The document discusses various concepts related to costs in health economics. It defines costs as the value of resources used for the production of good health. There are different types of costs including accounting costs, economic costs, opportunity costs, direct costs, indirect costs, average costs, and marginal costs. Accounting costs focus on past expenditures while economic costs also include opportunity costs. Direct costs are those directly related to an intervention while indirect costs are related to productivity losses. Understanding different types of costs is important for economic evaluation, priority setting, and making efficient management decisions in health care.

1. Concept of Costs and
Cost calculation
Health Economic
BPH 3rd year

2. • Costs are bad things endured or good things
lost. Government action -- spending, taxing,
borrowing, regulating, changing property
rights or liability rules, whatever -- typically
creates both "goods" and "bads." As Kip
Viscusi (1996) explains.

3. Concept and Definition
Definition of cost
• The cost of goods and services is the value of the resources spent
for the acquisition of those goods or services, which may be
expressed as monetary or non -monetary values (Carrin, 1995).
• Health economists define cost as the value of resources used for
the production of good health. The relation between medical
inputs and output can be captured in what economists called
production function.
• Cost generally refers to the price that must be paid for an item.
• Accounts always concern with financial statement. They tend to
retrospective look at a firm’s finances.
• An economist thinks of cost differently from an accountant.
Health Economists and we hope managers take a forward looking
view of the firm.
•

4. • They are concerned with what cost is expected to
be in future, and with how the firm might be able
to rearrange its resources to lower its cost and
improves its profitability. They must therefore be
concerned with opportunity cost.
Why study cost
• Information on the cost of health care is required
for many different purposes
• Collection and analysis data on programme costs
can provide considerable useful information on
primary health services of all kinds.

5. • To indicate the amount of funds ( from all sources) likely
to be required to continue, programes they can help the
program manager to assess the use of personnel in
delivering primary health care (PHC) and the efficiency
in putting supplies , transport , resources and other
inputs to work.
• For the assessment efficiency in an input /output of any
program.
• To plan services while staying within budget. to
compare efficiency between different facilities.
• To allocate cost to different programs in order to set
prices (for consumers, insurance funds, or for use in
contracting) we also need .

6. • To understand costs in order to priorities between different
health care interventions.
• Cost information is a vital managerial tool, but it usually has to
be interpreted together with other information. For example, to
priorities between different programs requires information not
just on cost but also on benefits.
• Similarly, assessing efficiency by looking at costs alone would
be misleading: the quality of the activities and the outcomes
must be compared too.
• Costs are often the start of the process of investigation, but
they are rarely the end.

7. Different types of costs in health care;
• Accounting cost, financial and economic cost;
• Opportunity cost;
• Direct and indirect cost;
• Total, average, and marginal cost;
• Capital and recurrent cost,
• Fixed and variable cost,
• Tangible and intangible cost,
• Contingency cost ;
• Short term and long term cost;
• Explicit and implicit cost;
• Historical and replacement cost;
• Transaction cost
• Sunk cost.
• Money and real cost
• Product and period cost

8. Accounting and financial cost
• Accounting cost : The accounting cost of goods or services
may be defined as the monetary value of actual expenditure
for the acquisition of these goods and services. For
example: If the stethoscope used by a health worker HW is
purchased at a market price of Us $200,its cost is
effectively US$200. This Cost includes all such business
expenses that are recorded in the book of accounts of a
business firm as acceptable business expenses. Such
expenses include expenses like cost of raw material,
wages and salaries, various direct and indirect business,
overheads, depreciation Taxes etc.

9. • Accounting Profit = Sales Income -
Accounting Cost
• Accountants define cost in terms of resources
consumed. Accountants always have been
concerned with firms’ financial statements.
Accountants tend to take a retrospective look
at firms finances because they keep trace of
assets and liabilities and evaluate past
performance. The accounting costs are useful
for managing taxation needs as well as to
calculate profit or loss of the firm.

