Introduction To Pharmacoeconomics (Phar 4211)

By: Gizachew Tilahun
Assistant Professor
By Gizachew T. Jimma University School of Pharmacy 1

Chapter One:
1.1. Applications of economic principles in health
care and pharmacy

What is Economics
 Definition
 Scarcity and economics
 Choice among competing demands and economics
 How people make decisions
 How people interact to each other
 How the economy as a whole works
 Principles of economics

Economy. . .
. . . The word economy comes from a Greek word for “one who manages a
household.”

1. Introduction
Economics is:
 The study of how individuals & society end up choosing, with or without
the use of money, to employ scarce resources that could have alternative
uses, to produce various commodities & distribute them for consumption
now, now or in the future, among various people and groups in society.
“Paul Samuelson”

ECONOMICS DEFINITIONS
Economics is the study of how society manages its
scarce resources.
1. The science of household affairs, or of domestic
management.
2. Political economy; the science of the utilities or the
useful application of wealth or material resources.
 Utility (Polit. Econ.) Adaptation to satisfy the
desires or wants; intrinsic value

Definition of Economics
 Mankiw’s definition
 How Society manages its scarce resources
 Hedrick’s definition
 How society chooses to allocate its scarce resources among competing
demands to best satisfy human wants
 Alternative definitions
 Economics is the study of choice.
By Gizachew T. Jimma University School of Pharmacy slide 7

… Intro..
 Economists studies
 How people make decisions.
 How people interact with each other.
 The forces and trends that affect the economy as a whole.

Scarcity and the Fundamental Questions of Economics
 Scarcity : Unlimited wants versus limited resources
 Choices and tradeoffs
 Opportunity Costs
 All societies must answer the WHFM questions
 What is to be produced?
 How is to be produced?
 For whom will it be produced?

Economics is about …
 Limited resources
 Unlimited “wants”
 Choosing between which

‘wants’ we can ‘afford’
given our resource
‘budget’
Economics is about choice
Good ‘B’
Good ‘A’
Budget

Economists view of the world...
 Pessimist: bottle ½ empty

 Optimist: bottle ½ full
 Economist: bottle ½ wasted
inefficient!

Ten principles of economics
 How people make decisions
1. People face tradeoffs.
2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. People respond to incentives.
 How people interact
5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Governments Can Sometimes Improve Market Outcomes.
 How the economy as a whole works
8. The standard of living depends on a country’s production.
9. Prices rise when the government prints too much money.
10. Society faces a short-run tradeoff between inflation and
unemployment.

Ten Principles of Economics
(A) How People Make Decisions
 (1) People face tradeoffs.

 “There is no such thing as a free lunch.”
 To get one thing that we like, we usually have to give up another thing that we
like. Making decisions requires trading off one goal against another.
 Ex. Consider a student who must decide how to allocate her most valuable
resource— her time.
Pharmacoeconomics, Chapter 1 By: Gizachew T. slide 14

…Ten Principles of Economics
(A) How People Make Decisions…
 (2) The cost of something is what you give up to get it.

 Because people face tradeoffs, making decisions requires comparing the costs
and benefits of alternative courses of action
 Consider, for example, the decision whether to go to college
 What are the benefits?
 What are the costs ?

 (3) Rational people think at the margin.

 Economists use the term marginal changes to describe small incremental
adjustments to an existing plan of action.
 For example, consider an airline deciding how much to charge passengers
who fly standby. Suppose that flying a 200-seat plane across the country costs
the airline $100,000.
 What is the marginal cost of flying a standby passenger?
 the marginal cost is merely the cost of the bag of peanuts and can of soda that
the extra passenger will consume.

• (4) People respond to incentives.

 Because people make decisions by comparing costs and benefits, their behavior may
change when the costs or benefits change. That is, people respond to incentives.
 Public policymakers should never forget about incentives, for many policies change the
costs or benefits that people face and, therefore, alter behavior.
 A tax on gasoline, for instance, encourages people to drive smaller, more fuel-efficient
cars.
 It also encourages people to take public transportation rather than drive and to live
closer to where they work.

