A paper presented at the International Conference on Policy Modeling Convention and Exhibition Centre, Hong Kong on June Health Sector Planning: Modeling and Implications Dr. Christine MAK Professor Sardar M. N. ISLAM Abstract A social cost benefit analysis (SCBA) is a common methodology used in economic evaluation of health programs. However, SCBA is not yet fully developed in health economics and some technical issues such as benefit and cost measurement, incorporating ethics in economic evaluation, social discount rate, shadow pricing, intergenerational equity etc. require further research. Operational mathematical models for SCBA, especially for sectoral analysis, are not well developed either. It is argued that a SCBA of health programs should be based on the recent advances in the principles of welfare economics, and operations research techniques such as dynamic optimisation to operationalise SCBA. To demonstrate the application of this approach, an operational model of cost-benefit analysis and health sectoral planning (Pharmaceutical Benefit Scheme (PBS)) is developed. The GAMS system is used to solve the dynamic optimisation model. This research demonstrates that an application of operations research techniques such as dynamic optimisation provides a proper health sector project planning.
In spite of the persuasiveness of the use of cost benefit analysis, there are several limitations in the
existing literature in applying cost benefit analysis to health economics and other areas in
economics and social sciences. Present applications of cost benefit analysis in health economics
focus predominantly on financial and economic analysis rather than real social and welfare
economic analysis based on principles of ethics, social and extra-welfaristic considerations.
Rigorous specifications of health sector modeling and planning based on cost benefit analysis of
programs and policies are not yet well developed. Furthermore, certain useful mathematical
methods of capital budgeting and project appraisal have not yet been applied in health sector
planning and project evaluation (Brent 2003; Pearce and Nash 1981).
In order to overcome these limitations, the objective of this paper is to develop a new cost benefit
analysis approach with an appropriate basis of normative economics in a dynamic optimization
framework for planning in the health secotor (PBS). In some previous papers of the authors (Islam
and Mak 2002a, 2002b, Islam, Mak and McCallum 2005), a cost benefit analysis of six medications
was performed. That exercise was useful in providing information in decision-making about listing
individual medication on the Pharmaceutical Benefit Scheme (PBS) in Australia. These costs and
benefits estimates are given in Islam and Mak (forthcoming). However, a realistic exercise of
health programs evaluation should be in the form of proactive health sector planning. In health
sector planning, a set of health programs is chosen from alternatives to be financed by the available
budget. In this chapter, we develop a PBS sub-sector planning. We apply the new3 cost benefit
analysis developed for sub-sector planning of the PBS referred here as PBS planning, and discuss
the implications of PBS sub-sector planning in selecting a set of medications for PBS listing that
can maximise the health and social welfare of a society.
This paper is structured is as follows. Section 2 discusses sector planning in general and Section 3
is about the issues and model of PBS sub-sector planning, and discussion of implications of results
of PBS sub-sector planning. Section 4 discusses the implications for decision making in the PBS
setting. Section 5 discusses welfare economics implications. Section 6 discusses the plausibility
of the approach and the results. Section 7 presents the conclusion.
2 Sector Planning via Project Planning
The PBS is a prominent example of a health project or program. It is an Australian
Commonwealth-funded health program through which pharmaceuticals are provided with
government subsidy for the Australian public.
The objective of this research is to apply social cost benefit analysis in a holistic manner to the PBS
setting to go beyond a single program consideration and towards health sector planning. So far we
have considered the economic evaluation of individual medications for PBS listing, but the real
challenge is the decision-making on a set of medications to be included in a systematic manner. In
this situation, economic evaluation needs to be applied to each medication. In order decide on a set
of medications among other alternatives to be included in the PBS, i.e. to prepare a PBS sub-sector
planning, we need to apply the principles and methodologies of project planning which are
Project planning in the health sector involves identification of a set of health programs to be
approved and implemented by the Government. Health sector planning is a sectoral exercise: a
sum of money (the sectoral budget) is allocated to the health sector, and certain programs are
selected and financed by such a budget on the basis of the principles and methodologies of project
planning. In selecting programs to be undertaken in a sector, the relative cost benefit ratios or net
present values are used. Formulation of a total sectoral plan for the health sector on the basis of
cost benefit analysis by applying some health sector-wide mathematical models is not yet a popular
practice. Such an exercise will be undertaken in Section 3.
