baseline, the best of two generally undesirable options may be chosen. Sometimes, however, the do nothing option may be unethical, such as when a new treatment is being compared with one that has been shown to be beneficial. Partly for this reason, many studies compare particular interventions with existing practice1 which may or may not be well defined. Failure to select an appropriate comparator may make the intervention appear more cost effective than it should, leading to wrong estimates of the opportunity cost.

Thirdly, the incremental rather than average cost effectiveness ratio should be estimated. The average cost per benefit (calculated by dividing the total cost of an intervention by the total benefits) may be less appropriate than the incremental ratio (derived by dividing the additional (incremental) costs by the additional (incremental) benefits).4 A recent study showed that the incremental cost effectiveness ratio for maternal age screening was 27% higher than the average ratio and concluded that the failure to consider incremental ratios could mislead decision markers about the opportunity cost of screening in Down's syndrome.4

Resources used in economic evaluations should be valued at opportunity cost, but doing this is difficult (especially in health care, where there is no perfect market),5 so unit costs tend to be used instead, based on the costs of the various inputs.

Accounting practices do not aim to measure opportunity costs.6 Opportunity costing generally requires comprehensive, disaggregated data at the individual patient level. Even then, the allocation of overhead and fixed costs is difficult since the cause and effect relation between resources and different users is difficult to determine. Since many economic evaluations use accountancy cost data, the results should be treated with some caution. The prices of pharmaceutical products may be poor estimates of their opportunity cost because the retail price reflects the patent, the regulation of profits by governments, and the sunk research and development of both successful and unsuccessful products. In practice, very few studies attempt to estimate the opportunity costs of drugs, relying instead on prices.

Finally, valuation of resources for which no market exists, such as informal care, or patient time costs, requires methods to derive what economists call “shadow prices”—the true social value (or opportunity cost)of non-marketed resources, such as time and informal care.7

Health economists disagree about the most appropriate technique for measuring the opportunity cost of time. The best valuation of the opportunity cost of time for working age adults is the wage they are, or could be making, in paid work,1 varying according to whether the time lost involves lost work or leisure time8 and the likelihood of being unemployed.9

If resources are to be allocated efficiently, then the value of using these resources in alternative ways needs to be made explicit. Despite the importance of this concept, the complexities of its application mean that few studies are even completely explicit about their estimates of opportunity costs. Greater clarity about the perspective of the study could help in clarifying the range of opportunity costs included.