Important Terminologies
 Value
 Utility
 Cost
 Price
 Valuation
 Goods
 Normal goods
 Inferior goods
 Complement goods
 Substitute goods

R E A D
 Demand and supply and the d/t factors affecting it
 Demand and supply curve and the effect of the d/t factors on it
 Price determination

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Definitions
 Market = where demand and supply adjust through price.  can be
seen as a tool or mechanism, for allocating resources in a society.
 Market failure = all the ways in which a specific market may not meet
the conditions for social optimality.
E.g. if there are barriers to entry, or a lack of information, then that market will fail to produce
the best possible outcome.
 In bureaucracies  “government failure” = the ways in which a
bureaucratic approach may fail to optimize social welfare.
Market mechanism
 Markets produce goods efficiently  Market distribute goods according
by balancing demand and supply to the ability and willingness of
through the price mechanism consumers to pay for them –
demand/supply.
Conditions for perfect market
1. Perfect information
- Symmetric
2. ‘Rational’ behavior
- Incorporating both individual and societal costs/benefits
3. Market exists
- for all products desired by all people
4. Many buyers and sellers, homogenous products
- so each is price taker
5. Equity or politics not considered
Market failures
1. Imperfect information
2. “Irrational” behavior
3. Externalities
4. Public goods
5. Incomplete competition
 Reason for government intervention:

Regulation, legislation, provision, …
Also: social equity

Information asymmetric
= One party to a transaction has better information that the other.
e.g. car salesman, market for insurance or credit.
Leads to less than ideal provision:

-People avoid products
-People pay less/more than what is might be worth
Unless:
-use of warranty, reputation
-Performance related payments
-Norms and standards
Information asymmetry - Health
Uncertainty about products:
 Knowledge patient/doctor
 Difficult to distinguish products (heterogeneous)
 Supplier-induced demand
 Over/under-production
 Low quality, high price
 Role government:
 Accreditation
 Quality Assurance
 Health education
“Irrational” Behavior
= People might not always do what is best for themselves (still “rational”
choice based on personal utility)
Leads to:
- Over-consumption of “bad” goods (cigarettes)
- Under consumption of “good” goods (education)
Need to change incentives…

“Irrational” behavior - health
 Merit goods (good goods)
= vaccines, vitamins, physical activity
 De-merit goods (bad goods)

= cigarettes, drugs, speed
 Health education
 Subsidising / taxing consumption
 Legislation
Externalities
 Side-effect of consumption or production of goods and services, that are not
considered when consuming/producing.
 Positive externalities: e.g. well-kept front

garden, public artwork,
 Individual benefit < social benefit
volunteer, vaccine
 Individual cost > social cost
 Under-production / consumption
 Negative externalities:
 Individual benefit > social benefit
e.g. pollution, over-
fishing, smoking
 Individual cost < social cost
 Over-production / consumption
Externalities - Health
 Positive externalities
 E.g. prevention contagious disease, immunization, treatment STDs, caring
  benefit of consumption/production is lower for individual for society as a

whole
  price paid will be below price it is worth
  supply will be below what is ideal for society
 Subsidize consumption/production
 Provision  create market
 Funding
Public Goods
 = non rival and non-exclusive good
No additional costs No one can be
of extra consumer excluded from
consumption
 E.g. radio broad cast, fresh air…
 Impossible to set a price:

 Non payers can not be excluded
 Extra consumer doesn’t lead to extra costs
 No body willing to pay (free riding)
 Nobody willing to supply
Public goods - Health
Healthy society:
Everyone benefits
Incentive to “free ride”: leave the healthy life-style and preventive measures to
others.
e.g. incentive not to be vaccinated if everyone else is?