3 PBS Sub-sector Planning – Issues and Models 3.1 Issues in PBS Planning
In the area of healthcare, project planning is a decision making process of selecting a suitable
health program. In the context of the PBS in Australia, project planning is about the selection of a
set of medication from their alternatives for government subsidy which can be funded by an
available budget in a particular year or time period. With the aid of economic analysis, a set of
medications should be selected on the basis that it achieves the desired health outcomes at the
minimum possible cost of resources. When conducting the economic analysis, one should consider
the macroeconomic and sector implications, economic efficiency, equity and distributional justice,
ethics and moral philosophy, as well as sustainability and issues of intergenerational equity of the
Through provision of medications to the public, the PBS aims to preserve or maintain, to restore
and hopefully improve the health status of the Australian population. Fiscal responsibility was
identified as one of important measures in the Intergenerational Report 2002 (Costello 2002) for
preserving intergenerational equity over a 35-year time span. With the ageing population in
Australia, investment in health is important to maintain optimal health status of the population, to
preserve and/prolong the productivity of the labour market, and hence the tax revenue of the
Early intervention is crucial in the area of health. Without early intervention, most conditions such
as cardiovascular diseases and type 2 diabetes will progress to critical stages, resulting in
hospitalisation, or even impaired functional status or disability of patients. In the latter case,
institutional care such as hostels or nursing homes may become the only viable, and perhaps most
At the initial planning stage of the project, one should assess the demands or needs of the project.
In the context of the PBS, the demand of a medication can be estimated by epidemiological studies,
statistical data on the prevalence of the diseases, and the burden of the diseases to Australia. These
data help to establish the economic rationale for public sector involvement. However, a more
efficient system, regardless of public or private sector involvement, should be established. The
PBS in Australia is implemented under a public system, and is administered by the Health
Insurance Commission of the Commonwealth Government of Australia. Therefore, economic
efficiency of individual medications in the PBS system as well as their social considerations stated
above need to be considered in the PBS decision making.
Another issue in the Australian health sector is the sustainability of the health of the population.
Sustainability is a concept from environmental economics. Sustainable development refers to the
notion that economic development should proceed at a pace and in a manner which conserves the
environment and depletable natural resources (see Bannock et al. 1998). In the context of health,
sustainability should be considered in implementing health programs aiming at preserving the
optimal health status of the Australian population.
New3 cost benefit analysis (discussed in Section 3.4), based on new3 welfare economics (also
defined in Section 3.4), provides an appropriate framework for addressing the above issues of PBS
sub-sector planning. By applying the new3 cost benefit analysis in PBS planning, the economic and
social costs and benefits of medications are valued in monetary terms and compared. A set of
medications is selected among other alternatives by using the criteria of new3 cost benefit analysis,
an exercise which addresses the PBS issues discussed above. Health policy on pharmaceutical
subsidy formulated under such criteria offers a much broader perspective and caters for the needs
3.2 Capital Budgeting and Operations Research Techniques
A social cost benefit analysis is developed on the basis of the capital budgeting technique and can
be considered as capital rationing. Capital budgeting is an operations research technique designed
to select a portfolio of projects from a set of alternative proposals in order to achieve maximisation
Operations research methods have been applied to the healthcare sector since the 1960s. With cost
containment being the common theme in public healthcare systems around the world, interest in
operations research methods in healthcare delivery is growing. When applying an economic
evaluation of a health program such as the PBS, studies of operations research methods in the area
of allocation, forecasting demand, as well as quality and efficiency are most relevant (Gass and
With scarcity of resources, allocation is an important measure to ensure optimal health outcomes.
