INTRODUCTION OF COSTS IN PHARMACOECONOMICS

PHARMACOEPIDEMIOLOGY & PHARMACOECONOMICS

PHARM-D 5TH YEAR

K.Pradeepthi
Assistant Professor
Department of Pharmacy Practice
 An economic evaluation is a study that
compares the costs and benefits of two or
more alternative interventions or services.
 Therefore, it is clear that the two major
components of an economic evaluation are
costs and benefits.
 It is important to know how costs and
benefits should be presented correctly in the
economic evaluation of a healthcare
intervention, such as a medicine or a service.
 The resources consumed in the process of healthcare
mean that there is a cost associated with any
intervention. Correct identification, measurement, and
valuation of costs is essential in health economics.
 Economic cost is difficult, but it is essential to make
sure that cost information reflects true economic cost
as closely as possible. This is not usually
straightforward in healthcare because normal markets
and pricing mechanisms are not necessarily
operating.
 For example, prescribing the highly effective antipsychotic
drug clozapine for a person with schizophrenia does not just
incur the costs of buying the drug.
 Clozapine can have serious side effects, and so regular
blood monitoring tests have to be carried out in all patients.
 Therefore, these monitoring costs must be taken into
account when the economic implications of using clozapine
are being assessed.
 A very small number of patients go on to experience serious
side effects that require hospitalisation and treatment, and
these costs must also be identified and measured.
TYPES OF COSTS
 Economic studies use a range of costs. It is
important to be able to distinguish between
the different types of costs that are used.
DIRECT COSTS
 Direct costs are those costs associated directly
with a healthcare intervention.
 Direct medical costs are the costs incurred by
the health service and are split into fixed, semi
fixed, and variable These costs include staff time,
medical supplies, hotel costs, capital costs, and
overhead costs. Also, there may be direct costs
not incurred by the health service (direct non-
medical costs). These can include:
 Patients' out-of-pocket expenses (such as
travelling or child care costs)
 Costs falling on other parts of the public sector,
such as social services (this would include the
provision of domestic help or disability pension
payments).
 Indirect costs
 Indirect costs are incurred by the reduced
productivity of a patient and their family, resulting
from illness, death, or treatment. They may include
time off work or housekeeping; time spent going to
healthcare providers; time spent caring for the
patient by relatives or paid carers; time forgone
from leisure; and other non-market activities
(Hodgson, 1994). Only the following indirect costs
can be calculated reliably from data:
 Time off work due to sick leave

 Early retirement

 Reduced productivity at work

 The significance of indirect costs depends upon
the particular illness and treatments involved.
Diseases such as asthma, migraine, and
depression affect working-age groups, whereas
other diseases, such as Alzheimer’s, do not.
 Indirect costs are difficult to measure. Also, there

are unresolved issues about including indirect

costs because this would tend to favour
interventions where the individuals are in
employment.(i.e., not children, the retired, or
housekeepers, such as the elderly).
 The alternative to this is to attach a value to

unpaid activities, such as attending school or

carrying out household duties.
 This can make economic evaluation of the
intervention produce benefits that reflect the
target group to return to work or normal
business activity. For example, this could include
the management of depressive illness, asthma,
or rheumatoid arthritis.
 Because of the difficulties in measuring indirect
costs, they are not often included in economic
studies. However, it is likely that most
intervention
EXAMPLE OF DIRECT, INDIRECT AND INTANGIBLE COSTS
IN A PHARMACY-BASED CHOLESTEROL SCREENING
SERVICE TAKING A HEALTH AUTHORITY’S PERSPECTIVE
 These costs will affect indirect costs, so they should
always be considered, if not measured. When indirect
costs are included, they can have a dramatic effect on
the results of the analysis.
 Intangible costs

 Intangible costs are difficult or impossible to measure,

but they still occur and it is of value to identify them.

They can include anxiety, pain, or suffering from an
illness or treatment.
 Fixed, semifixed and variable costs

