Chapter 3
Cost and Benefit
Analysis
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Cost Identification Analysis
• Cost identification studies
– Measure the total cost of a given medical
condition or type of health behavior on the
overall economy
• Total cost - three major components:
1. Direct medical care costs
2. Direct nonmedical costs
3. Indirect costs
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2
Cost Identification Analysis
• Direct medical care costs
– Incurred by medical care providers
• Hospitals, physicians, and nursing homes
– All necessary medical tests and examinations
– Administering medical care
– Any follow-up treatments
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Cost Identification Analysis
• Direct nonmedical costs
– All monetary costs imposed on any nonmedical
care personnel, including patients
• Transportation to and from the medical care provider
• Home care; specific dietary restrictions
• Indirect costs
– Time costs associated with implementation of
the treatment
– Opportunity cost of the patient’s (or anyone
else’s) time that the program affects
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Cost Identification Analysis
• Druss et al. (2001)
– Total economic cost of chronic medical
conditions in 1996
– Hypertension, $121.8 billion
– Mood disorders, $66.4 billion
– Diabetes, $57.6 billion
– Heart disease, $42.4 billion
– Asthma, $31.2 billion
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Cost Identification Analysis
• Meltzer et al. (1999)
– Estimated influenza pandemic in the U.S.
•
•
•
•
89,000 to 207,000 deaths
314,000 to 734,000 hospitalizations
18 to 42 million outpatient visits,
20 to 47 million other illnesses
– Economic impact: $71.3 to $165.5 billion
• Sobocki et al. (2006)
– Cost of depression in Europe
• 118 billion euros (Direct costs = 42 billion euros)
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Cost Identification Analysis
• The American Diabetes Association (2008)
– Direct and indirect costs of diabetes in 2007
• $174 billion
– $116 billion direct medical costs
– $58 billion indirect expenses such as lost work days and
permanent disability
• The American Heart Association
– Cost of cardiovascular disease and stroke
• $448.5 billion in 2008
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Cost-Benefit Analysis
• Resource scarcity
– Forces society to make choices
• Economics - social science
– Analyzes the process by which society makes
these choices
• People - rational decision makers
– People know how to rank their preferences
from high to low or best to worst
– People never purposely choose to make
themselves worse off
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Cost-Benefit Analysis
• People - make choices
– Based on their self-interests
– Choose those activities they expect will provide
them with the most net satisfaction
• Decision rule
– If expected benefits exceed expected costs for
a given choice, it is in the economic agent’s
best interest to make that choice
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Cost-Benefit Analysis
• Optimizing rule: NBe(X) = Be(X) – Ce(X)
– X - a particular choice or activity under
consideration
– Be – expected benefits associated with the
choice
– Ce - expected costs resulting from the choice
– NBe - expected net benefits
• If NBe >0
– Economic agent’s well-being is enhanced by
choosing the activity
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Cost-Benefit Analysis
• Surgeon general
– Maximize the social utility of the population by
choosing the best aggregate mix of goods and
services to produce and consume
– Allocate land, labor, and capital resources to
any and all uses
– Maximize the total net social benefit (TNSB)
from each and every good and service
produced in the economy
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Cost-Benefit Analysis
• TNSB = TSB – TSC
– TSB - total social benefit in consumption
• Money value of the satisfaction generated from
consuming the god or service
– TSC - total social cost of production
• Money value of all the resources used in producing
the good or service
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Cost-Benefit Analysis
• TNSB from medical services
TNSB(Q) = TSB(Q) - TSC(Q)
– Q – quantity of medical services
• Maximize TNSB(Q)
– Choose Q at which the difference between TSB
and TSC reaches its greatest level
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13
FIGURE 3–1
Determination of the Effi cient Level of Output
The TSC curve represents the TSC of producing medical care and is upward sloping because total
costs increase as more medical care is produced. The curve bows toward the vertical axis because
the marginal cost of producing medical care increases as more medical care is produced.