Who would invest in R&D for medicines in a completely liberalized private market?
Role of government:
-Subsidize consumption/production
-Provision
-Funding
-Regulation (e.g. patient law)
Incomplete competition
= One or few providers of goods (monopoly: single seller), or one or few buyers of
a goods (monopsony: single buyer), who thus have power in the market to
influence prices.
e.g. OPEC: artificially high prices because of power of suppliers (as long as no
alternatives)
 artificial shortage of oil
e.g. hirer of daily wage labour: few offering work (demand), ability to pay very low
wages (low price)
 artificial surplus of labour
Incomplete competition - Health
 Health care facilities often monopolies:
 High start-up cost (investment in building and equipment, risks)
 High barriers to enter market as supplier (specialized, long training, licensing)
 Limited choice for consumer:

 Price set higher that costs, no incentive to be efficient or to provide quality services
 Role of government:
 Provision
 Quality control
 Price regulation
 Legislation
Equity
 Equity = being fair or just.
 Perfect market
  technical (how) and allocative (what) efficiency,

regardless of who gets
 so inequality is not a market failure
BUT
Still reason for government intervention
Trade-off between equity and efficiency?
Social welfare as positive externalities?

Equity - Health
 Health = Human right
 Ethical duty of health workers to treat according to need, not ability to pay.
 In private market:
Less supply at higher price than ideal for society
 Guarantee human right for good health
 Provision
 Subsidizing
 Funding
Recap…
D=S, price adjusts, efficiency
Perfect market
1. Imperfect information
2. “irrational” behavior
Market failures
3. Externalities
4. Public goods
5. Incomplete competition
6. Equity
Government intervention
Legislation, regulation, subsidizing/taxation, funding, provision, social protection,
…
Government failures
1.2. Introduction to Pharmacoeconomics

Chapter Objectives
 At the end of this chapter you will be able to
 Define Pharmacoeconomics
 Understand the importance and clinical relevance of Pharmacoeconomics
 Understand the relationship with other relevant fields
 List and describe differences between the four common pharmacoeconomics
studies

Introduction to Pharmacoeconomics
 New technologies including medicines are usually expensive

 If a given new medicine is known to be effective over the existing one did
the extra benefit of the new medicine worth the extra cost?
 To answer this question one needs to perform an economic analysis
 The economic analysis of pharmaceuticals and therapies that evaluates
the cost and outcomes alternative choices is …………..

1.1. Introduction to Pharmacoeconomics
Pharmacoeconomics
Definitions
 Pharmacoeconomics is an economics discipline that evaluates the
behaviour of individuals, firms and markets relevant to the use of
pharmaceutical products, services and programmes.
 It focuses on the costs (inputs) and consequences (outcomes) of such
a use. It applies the theories and tools of economics, including Managerial
Economics, to the science and business of pharmaceuticals.
 It can be defined as the description and analysis of the cost of drug
therapy to healthcare systems and society.

Introduction
Pharmacoeconomics
Definitions
 More specifically, pharmacoeconomics research is the process of
 identifying, measuring, and comparing the costs, risks, and benefits of
programs, services, or therapies
 determining which alternative produces the best health outcome for the
resource invested.

Introduction
Pharmacoeconomics
Definitions
 “Research that identifies, measures and compares

 the costs (resources consumed) and the Economic, Clinical and Humanistic
Outcomes of diseases, drug therapies and programmes directed to these
diseases.”
 Determination of „Value for money” of health care programms in the
context of limited resources

Introduction
Pharmacoeconomics
Definitions
 For most practitioners, this translates into
 weighing the cost of providing a pharmacy product or service against the
consequences (outcomes)
 which alternative yields the optimal outcome per dollar spent.
 This information can assist clinical decision makers in choosing the most
cost-effective treatment options.


… intro…
 Different countries invest d/t proportions of their GDP on health care
 Some invest very little proportion of the GDP and some higher proportion
 Which countries will get higher outcome of their investment?

