Abstract
In countries such as Australia, the UK and Canada, regulators are required to select a decision threshold that is a signal to firms of a price above which the drug is less likely to be purchased. The maximum willingness to pay (maxWTP) for a health effect was the decision threshold preferred by a number of institutions and academics since 1993. In this chapter, the advantages of using a shadow price rather than a maxWTP are demonstrated. These advantages arise because the former necessarily captures information about the forgone benefit of a purchase whereas the latter might or might not. Furthermore, if the price of a substitute good reduces, only the shadow price will reflect the increased competition, not the maxWTP. But which shadow price? There are at least three different shadow prices used in practice, all of which value an action with reference to its minimum possible loss or maximum possible gain. I show that in contexts where there is economic inefficiency and the market fails for a particular input, the derivation of a shadow price for an input from existing information about the economic context (Cost Benefit Analysis, CBA, style) is a more appropriate approach than using the shadow price of a budget constraint. A general method of deriving a CBA-style shadow price for an input without a market price is illustrated.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
See Pekarsky (2012, Appendix 7) for a discussion the issue of choice of the aICER and full value price in more detail.
- 2.
See page 345 in Weinstein (2008).
- 3.
The inspiration for the study was one very similar to that described in Donaldson et al. (2011).
- 4.
There is a reduction in social surplus, not just a redistribution of surplus; even if one subgroup is better off, the entire group is worse off.
- 5.
The maxWTP is not immune to changes in context for example, when it rains, the price of umbrellas night increase.
- 6.
The shadow price can also be defined in an examination of the first order conditions required for Pareto optimality. It can be defined as the multiplier derived from the Kuhn-Tucker theory at optimality—it is the additional utility to a consumer as a consequence of relaxing an endowment constraint. See for example (Mas-Colell et al. 1995) page 563.
- 7.
If there were decreasing marginal returns to additional inputs or resources we would expect that a shadow price that was derived using the operations research definition would be greater than that derived using the economic definition.
- 8.
- 9.
See for example Drummond et al. (2005) pages 58–59.
- 10.
Sculpher et al. (2005) appear to characterise shadow pricing as exclusively defined within and applying to a first best world and hence the limits on using shadow pricing can be inferred as equivalent to the limits of assuming a first best world. The authors argue that neoclassical welfare economic theory is an “application to a presumed nirvana of a first-best neoclassical world” despite it clearly not being a world in which market prices do not represent social opportunity cost nor can these goods and services be shadow priced in this world. The authors use this argument as a justification for their preference for a social decision making rather than neoclassical welfare economic theory as a foundation to economic evaluation of health care technologies. The capacity to develop a shadow price for a good within welfare economic theory and attempt to take into account market failure is not explored by these authors. It is likely (but not certain) that the authors’ argument is an extension (or characterisation or application) of the debate between Mishan and Williams, one side of which is expounded in Mishan (1982). It would be useful to reduce the uncertainty surrounding the rationale of their decision to use this as a justification.
- 11.
- 12.
Weinstein and Stason (1976) seems to be the earliest reference used in the health economic literature to refer to the discrete properties of health programs and the implications for optimal allocation of health resources. Birch and Gafni (1992) is probably a better known reference and discussed the implications for shadow prices and budget constraints.
- 13.
For example, many neoclassical macroeconomic problems start with the Inada conditions about a production function of a firm. These conditions are necessary to ensure that in a neoclassical growth model, the growth path is stable. There are six conditions, one of which is that the function is continuously differential, which in turn implies that the inputs are continuous and not “lumpy” (Hahn 2008). Cobb Douglas production functions also meet the condition of being continuously differentiable (Brown 2008).
- 14.
- 15.
So why is there a preference for maximum willingness to pay as a way of valuing the benefits in a CBA? [For example see Sugden and Williams (1978) and Drummond et al. (2005).] The dung beetle example presented in this Chapter shows how if the maxWTP is used to value the output of the dung beetle and then to price the dung beetle, particularly when there is market power, and there is competition in means of producing the output. Essentially we can separate out the valuation of the surplus from the question of the allocation of that surplus across producer and consumer by introducing the competing use of resources, the outdoor fly screens. This issue seems to me to be one of the sources of tension between Williams and Mishan as described by Mishan (1982).
- 16.
This situation is explored in detail in Chap. 5.
- 17.
A paper by O’Brien and Gafni(1996) does apply Mishan’s methods of contingent valuation to the health outputs of a health program, however it does not address the issue of valuing inputs with market power. It does address the issue of analysing the relationship between price and demand in a private market for health services as a way of valuing health.
- 18.
Pharmaco-economic models are often developed by operations researchers (applied mathematicians) in conjunction with economists.
- 19.
- 20.
The concept of an average ICER for displaced services takes into account the fact that if the amount of services that are displaced changes, then the aICER could change if there are increasing or decreasing marginal costs.
- 21.
McNeil et al. (1975) is an example of this history. While there were some earlier discussions about this issue in the literature, this discussion of the issue is particularly eloquent. The paper makes no reference to the question of market power of the patent holders of the new technology; an omission typical of most cost-effectiveness analyses. The paper does refers to the idea that even if the new technology is cost-effective that this is not sufficient information to justify its adoption because budgetary implications also need to be considered. That particular edition of the New England Journal of Medicine was a microcosm of the critical issues in health economics and Bayesian statistics at that time.
- 22.