10. • Economist cost : Economists take forward-
looking view of the firm. They are concerned
with what cost is expected to be in the future
and how the firm might be able to rearrange its
resources to lower its costs and improve its
profitability. They must therefore be concerned
with opportunity cost. Since the only cost that
matters for business decisions are the future
costs, it is the economic costs that are used for
decision-making.

11. • Economic Cost on the other hand includes all the accounting
expenses as well as the Opportunity cost of a business firm.
Economic Cost and Economic Profit is thus calculated as
follows:
• Economic Cost = Accounting Cost (Explicit Costs) +
Opportunity Cost
• Economic Profit = Total Revenues - (Accounting Cost +
Opportunity Cost).
• Hence, from the accountant's standpoint, costs are retrospective
and objective -- they are seen from the perspective of a detached
observer .Accountants usually define costs as flows: costs reflect
changes in stocks (reductions in good things, increases in bad
things) over a fixed temporal interval.

12. Common in both concepts:
• Accountants and economists both that, costs should be measured
in terms of dollars (money).
• Both agree that cost ( benefit ) are born by individual along with
organization.
• Cost are to do something . Both follows the principle of Cost
Accounting Standards Board (CASB) calls it).
• provide perfect markets and information and holding for what
and to whom constant, the two concepts may be made to collapse
to a single identity.
• Cost can be measure in present value rather than future.

13. Opportunity Cost
• The resources of any firm operating in the
market are limited and investment options are
many. The firm therefore has to decide or select
only those investment opportunities/options
which provide the firm with the best return or
best income on investment.
• This means that if a firm can invest money/
resources only in one investment option then the
firm will select that investment option which
promises best return on investment to the firm.

14. • This can also be understood by a simple example
- Let us assume that an individual has two job
offers in hand. One job offer is promising him a
salary of Rs. 30, 000 per month while the other
job offer will ensure salary of Rs. 25, 000 per
month. If the job profile and other factors related
to the job offers are more or less same then it can
be easily expected that the individual will select
the job offer which will provide him with higher
salary that is salary of Rs. 30, 000 per month.
Thus, in this case, the opportunity cost is the
return involved in the next best alternative i.e;
Salary of Rs. 25, 000 in the next best job offer.

15. Concept of opportunity cost is closely related to the concept
of Economic profit or Economic Rent.
Economic Profit is thus earned only when following is true for
the Firm:
• Income of a Firm > Various Costs of Operations +
Opportunity Cost
• OR Economic Profit = Earnings or Revenue of Firm -
Economic Costs. Here Economic Cost is various expenses of
the business plus the opportunity cost

16. Case study :
Economists often talk about the “opportunity cost” of a particular activity. By
this they mean next best use to which the resources could have been put, if
they had not been consumed in this activity. This measure how much is ‘given
up” by carrying out the activity (and therefore it’s real cost)
• Let us take the example of Rita visiting the Maternity hospital, at Thapathali.
What are the real costs to her?
• First, there is the value of the time she spends. What would she have been
doing if she had not been attending? She might have been working and the
value of that production lost is one opportunity cost. Or she might have been
talking care of her children. That, too, is valuable, even though it may not
have a direct value in money terms.
• It has value because she enjoys it, and both she and her children. That too is
valuable, even though it may not have a direct value in money terms. It has
value because she enjoys it, and both she and the children gain from their
interaction.
• It also has value in the sense that there is cost to replacing her.-for example,
she may owe the neighbor a favor for looking after them while she is away.
These cost tend to be ignored because they may not involve actual transfer of
money.