Why study Pharmacoeconomics?
Health Expenditures as a % of GDP by Country
18.0
16.0
14.0 Canada
12.0 France
% GDP
10.0 Germany
8.0 Japan
6.0 United Kingdom
4.0 United States
2.0
0.0
70
75
80
85
90
95
00
05
19
19
19
19
19
19
20
20
Year

But when it comes to outcomes…
Life Expectancy at Birth by Country
84
81
Canada
78
Years of Life
France
75
Germany
72
Japan
69
UK
66
US
63
60
61
66
71
76
81
86
91
96
01
04
19
19
19
19
19
19
19
19
20
20
YEAR
So…
 What are we doing wrong?
 And how can we improve our performance?

 by spending less
 getting better outcomes

Pharmacoeconomics
Definitions
Cost Rx(interventions) Outcomes
Pharmacoeconomics

Introduction
VALUE
Health
Cost
Outcome

1.2. Rationale
 The United States spent about $2.7 trillion on health care in 2010, for an
average of about $8,000 per person, or about 17% of the gross domestic
product (GDP).
 About 12% (over $900 per person) of health care expenditures were for
medications
 Health care costs have been increasing each year more than the average
rate of inflation.
 This continued increase in costs has resulted in a need to understand how
limited resources can be used most efficiently and effectively

1.2. Rationale
 For example, two medications that were approved by the U.S. Food and Drug
Administration (FDA) in 2012 (Kalydeco for cystic fibrosis and Gattex for short
bowel syndrome) are planned to be priced at about $300,000 per year.
 It has been argued that these medications save enough—by decreasing the
number of hospital admissions or the need for parental nutrition—to offset
their high cost.
 Clinicians want their patients to receive the best care and outcomes available,
and payers want to manage rising costs.
 Pharmacoeconomics combines these objectives by estimating the value of
patient outcomes received for the expenditures spent on medications and other
health care products and services.
1.2. Rationale
 The result of Pharmacoeconomic analysis is used to make important

decisions at different level
 Individual patient level
 Group of patients
 Large group of patients
 National or societal level

Example (individual patient level)
 If a new branded medication is approved by the FDA that has an advantage over
another marketed medication that is less expensive, the professional can take
this into account. For example, if the new treatment is $100 per month ($40
patient co-pay, and $60 reimbursement by health insurance) compared with a
similar treatment that is available for $20 per month ($5 patient co-pay, and $15
reimbursement by health insurance),
 is the extra $35 per month out-of-pocket costs worth it to the patient?
 If the advantage is slight (e.g., more convenient once a-day dosing compared
with twice-a-day dosing of its competitor), the patient might not value the
added convenience at $35 per month.
 But if the advantage is a reduction in side effects (e.g., no diarrhea or no daytime
drowsiness), the added advantage may be worth the added cost

1.2. Rationale
Why PECo? Rationale

 The purpose of Pharmacoeconomics is to establish the relative worth of a
product/service that can be used by decision-makers who face limited
budgets.

Rationale
Why PECo? Rationale

 Without systematic analyses, it is difficult to identify clearly the
relevant alternatives
 Viewpoint assumed in an analyses is important
MOH, Patient, society
 Without some attempt at measurement, the uncertainty surrounding

order of magnitude can be critical

Rationale
Pharmacoeconomics
 Should clinicians check the blood pressure of each adult whom they see?
 Should an expensive new drug be approved for use?
 Should a hospital buy a new expensive diagnostic instrument?
 Should a drug A be used instead of surgery?

Rationale
Importance of PECo
 Pharmacoeconomics thus addresses critical questions like
 Are there two or more alternatives?
 Do the interventions examine cost and health effects?
 Which drugs should be included in a hospital formulary?
 Which is the best drug for a particular patient?
 Which is the best drug that a Pharma manufacturer can develop?
 How can two clinical pharmacy services be compared?