TSC
Costs and
benefits
of medical
services
TSB
A
B
0
Q0
The TSB curve represents the monetary
value of the total social benefit
generated from consuming medical
care. The curve is positively sloped to
reflect the added monetary benefits
that come about by consuming more
medical care. The curve bows
downward to capture the fact that
society experiences diminishing
marginal benefit with regard to medical
care.
Quantity of medical services (Q)
TNSB is maximized when the vertical distance between the two curves is greatest and that occurs
at Q0 level of medical services.
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Cost-Benefit Analysis
• TSB - increase at a decreasing rate
– Diminishing marginal benefit
• Successive incremental units of medical services
generate continually lower additions to social
satisfaction
– Slope: MSB(Q) = ΔTSB/ΔQ
• MSB - marginal social benefit from consuming a unit
of medical services
• MSB decreases with quantity since the slope of the
TSB curve declines due to diminishing marginal
benefit
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Cost-Benefit Analysis
• TSC - increase at an increasing rate
– Increasing marginal costs of producing medical
services.
– Slope: MSC(Q) = ΔTSC/ΔQ
• MSC - marginal social cost of producing a unit of
medical services
• MSC increases with output as the slope of the TSC
curve gets steeper due to increasing marginal cost
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Cost-Benefit Analysis
• Maximize TNSB
– Slope of TSB = slope of TSC
– MSB(Q) = MSC(Q)
– At output level Q0
• Allocative efficiency - best quantity of medical
services
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Cost-Benefit Analysis
• MSB curve - negatively sloped
– Diminishing marginal benefit
• MSC curve - positively sloped
– Increasing marginal costs, respectively
• Efficient amount of medical services: Q0
– Where MSB = MSC
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FIGURE 3–2
Under- and Overprovision of Medical Services
Costs and
benefits
of medical
services
The MSC curve stands for the marginal social cost of producing medical care and is
upward sloping because of increasing marginal costs.
A
MSC
G
E
C
H
F
B
MSB
QL
Q0
TNSB is maximized at Q0 level of medical
care where the two curves intersect. At
that point, the MSB of consuming medical
care equals the MSC of production.
The MSB curve stands for the marginal
social benefit generated from
consuming medical care and is
downward sloping because of the
notion of diminishing marginal benefit.
QR Quantity of medical services (Q)
If QL amount of medical care is produced, then the MSB exceeds the MSC and society would be better
off if more medical services were produced. If QR amount of medical care is produced, then the MSB is
less than the MSC and too much medical care is produced.
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Cost-Benefit Analysis
• TNSB
– Area below MSB curve but above MSC curve
• Sum of net marginal social benefits
– Area ABC = maximum TNSB that society
receives if resources are allocated efficiently
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Cost-Benefit Analysis
• For QL < Q0 : MSB > MSC
– Too few medical services are being produced
– Deadweight loss: ECF
• Lost amount of net social benefits
• Cost associated with an underallocation of resources
to medical services
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Cost-Benefit Analysis
• For QR > Q0 : MSC > MSB
– Too many medical services are being produced
– Deadweight loss GCH
• Net cost to society from producing too many units of
medical services and therefore too few units of all
other goods and services.
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Cost-Benefit Analysis
• NMSB(Q) = MSB(Q) - MSC(Q)
– NMSB - net marginal social benefit the society
derives from consuming a unit of the good
• If NMSB > 0
– Total net social benefit increases if an additional
unit of the good is consumed
• If NMSB < 0
– Society is made worse off if an additional unit of
the good is produced and consumed
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23
Practical Side of Using Cost-Benefit
Analysis - Health Care Decisions
• Benefits, or diverted costs, of a medical
intervention - four broad categories:
1. The medical costs diverted because an illness
is prevented
•
Easiest to calculate
–
Estimate medical costs that would have been incurred
had the medical treatment not been implemented
2. The monetary value of the loss in production
diverted because death is postponed
•
Projecting the value of an individual’s income that
would be lost due to illness or death
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Practical Side of Using Cost-Benefit
Analysis - Health Care Decisions
3. The monetary value of the potential loss in
production saved because good health is
restored
•
Projecting the value of an individual’s income that
would be lost due to illness or death
4. The monetary value of the loss in satisfaction
or utility averted due to a continuation of life or
better health or both.
