Economic Foundations of Cost Effective Analysis

Alan M. Garber, Charles E. Phelps

NBER Working Paper No. 4164
Issued in September 1992
NBER Program(s):   HC

In order to address several controversies in the application of cost-effectiveness analysis, we investigate the principles underlying the technique and discuss the implications for the evaluation of medical interventions. Using a standard von Neumann-Morgenstern utility framework, we show how a cost-effectiveness criterion can be derived to guide resource allocation decisions. We investigate its relation to age, gender, income level, and risk aversion. Cost-effectiveness analysis can be a useful and powerful tool for resource allocation decisions, but in the presence of heterogeneous preferences and personal characteristics, a cost-effectiveness criterion that is applied at the population level is unlikely to yield pareto-optimal resource allocations.

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Published: Journal of Health Economics, Vol. 16 (1997): 1-31.

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