Forecasting helps to establish future demand in healthcare services and resources in order to allow
a meaningful proactive project planning exercise. Mathematical programming such as goal
programming and integer programming are commonly used in this area of operations research.
Mathematical programming is a study of optimising the use and allocation of scarce resources.
Linear programming solves the problem by finding the maximum (or minimum) of an objective
function f(x) subject to a set of constraints of the form g (
with optimisation models when available data are subject to significant uncertainty. Stochastic
programming is closely related to other paradigms for decision making under uncertainty. Decision
analysis is usually restricted to problems in which discrete choices are evaluated in the view of
sequential observations of discrete random variables. The analytic approach allows decision
makers to use general preference functions in comparing alternative courses of actions.
Theoretically, both single and multiple objectives can be incorporated in the decision-making
framework. However, it is not practical to enumerate all choices (decisions) as well as outcomes
(of random variables) in the context of decision-making. This approach is normally used when a
few strategic alternatives are considered (Gass and Harris 2001)
Optimisation models developed under mathematical programming can then be interpreted under the
normative social choice and the new3 welfare economics framework. By incorporating social
welfare criteria and the static and dynamic constraints of the economy based on new3 welfare
economics, a set of optimal decisions for resource allocation that specifies optimal social welfare
and health outcome in the health sector can be formulated (Islam 2001). This optimisation can also
be specified by embedding cost benefit analysis concepts (in the present study new3 cost benefit
analysis), issues and decision making problems (Craven and Islam 2005a; Clarke and Islam 2004).
3.3 Public Policy Objectives
A social cost benefit analysis should incorporate the underlying government social and economic
policies including extra-welfaristic outcomes such as equity, justice, ethics and moral philosophy.
When considering the sector planning of the PBS, one should take into account macroeconomic
and sector implications in addition to benefits and costs of the health program alone. The main
objective of a health program is health maximisation, and improving the quantity and quality of
life of the individuals in a society. Other macroeconomic issues such as employment in the
healthcare sector, sustainability of the pharmaceutical industries, viability of a timely and
efficient distribution network of PBS medications should also be considered.
3.4 Sector Planning Models and New3 Cost Benefit Analysis
In new3 welfare economics, making social choices and decisions is feasible since quantifiability,
measurability, and comparability of social benefits or welfare are assumed in this paradigm on the
basis of the possibility perspective (Sen 1999) in social choice theory. This paradigm also provides
a framework for incorporating ethics and non-economic elements in economic analysis (therefore
also in cost benefit analysis) relatively conveniently and appropriately. This approach has not yet
been applied to economic evaluation of projects for making decisions or social choices in general
and in the health sector. It is possible to develop a type of cost benefit analysis (which we can
name new3 cost benefit analysis) on the basis of the principles of new3 welfare economics. In new3
cost benefit analysis, social choice can be operationsalised for practical application and social value
judgments, expert opinion, and scientific information need to be applied to the making of social
decisions. This paradigm can enable the development of a full social cost benefit analysis (i.e., the
new3 cost benefit analysis) with plausible estimates of social costs and benefits of health programs.
The elements of the new3 cost benefit analysis (Islam 2001; Islam and Mak forthcoming) are the
a. it considers economics and ethics in estimating costs and benefits in economic evaluation;
b. it assumes measurability of social welfare, non-economic costs and benefits on the basis of
social value judgment, preferences and public policy objectives; and
c. it aims to estimate costs and benefits of the health program by using scientific information,
The inclusion of the elements of the new approach in a health sector planning model developed in
this paper is done by the following methods:
a. including social costs and benefits in estimating the parameters of the values;
b. applying a combination of scientific information, expert opinions and social value judgment in
identifying and estimating parameters and coefficient, equations and objective functions of this
c. including social value judgment and ethical issues in the model through the objective function
and constraints and discount rates of the models.