Rationale
Importance of PECo
 Which drug delivery system is the best for a hospital?
 Will a patient’s quality of life improve by a particular drug therapy decision?
 Which is the best drug for a particular disease?
 What are patient outcomes of various treatment modalities?
 Which drug distribution system assures availability of EDs

Rationale
Importance of PECo
 By addressing these questions, Pharmacoeconomics becomes important
and relevant to all the different stakeholders of the Healthcare and
Pharma industry of any country.

Application of Pharmacoeconomics
Pharmacoeconomic Studies
Research and Pricing and Communication

Development Reimbursement to Physicians
Strategy Strategy and Patients
Phase II Phase III Regulatory Marketing

Phase Phase
Economic evaluation always involves a comparative analysis
of alternative courses of action
ConsequencesA
Program A
CostsA
Choice
ConsequencesB
CostsB
Program B
Source: Methods for the Economic Evaluation of
Health Care Programmes: Drummond 1997
Types of Evaluations
Are both costs and consequences of
alternatives examined
Comparison of two
or more alternatives No Yes
Examines Examine
Examine
only ssonly
only
No consequences costs
costs Cost-
Outcome Cost Outcome
Description Descriptio Description
n
Clinical Cost Full

FullEconomic
Economic
Yes Trial Analysis Evaluation
Evaluation

Adapted from Drummond: 1997
Common Misconceptions When Applying Pharmacoeconomic Principles
 Cost-effective care is initially the cheapest alternative in a

manner similar to other investments, least cost option may lead
to greater costs downstream
 Cost-effective care is outcome that generates “biggest” effect in a

manner to similar investments, smaller increments of outcome
may be achieved at a lower overall cost

 Pharmacoeconomics is
Economics
Public
Health and Pharmacy
medicine

Pharmacy-
related clinical Health care
or humanistic Pharmacoeconomics
economics
outcomes
research
Figure 1.2 . Schematic of overlap between pharmacy-related clinical or humanistic

outcomes research, health care economics, and pharmacoeconomics. This illustrates that

1.4. benefits of PEc0
 Key benefits
 Economic claims provide additional information to aid HCPs in making
appropriate therapeutic choices that may not be captured in claims based
solely on clinical evidence. They aim to provide decision makers with one or
more measures of value, compared with one or more measures of resource
use, so that decision makers can decide whether or where resources are best
spent.

PE Study Methods
 Clinical trials
 Economic evaluation in clinical trials widespread
 Little to no selection bias, but potential issues of generalizability
 Observational studies
 Often more generalizable, but problems with selection bias
 Decision models
 Often used to address pressing questions for which direct data are not available
 Shares strengths and weaknesses of source data
 Added uncertainties related to combining data from multiple sources and projection
beyond the data

Types of Pharmacoeconomics methods
 Cost minimization analysis (CMA)

 Applicable when competing alternatives are known to deliver exact equal
outcome
 Not considered as full economic analysis
 Used to find the alternative with minimum cost
 Doesn’t involve analysis of outcomes

… types of PhEco methods …
 Cost effectiveness analysis (CEA)
 Is a type analysis which measures and compares the cost Vs the effectiveness
of competing alternatives
 Can be applied when competing alternatives do have same common unit of
measurement of outcome
 Outcomes measured in natural units
 Cannot be used to compare d/t interventions with d/t outcome and outcome
measurement
 Outcome measurement conceders only quantity not quality of outcome
 Result is expressed in cost effectiveness ratio and incremental cost
effectiveness ratio

 Cost utility analysis (CUA)
 Special type of CEA which accounts for one of the drawbacks of CEA (
Quality of outcome)
 Conceders both quantity and quality of life (utility of outcome)
 Quality of life (QOL) is measured in terms of quality adjusted life
years(QALY) or disability adjusted life years(DALY)
 Result is expressed in terms of cost per QALY or cost per DALY