•
•
Most subjective, most difficult to quantify
Estimating the monetary value of the pleasure
people receive from a longer life and good health
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Discounting
• A benefit (or a cost) received today
– Has more value than one received at a future
date
• Present value, PV,
– Of a fixed sum of money, F, to be received a
year from now
– r - annual rate of interest (discount rate)
F
PV 
(1  r )
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Discounting
• PV of a fixed sum
– Inversely related to the rate at which it is
discounted
• PV of sums of money received over a
number of years, T:
– Ft (t = 1, 2, 3, . . . , T) equals the payment, or
net benefit, received annually for T years
F3
F1
F2
FT
PV 


 ... 
1
2
3
T
(1  r ) (1  r ) (1  r )
(1  r )
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27
Discounting
• Present value
– NB - the PV of net benefits
( Bt  Ct )
NB  
t
t 1 (1  r )
T
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28
Discounting
• Choosing the interest rate
– Affects the present value of a project
– Too high
• Choice of medical interventions that offer short-term
net benefits
– Too low
• Choice of medical projects that provide long-term net
benefits
– Should equal the rate at which society
collectively discounts future consumption
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29
Human capital approach
• Many medical interventions
– Extend or improve the quality of life
• Human capital approach
– Value of a life = the market value of the output
produced by an individual during his or her
expected lifetime
– Estimate the discounted value of future
earnings resulting from an improvement in or
an extension of life
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30
FIGURE 3–3
Present value of lifetime earnings, males & females, 2000
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31
Human capital approach
• Present value of lifetime earnings
– Initially increases with age
• Value of lifetime earnings that accrue mainly in the
middle adult years are discounted over a shorter
period of time
– Peak - between the ages of 20 and 24
– Then decreases with age
• Productivity and number of years devoted to work
decrease
– Sensitive to the discount rate
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32
Human capital approach
• Shortcomings
– Unable to control for labor market imperfections
• Gender, racial, other forms of discrimination
– Doesn’t take into account
• Value of any pain and suffering averted because of a
medical treatment
• Value an individual receives from the pleasure of life
itself
– A chronically unemployed person
• Has a zero or near-zero value of life
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33
Willingness-to-pay approach
• Willingness-to-pay approach
– How much money people are willing to pay for
small reductions in the probability of dying
– Deciding whether to purchase a potentially lifesaving medical service
• Benefit = reduced probability of dying, π, times the
value of the person’s life, V
• Purchase if benefit just compensates for the cost, C
• πˣ V = C
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Willingness-to-pay approach
• πˣ V = C
• V=C/π
– Value of the human life lower-bound estimate
• Advantage
– Measures the total value of life and not just the
job market value
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35
Should College Students Be
Vaccinated?
• Meningococcal disease
• Jackson et al. (1995)
– Cost-benefit analysis – policy to vaccinate all
college students
– Benefits - from a decrease in the number of
cases of meningococcal disease
– Cost of implementing a vaccination program for
all college students
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36
Should College Students Be
Vaccinated?
• Costs
– Cost of the vaccine ($30) multiplied by the
number of doses needed
• 2.3 million freshmen
• 80% receive the vaccine
– Estimated cost of any side effects
• One severe reaction per 100,000 students
vaccinated ($1,830 per case)
– $56.2 million a year
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37
Should College Students Be
Vaccinated?
• Benefits include
– Medical costs diverted
• Treatment costs per case = $8,145
• Costs for cases occurring in the2nd, 3rd, and 4th
years of college - discounted at 4%
• $3.1 million at 15 times the baseline rate
– Estimated value of lives saved
• Human capital approach - value of lost earnings
• Each life saved =$1 million
• $8.8 million for 2 times the baseline rate and $60.7
million for 15 times the baseline rate
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38
TABLE 3–1
Estimated Benefits and Costs for the Vaccination of College
Students against Meningococcal Disease (in millions of $)
Baseline times 2
Baseline times 15
Cost of the Vaccination Program
Total Benefits
Direct Medical Benefits
Indirect Benefits—Value of Lives Saved
$56.2
9.3
0.5
8.8
$56.2
63.8
3.1
60.7
Net Benefits—(Benefits – Cost)
-46.9
7.6
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39
Should College Students Be
Vaccinated?