 The costs of healthcare can be split into fixed costs

and variable costs. There is an intermediate category

called semifixed costs.
 Fixed costs

 Fixed costs are those incurred whether patients are

treated or not. The two major components of fixed costs

are overhead and capital costs.
 Capital costs
 Capital costs are incurred when major capital assets such as
counselling rooms are built, or equipment is purchased.
Overheads are those incurred by the running of the service,
such as lighting, heating, and cleaning costs.
 Variable costs
 Variable costs are incurred from a patient’s treatment. They
include disposable equipment, drugs, blood products,
investigations, and so on. Drugs and other consumables may
have prices that vary between purchasers owing to the
influence of buying groups, contractual agreements, quantity
discounts, and competitive bidding.
 Semi fixed costs
 Semi fixed costs tend to increase only when there is a
large increase in activity. This virtually always refers to
staffing costs. Staff costs may vary directly with activity,
and then they can be treated as variable costs. However,
staff costs may only increase when there is a large increase
in activity; when they are referred to as semi fixed costs.
 What costs need to be included in an economic
evaluation?
 When a medicine is prescribed or a service used, some costs
are incurred by some people and not by others. For example,
when a person goes to their local pharmacy for a cholesterol
test, the pharmacist does not bear the cost of their travel. In
an economic evaluation, the costs included depend on the
perspective of the evaluation. It is necessary to state the
perspective of the study, as this determines which costs are
included.
 Health economics focuses on the well-being of society, not just
individual patients or healthcare providers. The societal
perspective looks at all costs, including medical expenses,
lost work time, and emotional stress. However, most studies
only consider healthcare provider costs, like hospital bills
and treatment expenses. It’s important to be clear about
whose costs are being measured, as medical treatments can
also impact other sectors, like workplaces or families.
FIGURE 3.3 ILLUSTRATES THE POSSIBLE PERSPECTIVES THAT
COULD BE USED TO ASSESS THE COSTS ASSOCIATED WITH A
PATIENT HAVING A TOTAL HIP REPLACEMENT IN A UK NHS
HOSPITAL.
HOW ARE COSTS VALUED?

 How are costs valued?

 Costs can be measured using either the ‘top-

down’ or ‘bottom-up’ approach (also called

microcosting). Top-down studies use the
total budget to calculate the average cost
per patient. This method is quicker but
assumes all patients have similar conditions
and treatments, making it less sensitive to
variations. Bottom-up studies track
individual resource use, allowing for more
accurate cost assessments but are more
time-consuming and expensive.
RESOURCE USE AND
MEASUREMENT
 To measure costs accurately, resource use must
be identified. For example, when treating
depression, it’s essential to track GP visits,
appointment durations, and treatments
received over time. Resource use is measured in
physical units, such as staff hours or drug
quantities. Each resource has a unit cost (e.g.,
cost per staff hour, drug dose, or facility usage).
 Some resources, like heating and lighting, have

market prices, while others, like informal

caregiving, lack clear pricing. Economists
estimate these using shadow prices,
representing their social value.
 Costs vs Charges

 It is crucial to differentiate between the real

cost of a healthcare service and the
charges used to fund it.
 Real costs reflect the actual resources
consumed during treatment, while charges
may not always align with these costs.
 Healthcare providers often set prices based

on subsidies, profits, or budget constraints

rather than true costs.
 When to Stop Collecting Costs
 It is essential to continue collecting cost-related data
until no further events related to the original
intervention are likely to occur.
 These events may include follow-up treatments, side
effects, or complications.
 Data collection should continue until all relevant events
have stopped occurring, which could take months or
even years, depending on the condition being treated.
 The point at which data collection stops is known as the
time horizon.
 For interventions aimed at preventing future illnesses,
such as cholesterol-lowering drugs that reduce heart
disease risk, an ideal economic evaluation would track
patients throughout their lives to assess long-term
benefits (downstream medical costs). However, due
to cost constraints, studies often use a shorter time
horizon instead.
INCREMENTAL COSTS AND MARGINAL
COSTS

 Incremental cost refers to the cost

difference between two treatment options,
while marginal cost refers to the expense of
providing one additional unit of service. For
example, in a pharmacy-based cholesterol
screening, the marginal cost would be the
additional expense of conducting one more
test. Typically, this cost includes both
variable expenses and a portion of fixed
costs.
 Short-Term vs Long-Term Costs
 In economic studies, it is essential to distinguish

between short-term and long-term costs.

 Total cost refers to the overall expense of
producing a specific quantity of output within a
given period. In the short term, this cost includes
fixed and variable costs. Fixed costs do not
change with the quantity of output in the short term
and are based on time, such as capital investments
or overheads.
 Variable costs, however, fluctuate with activity

levels, such as the cost of drugs.

 The short-term total cost of a patient's treatment

includes both fixed and variable costs, but treating

one additional patient only increases variable
costs, known as the short-term marginal cost.
 In the long term, there are no truly fixed costs, as
all inputs can be adjusted. The healthcare provider
can expand or reduce activity levels, such as
building a new clinic or operating room to treat
more patients.
 This changes short-term fixed costs into long-

term variable costs, making the long-term

marginal cost equal to the short-term fixed
cost of treating more patients.
 FIXED AND VARIABLE COSTS IN A
PHARMACY-BASED CHOLESTEROL
SCREENING SERVICE-EXAMPLE
 Example of Marginal Cost (for the
1001st Patient in Indian Rupees)
 Marginal cost = Variable cost per

patient
 Components:
 Pharmacist’s time: ₹200
 Reagents: ₹50
 Disposable equipment: ₹50
 Total Marginal Cost: ₹300
 This means if 1000 patients have already
been screened, adding one more patient (the
1001st) will increase the total cost by only
₹300, as the fixed costs remain unchanged.
 Cost Breakdown for the Screening Service
 Fixed Costs:

 Refurbishment of screening area: ₹5,00,000

 Screening machine: ₹1,20,000

 Training costs: ₹1,50,000

 Total Fixed Costs: ₹7,70,000

 Variable Costs (per patient):

 Pharmacist’s time spent screening: ₹200

 Reagents: ₹50

 Disposable equipment: ₹50

 Total Variable Cost per Patient: ₹300

 Cost Calculations with Example (for 1000
Patients in 1 Year)
 2. Variable Costs for Screening 1000 Patients in

a Year
 Variable cost per patient: ₹300

 Total for 1000 patients: ₹300 × 1000 = ₹3,00,000

 3. Total Cost of Setting Up and Running the

Service for 1 Year (for 1000 patients)

 Fixed cost: ₹7,70,000

 Variable cost for 1000 patients: ₹3,00,000

 Total cost: ₹10,70,000

 4. Average Cost of Screening a Patient Over the

First Year
 Formula: Total cost ÷ Number of patients

 Calculation: ₹10,70,000 ÷ 1000 = ₹1,070 per

patient
 5. Marginal Cost of Screening the 1001st
Patient
 Marginal cost = Variable cost per patient

 Total marginal cost: ₹300

 Easy Example

 A pharmacy sets up a cholesterol screening

service, spending ₹7,70,000 on setup, machines,

and staff training. Each test costs ₹300 in
materials and staff time. If they test 1000
patients in a year, their total cost is ₹10,70,000.
 The average cost per patient is ₹1,070, but if

they test one more patient (1001st), it only costs

₹300 extra since the fixed costs remain the same
 EXAMPLE: BLOOD SUGAR TEST AT A DIAGNOSTIC CENTER 🏥
IMAGINE YOU ARE SETTING UP A SMALL DIAGNOSTIC LAB WHERE YOU
CONDUCT BLOOD SUGAR TESTS FOR PATIENTS.
YOU HAVE TWO TYPES OF COSTS:

 1. Fixed Costs (One-time setup cost –

Does NOT change with more patients)
 These are expenses that remain the same

whether you test 10 patients or 1,000

patients.
 Lab space rent = ₹20,000 per month

 Blood testing machine = ₹50,000 (one-

time purchase)
 Training for staff = ₹10,000

 ✅ Total Fixed Cost = ₹80,000

2. VARIABLE COSTS (COST PER PATIENT –
INCREASES WITH MORE PATIENTS)

 These are costs that change based on how

many tests you perform.
 Syringe and needle = ₹10 per patient

 Blood sample collection tube = ₹5 per

patient
 Test strip & reagent = ₹20 per patient

 Doctor’s consultation = ₹50 per patient

 ✅ Total Variable Cost per Patient = ₹10 +

₹5 + ₹20 + ₹50 = ₹85 per patient

 Step 1: Total Cost for 1,000 Patients
 Fixed Cost + (Variable Cost × 1,000 patients)

= ₹80,000 + (₹85 × 1,000)

= ₹80,000 + ₹85,000
✅ Total Cost = ₹1,65,000
 Step 2: Average Cost per Patient

 Total Cost ÷ Total Patients = ₹1,65,000 ÷ 1,000

✅ ₹165 per patient

 Step 3: Cost for 1 More Patient (1001st

Patient = Marginal Cost)

 If one more patient comes, you don’t need to pay

extra rent or buy another machine. You only pay

for:
 Syringe + blood tube + test strip + consultation =

₹85
 ✅ Marginal Cost (1001st Patient) = ₹85
 KeyPoints
 The average cost per patient (₹165) is

higher because it includes rent and

equipment cost.
 The marginal cost per patient (₹85) is

lower because it only includes the extra

materials and doctor’s fee.
 If you test more patients, the average cost

decreases, but the marginal cost remains

the same!
DISCOUNTING
 Definition:
Discounting is the process of adjusting costs over time because
money today is worth more than money in the future. This is
because money can be invested and earn interest over time.
 Key Points:
 Money today has more value than the same amount in the future
because it can be invested and earn interest.
 If ₹1,000 is invested at 10% interest, in one year, it becomes
₹1,100.
 If a hospital delays spending ₹1,000 on a medical machine by
one year, that money could have earned ₹100 in interest.
 The present value of ₹1,000 to be spent in one year is ₹909
today (assuming a 10% discount rate).
 Positive time preference means people prefer to spend later
rather than now.
 In healthcare, discounting is important to compare costs that
occur in different years.
 ✅ Conclusion: Future healthcare costs should be discounted to
reflect their true present value, as delaying spending can save
money due to interest earnings.
DISCOUNTING COSTS
SCENARIO:
A HOSPITAL IS COMPARING THE COST OF TWO
TREATMENTS FOR KNEE OSTEOARTHRITIS:
KNEE REPLACEMENT SURGERY (ONE-TIME COST)
PAINKILLER MEDICATION (ONGOING COST OVER 5
YEARS)
 1. What are the total costs for knee
replacement?
 The hospital pays ₹5,00,000 upfront in