By incorporating social objectives, the objective function represents social value judgment. By
adjusting the discount factor, intergenerational equity is considered and emphasis is put on future
In the context of PBS sector planning, new3 cost benefit analysis is used as an evaluation tool for
PBS decision-making by incorporating the elements of new3 cost benefit analysis discussed above.
Firstly, the Therapeutic Goods Administration assesses a medication for its safety and efficacy by
using scientific information, in order to determine whether the medication should be approved for
the Australian market. Secondly, medical treatment guidelines of the medication are established to
determine the clinical indications that are subsidised or funded by the PBS budget. Under the new3
cost benefit analysis, both social costs and benefits are included in the evaluation. Details of
calculation of the costs and benefits estimates are discussed in Islam and Mak (forthcoming). In
defining the costs and benefits of medications, social value judgments and ethical considerations
are incorporated in the analysis, in addition to the narrow definition of benefits under the
Pharmaceutical Benefits Advisory Committee criteria where social costs and benefits are excluded.
Thirdly, the percentage of government subsidy on PBS medications depends on the entitlement
status of patients. The population is divided into general patients and concessional patients
according to their entitlement. The entitlement status of patients is linked to income and is
determined by the Treasury. In addition to the distributional weights incorporated when calculating
costs and benefits, it is important that the government address the distributional issues through
taxation system rather than to rely on the process of project selection and design to redistribute
income. It is usually outside the terms of references of project analysts to influence government tax
and transfer policies (Jack 1999, p. 227).
The cost benefit ratios and net present values of the six medications, namely Atorvastatin,
Clopidogrel, Pioglitazone, Letrozole, Fluticasone/Salmeterol and Tiotropium are calculated in
Islam and Mak (forthcoming). Medications should be selected for listing on the PBS if their cost
benefit ratios are greater than 1, and/or their net present values are positive. Under the PBAC
criteria, the net present value of Clopidogrel is $4971.42 and its cost benefit ratio is 2.05. The
net present value of Pioglitazone 30mg is $3160.45 and its cost benefit ratio is 1.57. The net
present value of Tiotropoium is $579.55 and its cost benefit ratio is 1.13. All three medications
should be accepted on the PBS under the PBAC criteria. For the other three, Atorvastatin,
Letrozole and Fluticasone/Salmeterol, their net present values are negative and cost benefit ratios
are less than 1. The net present value and cost benefit ratio of Atorvastatin is -$190.22 and 0.96.
The net present value and cost benefit ratio of Letrozole is -$1054.07 and 0.91. The net present
value and cost benefit ratio of Fluticasone/Salmeterol is -$2822.41 and 0.37. Using the decision
rules of cost benefit analysis, all three medications should be rejected under the PBAC criteria
Under the financial cost benefit analysis approach, the net present values of Atorvastatin,
Clopidogrel, Pioglitazone, Letrozole, and Tiotropium are $2790.92, $8733.55, $7111.09,
$3410.63, and $4022.69 respectively. The cost benefit ratios of Atorvastatin, Clopidogrel,
Pioglitazone, Letrozole, and Tiotropium are 1.60, 2.85, 2.29, 1.28 and 1.92 respectively. The
cost benefit ratio of Fluticasone/Salmeterol is 0.98 and its net present value is -$104.27. Based
on net present values and cost benefit ratios, all medications should be selected with the exception
Under the new3 cost benefit analysis approach, the net present values of Atorvastatin, Clopidogrel,
Pioglitazone, Letrozole, Fluticasone/Salmeterol and Tiotropium are $30645.29, $31906.50,
$24639.47, $35046.27, $31921.88 and $36501.23 respectively. Their cost benefit ratios are
6.34, 4.52, 3.22, 2.47, 5.68 and 6.98 respectively. Based on net present values and cost benefit
ratios, all medications should be selected (see Islam and Mak forthcoming).