• Estimated costs, baseline times 2
– Outweigh the benefits by more than $46 million
• Net benefits, baseline times 15
– $7.6 million.
• Estimated possible rate: 2.6 times
– Costs outweigh the benefits
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40
Costs and Benefits of New Medical
Technologies
• Advances in medical technology
– Driving force behind rising medical costs
– Profound effect on health and well-being of
millions of people
• Overall mortality & disability rates in the United
States have fallen consistently since World War II.
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41
Costs and Benefits of New Medical
Technologies
• Impact of medical technology on health
– Total product curve for medical care
• Relationship between health and amount of medical
care consumed
– New medical technology - improves health
• Total product curve - rotates upward
• Each unit of medical care consumed now has a
greater impact on overall health
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42
Costs and Benefits of New Medical
Technologies
• Cutler and McClellan (2001)
– Benefits outweigh the costs
– Heart attack
• 1984 – 1998: increase life expectancy by 1 year
• Net benefit: $60.000; Payoff 7 to 1
– Low-birthweight infants
• Net benefits = $200,000 per infant; Payoff 6 to 1
– Depression
– Cataracts
– Breast cancer
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43
Cost-Effectiveness Analysis
• Cost-effectiveness analysis CEA
– Estimates the costs associated with two or
more medical treatment options or clinical
strategies
– For a given health care objective
– To determine the relative value of one medical
treatment or technology over another
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44
Cost-Effectiveness Analysis
• Incremental cost effectiveness ratio (ICER)
– Compare a new medical treatment (new) with
an existing treatment (old)
– Cost of new treatment, Cnew
– Cost of existing treatment, Cold
– Medical effectiveness of new treatment, Enew
– Medical effectiveness of existing treatment, Eold
Cnew  Cold
ICER 
Enew  Eold
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45
Cost-Effectiveness Analysis
• New treatment dominate the old
– New treatment is less costly than the old
– New treatment is more effective than the old
– Adopt new treatment
• Old treatment dominate the new
– New treatment is more costly
– New treatment less effective
– Don’t adopt new treatment
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46
Cost-Effectiveness Analysis
• New treatment - more effective & more
costly than the old
– Is the gain in improved health brought about by
the new treatment worth the additional cost in
dollars?
– If the cost of a new medical treatment is less
than $50,000 per additional year of life saved it
is generally viewed favorably
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47
Cost-Effectiveness Analysis
• New treatment - less effective & less costly
than the old
– Is the decrease in health worth the cost
savings?
– CEA – provide relative cost savings per life-year
• New medical treatment / technology
– Where none previously existed
Cnew
ICER 
Enew
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48
FIGURE 3–4
The Cost-Effectiveness Plane
Net Cost +
(Cnew > Cold)
II
Net Effect (Enew < Eold)
The cost-effectiveness plane shows how CEA can be used to determine
whether a new medical technology or treatment should be adopted.
I
Old
treatment
dominates
The horizontal axis measures the net impact of a new
medical treatment or technology on health outcomes.
Review
To the right of the origin, the new treatment
relative costs
and benefits Net Effect + enhances health or life expectancy, and to the
left of the origin it diminishes health when
III
IV
Review
relative costs
and benefits
New
treatment
dominates
Net Cost (Cnew < Cold)
(Enew > Eold)
compared to the current treatment.
Net costs are measured on the vertical axis with positive
net costs scored above the origin and negative net costs
scored below the origin.
Quadrant I depicts the situation in which a new medical option
is more effective and more costly than the current procedure.
In quadrant II the new option is less effective and more costly than the current one. In this case, the current
medical option should be retained. Moving counterclockwise, quadrant III shows the case in which the new
medical option is less costly and less effective than the current one. The relevant question is whether the
reduction in cost is worth the loss in health associated with the new medical option. In quadrant IV the new
medical option dominates the old one because it is more effective and less costly.