Year 0.
 Total cost = ₹5,00,000

 2. What are the total costs for painkiller

treatment?
 The hospital pays ₹1,00,000 per year for 5

years.
 Total cost (without discounting) =

₹5,00,000
 3. Applying Discounting (Using a 10%

Discount Rate)
 The discounting formula is:
 4. Conclusion: Which treatment is
cheaper?
 The knee replacement cost remains

₹5,00,000 because it is paid immediately.

 The painkiller treatment appears

cheaper (₹4,16,985) after discounting.

 Discounting shows that spreading costs

over time reduces their present impact!

 Final Decision: If funds are limited, the

hospital may prefer the painkiller

treatment since it is cheaper when
discounted.
 Inflation
 Inflation refers to the general increase in prices

over time, reducing the purchasing power of

money. In healthcare, inflation affects long-term
costs, such as medical treatments and
interventions that span multiple years. Future
costs must be adjusted for inflation to reflect their
present-day value accurately.
 Inflation should not be confused with discounting.

 Healthcare interventions over many years (e.g.,

breast cancer screening) are affected by inflation.

 Prices increase in the future but generally do so

for all resources.

 Future inputs can be valued at current prices and

discounted at a real rate of interest.

 Older cost information must be adjusted for

inflation to present-day prices.

COST OF ILLNESS
 The cost of illness is the total economic
burden of a disease, including direct medical
expenses (e.g., diagnosis, treatment,
hospitalization), indirect costs (e.g., lost
wages, caregiver burden), and intangible
costs (e.g., pain and suffering). It helps in
understanding the financial impact of
diseases on individuals and society.
 Cost of Illness
 The cost of illness refers to the personal cost

of acute or chronic disease.

 It can be economic, social, psychological,

or personal (loss to self, family, or

community).
 It may reflect:
 Absenteeism (missed work)
 Loss of productivity
 Response to treatment
 Peace of mind & quality of life
 It differs from healthcare costs, which
measure the cost of providing services.
 Types of Cost of Illness
 Direct Medical Costs
 Includes: diagnosis, medical treatment, surgery,
and follow-up care.
 Example: Ischemic heart disease cost includes:
 Primary care visits
 Medications

 Cardiologist visits

 Diagnostic tests (ECG, angioplasty)

 Cardiac surgery, emergency hospital stays,

rehabilitation.
 Indirect Costs
 Includeslost time or wages of patients and
unpaid caregivers.
 Intangible Costs
 Includes pain and suffering associated with
illness.
 Importance of Estimating Cost of Illness
 Helps in planning budgets.

 Underestimation is common.

 Good data on disease progression and treatment is

essential for accuracy.

 Easy Example of Cost Calculation in Medical
Treatment (in Rupees ₹)
 Scenario:

 Imagine two hospitals treating appendicitis

patients with different anesthesia methods:

 Hospital A uses Local Anesthesia

 Hospital B uses General Anesthesia

 Each hospital treats 100 patients in a year.

 Step-by-Step Cost Calculation
 Variable Costs (Cost per Patient)
 Hospital A: ₹1,000 (anesthesia) + ₹500 (equipment)
= ₹1,500
 Hospital B: ₹2,500 (anesthesia) + ₹700 (equipment)
= ₹3,200
 Fixed Costs (Staff + Theatre Cost per Patient)
 Hospital A:
 Staff Cost: (₹5,000 ÷ 60) × 20 = ₹1,667
 Theatre Cost: (₹6,000 ÷ 60) × 20 = ₹2,000
 Total Fixed Cost = ₹3,667
 Hospital B:
 Staff Cost: (₹5,000 ÷ 60) × 40 = ₹3,333
 Theatre Cost: (₹6,000 ÷ 60) × 40 = ₹4,000
 Total Fixed Cost = ₹7,333
 Total Cost per Patient
 Hospital A: ₹1,500 + ₹3,667 = ₹5,167
 Hospital B: ₹3,200 + ₹7,333 = ₹10,533
 Which Hospital is More Cost-Effective?
 Hospital A (₹5,167 per patient) is cheaper than

Hospital B (₹10,533 per patient).

 If both methods work equally well, choosing the

cheaper option saves money.

 Real-World Example:

 Imagine a government hospital choosing between

Local vs. General Anesthesia for minor surgeries. If

both methods work equally well, the hospital
should choose Local Anesthesia to save costs and
treat more patients with the same budget.
 This is called Cost-Minimization Analysis in

healthcare! 😊