The cost data are obtained from the Schedule of Pharmaceutical Benefits (published by the
Medicare Australia) and computer dispensing programs used by community pharmacies. The
benefits are calculated from statistical data of health services consumption from the Australian
Bureau of Statistics and the Australian Institute of Health and Welfare, the Medicare Benefit
Scheme, published data of the statistical values of life, and professional opinions of researchers.
3.5 Health Sub-sector Planning: PBS Planning Model
As an exercise for health sub-sector planning, let us assume that selection of medications for listing
on the PBS is subject to the constraints of an allocated budget. In addition to the positive net
present values and cost benefit ratios being greater than 1, the net cash flow of that year must be
within the allocated budget so that the chosen program is socially and financially viable within that
year. The net cash flow of the program is calculated as the net benefits (benefits less costs) of
these medications considered for PBS selection.
A PBS planning model
= net benefit stream of drug j at time t = (Btj - Ctj);
= allocation of resource to drug j at time t;
ξj = the social discount rate of drug j; Btj = benefit for a drug j at time t; and Ctj
This is a dynamic integer-programming problem for choosing a set of medications in the PBS for a
planning period. The objective function represents economic efficiency (net benefits) and public
policy objectives. The constraints represent the economic and social costs of the medications, and the
RHS figures show available PBS budgets. The model results can provide information regarding
which medications should be chosen for the PBS in the given period. Public policy objectives
derived from extra-welfaristic considerations can be represented by the discount rate, the cost and
benefit estimates and the availability of funds. This objective function explicitly can incorporate both equity and efficiency and other extra-welfaristic elements of social welfare objectives simultaneously, allowing the choice on the amount of government subsidy and its distribution to be
made concurrently, not sequentially (Jack 1999, p. 221).
An Australian PBS Planning Model (PBSPLAN)
Let the decision variables of the Australian PBS model be:
The Objective Functions
The objective function is derived by maximising the net present values/benefits of the six
medications under budget constraints (the details of the estimates of costs and benefits may be
seen in Islam and Mak (forthcoming)). The government cost of the PBS prescription for the year
ending 30 June 2004 is $5 billion. Cardiovascular diseases, type 2 diabetes, breast cancer,
asthma and chronic obstructive pulmonary diseases together account for about 30% of the disease
burden in Australian society. The budget constraint for the six medications is assumed to be $1.5
billion (30% of $5 billion). The government cost of PBS prescriptions increased at 8.5%
annually for the last five years (1999-2004). Assuming budget constraints increase by 8.5%
annually for the 5-year period, objective functions and constraints are derived as follow.
Model 1 PBAC criteria Objective Function
– 190.22X1 + 4971.42X2 +3160.45X3 –1054.07X4 –2822.41X5 + 579.55X6 (2)
Subject toBudget Constraints
–1030.77X1–1038.09X2–1214.97X3+2959.01X4–983.13X5–959.37X6 ≤ 1627500000
–1030.77X1–1038.09X2–1214.97X3–2633.91X4–983.13X5–959.37X6 ≤ 1773975000
–1030.77X1–1038.09X2–1214.97X3–2633.91X4–983.13X5–959.37X6 ≤ 1933632750
–1030.77X1–1038.09X2–1214.97X3–2633.91X4–983.13X5–959.37X6 ≤ 2107659698
Model 2 Financial Cost Benefit Analysis Objective function
2790.92X1 +8733.55X2 + 7111.09X3 + 3410.63X4 –104.27X5 + 4022.69X6
Subject toBudget Constraints
–305.77X1–313.09X2–489.97X3+4764.26X4–258.13X5–234.37X6 ≤ 1627500000
–668.27X1–675.59X2–852.47X3–2271.41X4–620.63X5–596.87X6 ≤ 1773975000
–668.27X1–675.59X2–852.47X3–2271.41X4–620.63X5–596.87X6 ≤ 1933632750
–668.27X1–675.59X2–852.47X3C2271.41X4–620.63X5–596.87X6 ≤ 2107659698