In pages 135–139, McKean sets out three method to derive the shadow price of an input by using information available from other decisions and other “price relationships observed in other markets for similar items” (McKean 1972).
References
Brown M (2008) Cobb-Douglas functions. In: Durlauf SN, Blume LE (eds) The New Palgrave dictionary of economics. Palgrave Macmillan, Basingstoke
Birch S, Gafni A (1992) Cost-effectiveness/utility analyses: do current decision rules lead us to where we want to be? J Health Econ 11(3):279–296
Commonwealth Scientific and Industrial Research Organisation (2006) Dung beetles. http://www.csiro.au/resources/DungBeetles.html. Accessed 25 Dec 2013
Coupé V, Veenhof C, Van Tulder M, Dekker J, Bijlsma J, Van den Ende C (2007) The cost-effectiveness of behavioural graded activity in patients with osteoarthritis of hip and/or knee. Ann Rheum Dis 66(2):215–221
Donaldson C, Baker R, Mason H, Jones-Lee M, Lancsar E, Wildman J, Bateman I, Loomes G, Robinson A, Sugden R, Prades J, Ryan M, Shackley P, Smith R (2011) The social value of a QALY: raising the bar or barring the raise? BMC Health Serv Res 11(1):8
Drummond MF, Sculpher MJ, Torrance GW, O’Brien BJ, Stoddart GL (2005) Methods for the economic evaluation of health care programmes, 3rd edn. Oxford University Press, Oxford
Hahn FH (2008) Neoclassical growth theory. In: Durlauf SN, Blume LE (eds) The New Palgrave dictionary of economics. Palgrave Macmillan, Basingstoke
Jehle G, Reny P (2001) Advanced microeconomic theory, 2nd edn. Addison Wesley, Boston
Johannesson M, Weinstein MC (1993) On the decision rules of cost-effectiveness analysis. J Health Econ 12(4):459–467
Kim S, Cho SC (1988) A shadow price in integer programming for management decision. Eur J Oper Res 37(3):328–335
Mas-Colell A, Whinston M, Green J (1995) Microeconomic theory. Oxford University Press, New York
McKean RN (1972) The use of shadow prices. In: Layard R (ed) Cost benefit analysis. Penguin, Harmondsworth, pp 119–139
McNeil BJ, Varady PD, Burrows BA, Adelstein SJ (1975) Cost-effectiveness calculations in the diagnosis and treatment of hypertensive renovascular disease. N Engl J Med 293(5):216–221
Mishan E (1971) Cost-benefit analysis: an informal introduction. Allen & Unwin, London
Mishan E (1982) The new controversy about the rationale of economic evaluation. J Econ Issues XVI(1):29–47
Mishan E, Quah E (2007) Cost-benefit analysis, 5th edn. Routledge, Abingdon
Mukherjee S, Chatterjee A (2006) Unified concept of bottleneck. Working Paper series of IIMA. Indian Institute of Management, Bangalore
O’Brien B, Gafni A (1996) When do the “dollars” make sense? Med Decis Mak 16:288–299
Pekarsky BAK (2012) Trust, constraints and the counterfactual: reframing the political economy of new drug price. Dissertation, University of Adelaide. http://digital.library.adelaide.edu.au/dspace/handle/2440/79171. Accessed 25 Dec 2013
Sculpher M, Claxton K, Akehurst R (2005) It’s just evaluation for decision-making: recent developments in, and challenges for, cost-effectiveness research. In: Smith P, Ginnelly L, Sculpher M (eds) Health policy and economics: opportunities and challenges. Open University Press, Maidenhead, pp 8–41
Sendi P, Gafni A, Birch S (2002) Opportunity costs and uncertainty in the economic evaluation of health care interventions. Health Econ 11(1):23–31
Stinnett AA, Mullahy J (1998) Net health benefits: a new framework for the analysis of uncertainty in cost-effectiveness analysis. Med Decis Mak 18(2):S68–S80
Sugden R, Williams A (1978) The principles of practical cost-benefit analysis. Oxford University Press, Oxford
Takayama A (1994) Analytical methods in economics. Harvester Wheatsheaf, Hemel
Van den Berg R (2005) Informal care: an economic approach. Erasmus University, Rotterdamn
Vernon JA, Goldberg R, Golec JH (2009) Economic evaluation and cost-effectiveness thresholds: signals to firms and implications for R & D investment and innovation. PharmacoEconomics 27(10):797–806
Weinstein MC (2008) How much are Americans willing to pay for a quality-adjusted life year? Med Care 46(4):343–345
Weinstein MC, Stason WB (1976) Hypertension: a policy perspective. Harvard University Press, Cambridge, MA
Weinstein MC, Zeckhauser RJ (1973) Critical ratios and efficient allocation. J Public Econ 2(2):147–157
Author information
Authors and Affiliations
Rights and permissions
Copyright information
© 2015 Springer International Publishing Switzerland
About this chapter
Cite this chapter
Pekarsky, B.A.K. (2015). The Shadow Price, λ. In: The New Drug Reimbursement Game. Adis, Cham. https://doi.org/10.1007/978-3-319-08903-4_5
Download citation
DOI: https://doi.org/10.1007/978-3-319-08903-4_5
Published:
Publisher Name: Adis, Cham
Print ISBN: 978-3-319-08902-7
Online ISBN: 978-3-319-08903-4
eBook Packages: MedicineMedicine (R0)