 Cost benefit analysis (CBA)
 A type of PhEco study which compares the monetary value of costs against
monetary value of outcomes of competing alternatives
 Can be used to compare d/t alternatives with d/t outcomes and outcome
measurement
 Is most popular method but it is the most difficult and complex
 The difficulty and complexity of this method is converting or valuation of
outcome to monetary value
 Human capital approach (HCA) and willingness to pay (WTP) are the
popular techniques of valuation of outcome
 Result is expressed as net benefit and benefit to cost ratio

Other methods
 Cost-of-Illness Analysis (COI)
 Cost consequence Analysis (CCA)
 Budget Impact Analysis (BIA)

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By: Gizachew Tilahun

By Gizachew T. Jimma University School of Pharmacy 1

By Gizachew T. Jimma University School of Pharmacy 2

By Gizachew T. Jimma University School of Pharmacy 3

By Gizachew T. Jimma University School of Pharmacy 4

By Gizachew T. Jimma University School of Pharmacy 5

By Gizachew T. Jimma University School of Pharmacy 6

By Gizachew T. Jimma University School of Pharmacy slide 7

By Gizachew T. Jimma University School of Pharmacy slide 8

By Gizachew T. Jimma University School of Pharmacy slide 9

 Choosing between which

By Gizachew T. Jimma University School of Pharmacy slide 11

 Pessimist: bottle ½ empty

By Gizachew T. Jimma University School of Pharmacy slide 12

By Gizachew T. Jimma University School of Pharmacy slide 13

 (1) People face tradeoffs.

Pharmacoeconomics, Chapter 1 By: Gizachew T. slide 14

 (2) The cost of something is what you give up to get it.

Pharmacoeconomics, Chapter 1 By: Gizachew T. slide 15

 (3) Rational people think at the margin.

Pharmacoeconomics, Chapter 1 By: Gizachew T. slide 16

• (4) People respond to incentives.

Pharmacoeconomics, Chapter 1 By: Gizachew T. slide 17

By Gizachew T. Jimma University School of Pharmacy 18

By Gizachew T. Jimma University School of Pharmacy 19

 Reason for government intervention:

Also: social equity

Leads to less than ideal provision:

Need to change incentives…

 De-merit goods (bad goods)

 Positive externalities: e.g. well-kept front

  benefit of consumption/production is lower for individual for society as a

 E.g. radio broad cast, fresh air…

 Impossible to set a price:

e.g. incentive not to be vaccinated if everyone else is?

 Limited choice for consumer:

  technical (how) and allocative (what) efficiency,

Trade-off between equity and efficiency?

Social welfare as positive externalities?

By Gizachew T. Jimma University School of Pharmacy 38

By Gizachew T. Jimma University School of Pharmacy 39

 New technologies including medicines are usually expensive

By Gizachew T. Jimma University School of Pharmacy 40

By Gizachew T. Jimma University School of Pharmacy 41

By Gizachew T. Jimma University School of Pharmacy 42

 “Research that identifies, measures and compares

By Gizachew T. Jimma University School of Pharmacy slide 43

By Gizachew T. Jimma University School of Pharmacy 44

By Gizachew T. Jimma University School of Pharmacy 45

By Gizachew T. Jimma University School of Pharmacy 46

Life Expectancy at Birth by Country

 And how can we improve our performance?

By Gizachew T. Jimma University School of Pharmacy 48

By Gizachew T. Jimma University School of Pharmacy 49

By Gizachew T. Jimma University School of Pharmacy 50

By Gizachew T. Jimma University School of Pharmacy 51

 The result of Pharmacoeconomic analysis is used to make important

By Gizachew T. Jimma University School of Pharmacy 53

By Gizachew T. Jimma University School of Pharmacy 54

Why PECo? Rationale

By Gizachew T. Jimma University School of Pharmacy 55

Why PECo? Rationale