Model 3 New3 Cost Benefit Analysis Objective Function
30645.29X1 + 31906.50X2 + 24639.47X3 + 35046.27X4 + 31921.88X5 + 36501.23X6
Subject toBudget Constraints
Year 0: 25946.95X1+29847.28X2+23491.77X3+31661.16X4+28243.42X5+32374.45X6≤ 1500000000 Year 1: 1712.56X1+1052.78X2+824.90X3+6389.13X4+1839.07X5+1457.59X6 ≤ 1627500000 Year 2: 995.26X1+335.48X2+107.60X3–1001.34X4+1121.77X5+740.29X6 ≤ 1773975000 Year 3: 995.26X1+335.48X2+107.60X3–1001.34X4+1121.77X5+740.29X6 ≤ 1933632750 Year 4: 995.26X1+335.48X2+107.60X3–1001.34X4+1121.77X5+740.29X6 ≤ 2107659698
A dynamic optimisation integer-programming model is used to solve the problem. Under budget
constraints of the data above and the parameters, the PBSPLAN model was solved with the GAMS
program (Brooke et al. 1992; Levary et al. 1990). The GAMS program and output for PBSPLAN
is given in Islam and Mak (forthcoming).
For Model 1, the objective value of the social welfare function is 8711.3522 and the integer
solution is X2=X3=X6=1. Within the limitations of the allocated budget constraints, only three
medications are selected with ranking in the order of Clopidogrel, Pioglitazone and Tiotropoium.
Atorvastatin, Letrozole and Fluticasone/Salmeterol are rejected from PBS listing.
For Model 2, the objective value of the social welfare function is 26068.7841 and the integer
solution is X1=X2=X3=X4=X6=1. Within the limitations of the allocated budget constraints, only
five medications are selected with ranking in the order of Clopidogrel, Pioglitazone, Tiotropoium,
Letrozole, and Atorvastatin. Fluticasone/Salmeterol is rejected from PBS listing
Table 1 Results of PBSPLAN under different criteria Cost benefit Discount Budget Objective Ranking of Medications analysis model Constraints function value medications rejected
Notes: CBA = cost benefit analysis X1 = listing Atorvastatin 40mg on PBS.
X5 = listing Fluticasone/Salmeterol 500/50 on PBS.
For Model 3, the objective value of the social welfare function is 190660.6400 and the integer
solution is X1=X2=X3=X4=X5=X6=1. Within the limitations of the allocated budget constraints, all
six medications are selected with ranking in the order of Tiotropoium, Letrozole,
Fluticasone/Salmeterol, Clopidogrel, Atorvastatin and Pioglitazone.
The results from the GAMS modelling support the decision-making from using the net present
values and cost benefit ratios criteria. Under the PBAC criteria, only Clopidogrel, Pioglitazone
and Tiotropium are selected. Under the financial cost benefit analysis, Clopidogrel, Pioglitazone,
Tiotropoium, Letrozole, and Atorvastatin are selected. Under the new3 cost benefit analysis, all six
Apart from the criteria under the three models, different parameters are put into the PBSPLAN
model in order to test the validity of the model and the effects of the discount rate, budget
constraints and net benefit estimates on the results and the ranking of the medications selected.
Model 1 is the cost benefit analysis under PBAC criteria with a discount rate of 5%. Model 2 is the
financial cost benefit analysis with a discount rate of 5%. Model 3 is the new3 cost benefit analysis
with a discount rate of 0%. Model 4 is the new3 cost benefit analysis with a discount rate of 0%
and half of the allocated budget. Model 5 is the new3 cost benefit analysis with a discount rate of
0% and the exclusion of QALYs as benefit measures. Model 6 is the new3 cost benefit analysis
with a discount rate of 5%. Model 7 is the new3 cost benefit analysis with a discount rate of 5%
and an increase in the first year budget. Model 8 is the new3 cost benefit analysis with a discount
rate of 5% and an increase in the last year budget. Model 9 is the new3 cost benefit analysis with a
discount rate of 10%. Model 10 is the new3 cost benefit analysis with a discount rate of -5%. The
value of the objective function, the ranking of the medications selected and the medication rejected
changes with different criteria of the model specified. The results are listed in the Table 1.