17. • Nevertheless they are real to the patients and influence
decisions about which services to use.
• In addition, there may be a small direct financial cost: the
cost of travel, a small direct financial cost. The cost of travel,
a small gift to the doctor and buying some drugs in the
market after the visit. These resources could have been used
for food or some other desirable commodity. Again, this
alternative use measure the opportunity cost of the visit.
Direct and Indirect cost
• Direct cost include the value of all the goods, services, and
other resource that are consumed in the provision of an
intervention or in dealing with the side effects, or other
current and future consequences linked to it
• Indirect cost to refer to productivity gains or losses related
to illness or death

18. Examples of Direct costs
• Health professionals time
• Supplies and equipment
• Capital costs
• Cost for treating side effects and complications
• Costs of treating conditions during added years
of life

19. Direct non-health care costs
• Child care costs
• Home care services
• Transportation
• Special nutrition
• Time cost
Indirect costs
• Intangible or psychic costs
• Productivity gains or losses (income x days)

20. EXPLICIT AND IMPLICIT COSTS
• Explicit costs are those costs that involve an actual payment to
other parties. Therefore, an explicit cost is the monetary payment
made by a firm for use of an input owned or controlled by
others. Explicit costs are also referred to as accounting costs. For
example, a firm pays Rs. 100 per day to a worker and engages
15 workers for 10 days, the explicit cost will be Rs. 15,000
incurred by the firm. Other types of explicit costs include
purchase of raw materials, renting a building, amount spent on
advertising etc.
• Implicit costs represent the value of foregone opportunities but
do not involve an actual cash payment. Implicit costs are just as
important as explicit costs but are sometimes neglected because
they are not as obvious. For example, a manager who runs his
own business fore goes the salary that could have been earned
working for someone else as we have seen in our earlier
example. This implicit cost generally is not reflected in
accounting statements, but rational decision-making requires
that it be considered.

21. • Therefore, an implicit cost is the opportunity cost of using
resources that are owned or controlled by the owners of the
firm. The implicit cost is the foregone return, the owner of the
firm could have received had they used their own resources in
their best alternative use rather than using the resources for
their own firm’s production.

22. Cost and benefit in Economics Evaluation
Patients
Fees
Drugs
Travel etc
Direct
Health
Services
Other
organizations
Service
delivery
Higher level support
cost
Ministrie
s
Firms
Recurrent cost
Capital cost
Indirect
Patients Others
Educational effects production or
loss
Intangibl
e
Pain
Anxiety
Disability
Loss of
quality of life
Source: Witter Sophie et al (2000)

23. Averages cost (AC):
• Average cost is the cost of per unit of output. Average total cost
(A|TC) is the firm’s total cost divided by its level of output.
Basically, average total cost tells us the per unit cost of
production. By comparing the average total cost to the price of
product, we can determine whether production is profitable.
AC=TC/Q
• Average total cost (ATC) has two components: Average fixed cost
(AVC) and Average variables cost (AVC).
• Average fixed cost is the fixed cost divided by the level of output
(AVC=FC/Q)
• Average variable cost is the variable cost divided by level output
(AVC=VC/Q)
• Short run average cost is U-shaped.

24. • In the long run all costs are variables because more fixed
assets can be acquired or surplus capacity scrapped.
• The shape and slope of the long run average cost curve,
when all costs are variable, will be determined by the
extent of long run economies of scale.
Marginal Cost (MC):
• Marginal cost sometimes called incremental cost is increase in
cost that results from producing one extra unit of output.
Because fixed cost does not change as firm’s level of output
changes, marginal cost is equal to the increase in variable cost or
the increase in total cost that results from an extra unit of output.
We can therefore write marginal cost as
• MC=∆VC/∆Q=Change in variable cost/change in output
level=∆TC/∆Q
• Marginal costs tell us how much it will cost to expand the firm’s
output by one unit.