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49
Cost-Effectiveness Analysis
• Cost effectiveness of breast cancer
screening (mammogram)
– Age 50-69, cost per year of life saved = $21,400
– Age 40-49, incremental cost-effectiveness ratio
= $105,000 per life-year saved
• Critics: life-years are not homogenous
– Medical intervention
• Significant number of life-years saved but a reduced
quality of life
• Few life-years saved but an enhanced quality of life
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50
Cost-Utility Analysis
• Cost-utility analysis
– Number of life-years saved
– Quality of life
– Adjusts the number of life-years gained by some
type of index that reflects health status, or
quality of life
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51
Cost-Utility Analysis
• Rating scales
– Quality-adjusted life-years (QALYs)
• Life expectancy ˣ Health-utility index
– Health-utility index = measure of the quality of
remaining life-years
• Scale: 1 to 0
• 1 = one year of full health
• 0 = death
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52
Cost-Utility Analysis
• Survey techniques – health-utility index
– Rating scale
– Standard gamble
– Time trade-off
• Rating scale
– Individuals rate various health outcomes
– Scale 0 to 1
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53
Cost-Utility Analysis
• Standard gamble
– Two hypothetical health alternatives
• First: less than perfect health outcome (disability)
• Second
– Successful procedure
» Probability of success = π; Perfect health
– Unsuccessful procedure
» Probability (1- π); Death
– Choose π that generates an indifferent response
between the two alternatives
– Health-utility index = π
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54
Cost-Utility Analysis
• Time trade-off
– Hypothetical choice
•
•
•
•
Live for x years in perfect health followed by death
Live y years with a particular chronic condition
y>x
Vary x until the person is indifferent between the two
outcomes
– Health-utility index = x/y.
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55
Cost-Utility Analysis
• Cost-utility ratio from a new medical
treatment or technology
– QALYs – quality adjusted life-years
Costnew - Cost old
No. of QALYsnew - No. of QALYsold
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56
Cost-Utility Analysis
• Critics
– Survey techniques
– Discrimination
– Does not tell us whether the overall well-being of
society is increased
– Just whether one medical treatment or
technology is more cost effective than another
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57
Cost-Utility Analysis
• Neumann et al. (2000)
– Effectiveness of prescription drugs
• Mean ratio of $11,000 per quality-adjusted life-year
– Immunization - $2,000 per QALY
– Medical procedures - $140,000 per QALY.
– Surgery - $10,000 per QALY
– Screening at $12,000 per QALY
• Stone et al. (2000)
– Effectiveness of clinical preventive services
• Median cost utility ratio = $14,000 per QALY
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58
Cost-Utility Analysis
• Digital vs. film mammography
– Digital - superior in its ability to detect cancer for
certain subpopulations
• Far more expensive
– Tosteson et al. (2008)
• Replacement of all-film mammography screening with
all-digital = cost $331,000 per QALY gained
• Targeted-digital mammography screening
– Women 50 and younger - $26,500 per QALY
– Women 50 and younger plus women older than 50 with
dense breasts - $84,500 per QALY
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59
TABLE 3–2
An Example of Cost Effectiveness and Cost-Utility Analysis
Treatment option
Cost
Life-years gained
Health-utility index
QALY
Current procedure
$20,000
2 years
0.7
1.4
New procedure
$110,000
8 years
0.4
3.2
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60
Autologous Blood Donations Are They
Cost Effective?
• Autologous blood donation
– Donor and recipient are the same person
• Allogeneic blood donation
– Donor and recipient are different people
• Autologous blood donation
– Safer
– More costly
• More administrative and collection expenses
• Higher discarding costs
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61
TABLE 3–3
Estimated Cost Effectiveness of Autologous Blood Donations
Total Hip
Coronary-artery
Replacement Bypass grafting
Abdominal
Hysterectomy
Transurethral
Prostatectomy
$68
$107
$594
$4,783
QALY per unit
transfused
0.00029
0.00022
0.00044
0.00020
Cost effectiveness
(row one/row two)
$235,000
$494,000
$1,358,000
$23,643,000
Additional cost
per unit of autologous
blood transfused
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62