4. Implications of Results
After undertaking a cost benefit analysis under the three different approaches, a set of net benefits,
net present values and cost benefit ratios are calculated and included in the PBSPLAN model.
Under the new3 cost benefit analysis, social value judgment and ethical issues as well as scientific
information are incorporated in these definition and estimates of costs and benefits of the
As discussed in Section 3.5, the annual PBS budget is used as a constraint of the PBSPLAN model
to address the issues of project viability and sustainability. Issues such as burden of disease and
prevalence of the medical condition are factored into the budget constraints in order to address the
ethical issues of equity and allocation according to need. Distributional equity is addressed by the
entitlement status of patients that determined percentage of government subsidy, as well as the
prevalence of diseases in the Australian population. The discount rate is set at 0% in order to
address intergenerational equity. Under these criteria, a set of medications is selected under Model
3 new3 cost benefit analysis leading to an optimal, social, and health outcome for the Australian
From Table 1, the value of the objective function is influenced by the discount rate. Comparing
models 3, 6 and 9, the criteria of calculating net benefit estimates and the budget constraints are the
same for the three models, the objective function increases in value with a decrease in the discount
rate. The ranking of medications selected also differs. In Model 3, Fluticasone/Salmeterol is
selected ahead of Clopidogrel. The selection order is reversed in models 6 and 9.
The value of the objective function is also sensitive to the criteria of calculating net benefit
estimates of the medications. Comparing models 3 and 5, the value of the objective function
decreases substantially with the exclusion of QALY as benefits. The ranking of medications
selected also changes: Tiotropium drops from first and third position, and Clopidogrel moves from
When comparing models 3 and 4, as well as 5, 6 and 7, changes in budget constraints does not
affect the value of the objective function and the ranking of the medication selected. All
medications seem to be selected under the new3 cost benefit analysis model regardless of changes
in the discount rate, budget constraints and criteria of calculating net benefit estimates. Only six
medications are tested for PBS listing using PBSPLAN in this study. In a real life setting, there are
many more than six medications considered for PBS listing.
However, the new3 cost benefit analysis approach aids decision-making in the PBS, making it
sustainable and ethically justified, leading to better budget management and more efficient resource
allocation. The new3 cost benefit analysis also provides a policy plan that gives a high level of
social welfare for the Australian community. Therefore the model produced in this chapter can
5. Welfare Economics Implication
By incorporating the social cost into the cost stream calculation, we have also considered the
opportunity cost of the forgone capital or fund, in addition to the financial cost of the medications
and the program. By incorporating the social benefit into the benefit calculation, we attempt to
capture the benefit beyond the cost savings measure of the government. By estimating the
improvement in quality of life (health status) and the quantity of life (life expectancy) in addition to
saving in health costs and increase in economic productivity, we endeavour to measure
improvement in social welfare/utility rather than just the financial benefit to society.