25. Unit of
outputs
Total fixed
cost
Total variable
cost
Total cost (2)
+(3)
Average fixed
cost
(2) /(1)
Average
variable cost
(3)/1
Average cost
(5) +(6)
Marginal
cost
(1) (2) (3) (4) (5) (6) (7) (8)
0 30 0 30 - - -
1 30 10 40 30 10 40 10
2 30 18 48 15 9 24 8
3 30 24 54 10 8 18 6
4 30 32 62 7.5 8 15.5 8
5 30 50 80 6 10 16 18
6 30 72 102 5 12 17 22

26. Components of cost
• The cost of production has two components (a) fixed
cost(FC)and (b) Variable cost (VC)
• Fixed cost (FC) =costs which do not vary with the
quantity of output produced. Example: Cost of hospital
infrastructure, equipments, etc are fixed cost of producing
health services. Cost behavior: Remain constant over the
relevant range
• Variable cost (VC)=Costs which vary with the level of
output. Variable cost includes expenditure on salary, wages,
drugs, food supplies fee for services etc. Cost behavior:
Increase or decrease proportionally according to the level of volume

27. • Cost function (TC)=f(Q),total cost as a function of quantity. Total
cost (TC) = cost of producing a particular quantity of output.
• Total cost (TC)=fixed cost (FC)+variable cost (VC)
Historical and Replacement costs
• The historical cost of an asset is the actual cost incurred at the time,
the asset was originally acquired.
• Replacement cost is the cost, which will have to be incurred if that
asset is purchased now.
• The difference between the historical and replacement costs results
from price changes over time. Suppose a machine was acquired for
Rs. 50,000 in the year 1995 and the same machine can be acquired
for Rs. 1,20,000 in the year 2001.
• Here Rs. 50,000 is the historical or original cost of the machine
and Rs. 1,20,000 is its replacement cost. The difference of Rs.70,000
between the two costs has resulted because of the price change of
the machine during the period.

28. • During periods of substantial price variations,
historical costs are poor indicators of actual
costs. Historical costs and replacement costs
represent two ways of reflecting the costs of
assets in the balance sheet and establishing the
costs that are used to determine net income.

29. • Sunk costs are expenditures that have been made in the past or
must be paid in the future as part of contractual agreement or
previous decision. For example, the money already paid for
machinery, equipment, inventory and future rental payments on
a warehouse that must be paid as part of a long term
lease agreement are sunk costs.
• In general, sunk costs are not relevant to economic decisions.
For example, the purchase of specialized equipment designed
to order for a plant. We assume that the equipment can be used
to do only what it was originally designed for and cannot be
converted for alternative use.The expenditure on this equipment
is a sunk cost. Also, because this equipment has no alternative
use its opportunity cost is zero and, hence, sunk costs are
not relevant to economic decisions. Sometimes the sunk costs
are also called as non-avoidable or non-escapable costs.

30. Contingency cost
• When estimating the cost for a project , product or other item or
investment, there is always uncertainty as to the precise content
of all items in the estimate, how work will be performed, what
work conditions will be like when the project is executed and so
on.
• These uncertainties are risks to the project . Some refer to these
risks as "known-unknowns" because the estimator is aware of
them, and based on past experience, can even estimate their
probable costs. The estimated costs of the known-unknowns is
referred to by cost estimators as cost contingency

31. • In micro economics , the long run is the conceptual time period
in which there are no fixed factors of production so that there
are no constraints preventing changing the output level by
changing the capital stock or by entering or leaving an industry.
• The long run contrasts with the short run, in which some
factors are variable and others are fixed, constraining entry or
exit from an industry.
• In macro economics , the long run is the period when the
general price level, contractual wage rates, and expectations
adjust fully to the state of the economy, in contrast to the short
run when these variables may not fully adjust.
• In economics and related disciplines, a transaction cost is
a cost incurred in making an economic exchange (restated: the
cost of participating in a market)

32. • Transaction costs can be divided into three broad categories. Search
and information costs are costs such as in determining that the
required good is available on the market, which has the lowest price,
etc.
• Bargaining costs are the costs required to come to an acceptable
agreement with the other party to the transaction, drawing up an
appropriate contract and so on. In game theory this is analyzed for
instance in the game of chicken On asset markets and in market b
microstructure the transaction cost is some function of the distance
between the bid and ask .
• Policing and enforcement costs are the costs of making sure the other
party sticks to the terms of the contract, and taking appropriate action
(often through the legal system ) if this turns out not to be the case.
• For example, the buyer of a used car faces a variety of different
transaction costs. The search costs are the costs of finding a car and
determining the car's condition.
• The bargaining costs are the costs of negotiating a price with the
seller. The policing and enforcement costs are the costs of ensuring
that the seller delivers the car in the promised condition.