6. Plausibility of the Approach and Results 6.1 Validation of Model and Results
Model validation is a process of substantiating that the model behaves with a satisfactory level of
accuracy and consistency within its domain of applicability. During the validation process, the
model is run under the same input conditions that drive the system. The model behaviour is then
compared with the system behaviour to check whether the ‘right’ model has been built (Gass and
There are three levels of validation tests, namely descriptive, analytical and experimental. There
are also three types of validation criteria applied to the three levels of validation tests. For the
descriptive level, the validation criteria include the attainment of the objectives of the model, the
appropriateness of the model structure and the plausibility of the results. The objective of the
PBSPLAN is to select medications among other alternatives to be listed on the PBS in order to
maximise the health and social welfare of the Australian community subject to the budget
constraints of that time period. For the analytical level, the validation criteria include the
characteristics of model solutions and the robustness of the results. The results of the PBSPLAN
model supports the decision deriving from other criteria such as net present values, cost benefit
ratios, etc. For the experimental level, the validation criteria include the methodological tests
related to model documentation, costs and efficiency in model transfer and extension, tests related
to model execution such as accuracy and efficiency of the execution, and cost and efficiency in the
The model PBSPLAN is solved by a GAMS program used for capital budgeting. The objective of
this model is health sector planning with budget constraints. From the experience of this study
such as model convergence, results, the plausibility of the results (to be discussed in the next
section) and other model validation criteria, it is found to be an appropriate model for health sector
6.2 Plausibility of Results
The accuracy of the results can be verified by checking the relevance of the optimal solution
provided by the model to the expected results, the reported actual values or the historical data set.
Several methods are used to check the plausibility of the results, namely intuitive judgment,
comparison of results, statistical tests and self-auditing or third party auditing.
Intuitive judgment is used to check whether the results are consistent with the theory in this area
and acceptable to the profession. In the PBSPLAN, the results are consistent with the theory,
where all the six medications return positive net present values and a cost benefit ratio greater than
1. They are selected in PBSPLAN with the ranking of the six medications being consistent with the
order of their net present values and the burden of diseases in the Australian society. The capital
budgeting approach to health sector planning is new to the profession.
Results can also be compared with historical data, results from similar studies, and the ability to
predict the future performance of the system. It is difficult to compare the results of PBSPLAN
with historical data and results from similar studies as the model has not been used previously in
Justification of Theoretical Foundation
By including the social costs and benefits component, we capture the change in social welfare
better than the PBAC and the financial approach of cost benefit analysis. The social welfare
function of the PBSPLAN incorporates both equity and efficiency issues simultaneously, allowing
the decision of the amount of resource allocated and its distribution to be made concurrently rather
In this paper, we have undertaken a cost benefit analysis for these six medications along with a
sector planning exercise. Our exercise implied that the new3 cost benefit analysis is a suitable
methodology in selecting health programs that maximise the social welfare or benefit of society.
Under this approach, social value judgment, ethical issues and scientific information are
incorporated in the definition and estimation of costs and benefits of the health program. In
addition, sustainability and intergenerational equity are built-in criteria of the model. As a result,
the model under the new3 cost benefit analysis leads to selection of health programs that maximise
the social welfare and health outcome of the general community.
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PhD Thesis, Monash University, Melbourne.
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Costello, P. 2002, ‘Intergenerational Report 2002’, 2002-03 Budget Paper No.5, Canberra. Craven, B.D. and Islam, S. 2005a, Optimisation in Economics and Finance: Some Advances in Non-Linear, Dynamic, Multi-Criteria,and Stochastic Models, Spinger Verlag, Boston.
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(eds), Handbook of Health Economics, Elsevier, Amsterdam.
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Benefits Scheme’ seminar paper, Centre for Strategic Economic Studies, Victoria University, Melbourne.
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Islam, S. and Mak, C. 2002b, ‘A modified social cost benefit analysis and operations research model for evaluating
health programs’, paper presented at the Australian Health Economics Society Annual Conference, Sydney, 18-19 July.
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approach’, paper presented for the 27th Australian Conference for Health Economists, Auckland, 29-30 Sept.
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presented at the 26th Australian Conference of Health Economists, Melbourne, 30 Sept-1 Oct.
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Australian Conference on Quality of Life, Melbourne, 25 November.
Mak, C. and Islam, S. 2005, ‘Economic evaluation for including drugs in PBS: A case study of respiratory diseases
drugs’, paper presented at the conference on ‘Beyond Fragmented Government: Governance in the Public Sector’, Centre for International Corporate Governance Research, Victoria University, Melbourne, 15-17 August.
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