33. Money Cost of production is the actual monetary expenditure
made by company in the production process. Money cost
thus includes all the business expenses which involve outlay
of money to support business operations. For example the
monetary expenditure on purchase of raw material, payment
of wages and salaries, payment of rent and other charges of
business etc can be termed as Money Cost.
Real Cost of production or business operation on the other
hand includes all such expenses/costs of business which
may or may not involve actual monetary expenditure. For
example if owner of a business venture uses his personal
land and building for running the business venture and
he/she does not charge any rent for the same then such head
will not be considered/included while computing the Money
Cost but this head will be part of Real Cost computation.
Here the cost involved is the Opportunity Cost of the land
and building.

34. • Cost classification from program and budget
point of view

35. Capital
Vehicles: bicycle, motor cycle, four wheel
drive Vehicles, trucks
Equipment-ray machine, micro scope, other
equipment with a unit cost (price) of US$100 or
more
Buildings, space: hospital, health centers,
administrative office, storage facilities
Training: Training activities for health personnel
that occur only once or rarely
Social mobilization, non recurrent: social
mobilization activities, eg promotion, publicity
campaigns that occur only once or rarely
Cost Classification*
by inputs by function/activity By level By source By currency
Recurrent cost
Personnel (All type): supervisors, health workers,
administrators, technicians, consultants, casual labors
Supplies: Drugs, syringes, slides, small equipment (unit cost
of less than US$100)
Vehicles, operation and maintenance: petrol, diesel,
lubricants, tires, spare parts, registration, insurance
Buildings, operation and maintenance: electricity, water
heating, fuel telephone, telex, insurance, cleaning, painting,
plumbing, roofing, electricity supply/appliances
Training, recurrent (eg short in services course)
Social; mobilization: operating costs
Other operating costs not included above
Training
Supervision
Management
Monitoring and Evaluation
Logistic and transport
Central level
Regional Level
District Level
Grassroots Level
Ministry of Health other government ministries
Local Government Bodies International Donors
Bilateral Agency Charity
Private Organizations Community groups
Individuals Etc

36. Marginal cost versus average cost
• Average cost measures total costs per unit,
• Marginal cost is the additional cost of producing one
more unit of service, it varies as volume changes.

43. Q. Why short run cost curve is U
shaped?
Short run Cost curve is composed of Total Cost, Total Fixed cost and Total
Variable Cost
Total cost = Total fixed cost + Total Variable cost
(Average cost x Quantity) = (Average fixed cost x Quantity) + (Average
Variable cost x Quantity)
At first the Average Cost is too high due to large Fixed Costs and small
outputs.
As output increases, the Average Cost accordingly falls.
When diminishing returns due to increasing variable cost, then the Average
Costs start to increase
This gives the Short Run Cost Curve a “U”-Shape.

44. Q. Why is the long run average cost
curve L shaped?
• Long run average cost curve is L shaped in some industries
because of the fact that they represent indefinite economies of
scale derived from the optimal utilization of all the factors of
production.
• In such conditions, it is quite possible that firms having L
shaped long run average cost might be a bigger firm which has
more chances to turn in to monopoly in the future because of
more access to the resources and lesser chances of expected
new entrants in the market.
• L-shaped curve shows that per unit cost for producing a
product decline initially and then forms L-shaped which shows
cost advantages for indefinite period.

45. Issues to be considered in cost calculation