Opportunity Cost

Opportunity Cost

Opportunity cost is the value of the next-best alternative forgone when a resource is allocated to a particular use.

Opportunity cost arises because resources are scarce and have competing uses. Choosing one activity means that the same money, staff, equipment, time or capacity cannot be used fully for another activity.

In healthcare, the opportunity cost of funding or delivering an intervention is the value that could have been produced by the best feasible alternative use of the resources displaced by that decision. This value may be expressed as forgone health, reduced access, delayed services, lost productive capacity or another outcome relevant to the decision-maker.

What opportunity cost means

Opportunity cost is not simply the price paid for a resource. It is the value that could have been produced through its next-best alternative use.

A general representation is:

Opportunity cost of choosing A = Value of the best alternative forgone

If a health system chooses intervention A instead of intervention B, and B is the best feasible alternative that cannot also be provided, the opportunity cost of choosing A is the value that intervention B would have produced.

Opportunity cost therefore depends on the alternatives available at the time of the decision and on what would otherwise have happened.

Why scarcity creates opportunity cost

Scarcity means that available resources are insufficient to satisfy every competing want and need.

When resources are scarce:

1. more than one beneficial use competes for the same resources;
2. not every use can be funded or delivered;
3. a choice must be made; and
4. the selected use displaces at least one alternative.

Scarcity is the underlying condition. Opportunity cost is the value forgone because of the resulting choice.

If a resource has no feasible alternative use and its use displaces nothing of value, the relevant opportunity cost may be zero even though a financial cost has been recorded.

Opportunity cost in healthcare

Healthcare decisions use more than financial resources. They may also require:

• clinician time;
• hospital beds;
• operating-theatre capacity;
• diagnostic equipment;
• medicines and supplies;
• laboratory capacity;
• information systems;
• managerial attention;
• patient and caregiver time; and
• implementation capacity.

A decision can therefore create an opportunity cost even when its additional financial expenditure appears small.

For example, a new service may require limited additional funding but occupy specialist staff who would otherwise treat another patient group. The value of the forgone care is part of the opportunity cost.

Opportunity cost and financial cost

Financial cost describes monetary expenditure. Opportunity cost describes the value of the best alternative use forgone.

The two may differ.

A payment of £1 million records what was spent. It does not by itself identify:

• which activity lost resources;
• which patients were affected;
• what outcomes the displaced activity would have produced; or
• whether a non-financial constraint caused the displacement.

Financial costs can help estimate opportunity cost when they represent resources that could genuinely have been used elsewhere. They should not automatically be treated as a complete measure of what was forgone.

Opportunity cost and economic cost

Economic cost values resources according to their opportunity cost rather than merely their accounting price.

Market prices may approximate opportunity cost when markets function well and resources can be obtained or released at those prices. They may be poor proxies when:

• prices are regulated;
• labour or equipment cannot be expanded quickly;
• contracts fix expenditure;
• capacity is constrained;
• resources cannot be transferred between uses;
• taxes or subsidies distort prices; or
• no functioning market exists.

Health economic analysis should therefore consider what resources could have produced elsewhere, not only what appears in financial accounts.

Opportunity cost and sunk cost

A sunk cost is a cost that has already been incurred and cannot be recovered through the current decision.

Sunk costs should not determine a prospective choice between alternatives because they are no longer avoidable. The relevant opportunity costs concern future resources and benefits that differ between the available options.

For example, the historical cost of constructing a hospital building may be sunk. Future staff time, maintenance expenditure and service capacity used by a new programme are not sunk when they could still be allocated differently.

Opportunity cost and budget impact

Budget impact analysis estimates how a decision changes expenditure for a defined budget holder over a specified period.

Opportunity cost asks what valuable activity or outcome is displaced when resources are committed to the decision.

A large budget impact may indicate substantial potential displacement, but budget impact does not identify the displaced activity or measure its value.

Likewise, an intervention with a manageable budget impact may still have an important opportunity cost if it uses tightly constrained workforce, facility or service capacity.

Affordability and opportunity cost are therefore related but distinct questions.

The next-best alternative

Opportunity cost is based on the next-best feasible alternative, not the combined value of every rejected alternative.

Suppose a healthcare organisation can fund only one of three mutually exclusive programmes:

• Programme A would produce 100 health units.
• Programme B would produce 85 health units.
• Programme C would produce 60 health units.

If Programme A is chosen, the opportunity cost is the 85 health units that Programme B, the next-best alternative, would have produced.

The opportunity cost is not 145 health units. Programmes B and C could not both have been selected with the same constrained resources.

Marginal opportunity cost

Many healthcare decisions concern small additions to or reductions in resource use. The relevant opportunity cost is therefore often marginal: the value produced by the activities changed at the margin.

Marginal opportunity cost may differ from:

• average health-system productivity;
• the average cost of an existing programme;
• the lowest-priority activity listed in a budget;
• the accounting value of released resources; or
• the benefits of an entire service.

This distinction matters because new expenditure commonly displaces many small changes across a system rather than eliminating one complete programme.

Health opportunity cost

When a healthcare system seeks to improve population health from constrained resources, opportunity cost may be expressed as health forgone elsewhere in the system.

If additional expenditure displaces healthcare activity that would have generated health, the displaced health is the health opportunity cost of the decision.

When the threshold is intended to represent marginal health opportunity cost, a simplified threshold-based estimate is:

Health opportunity cost = ΔC / k

where:

• ΔC is the additional healthcare expenditure; and
• k is an estimate of the additional cost associated with producing one unit of health at the relevant margin elsewhere in the system.

When health is measured in QALYs:

QALYs displaced = ΔC / k

This is an estimate rather than a directly observed quantity. Its interpretation depends on what k represents, how it was estimated, the system and period to which it applies, and whether it is transferable to the decision being analysed.

Worked health opportunity-cost example

Suppose a new medicine requires an additional £600,000 from a fixed healthcare budget. An empirical estimate suggests that £30,000 of displaced healthcare expenditure corresponds to one QALY forgone elsewhere.

£600,000 / £30,000 per QALY = 20 QALYs

The estimated health opportunity cost is therefore 20 QALYs displaced elsewhere.

If the medicine produces 15 additional QALYs:

Net incremental health = 15 − 20 = −5 QALYs

The 20 displaced QALYs are the estimated health opportunity cost.

The −5 QALYs are the resulting incremental net health effect after comparing health gained with health estimated to be forgone elsewhere.

These quantities should not be confused.

Opportunity cost and the cost-effectiveness threshold

A cost-effectiveness threshold can represent different concepts in different decision frameworks.

A threshold intended to reflect marginal health opportunity cost represents an estimate of the rate at which additional healthcare expenditure displaces health elsewhere in a constrained system.

A threshold may instead represent:

• willingness to pay for health;
• a policy benchmark;
• an appraisal range;
• a negotiated convention; or
• another institutional decision rule.

These interpretations are not interchangeable.

When a threshold is used to estimate opportunity cost, report:

• what the threshold represents;
• how it was estimated;
• the health system and period to which it applies;
• the expenditure margin it describes;
• whether it reflects marginal productivity;
• uncertainty around the estimate; and
• whether it is transferable to the present decision.

Opportunity cost and net health benefit

Opportunity cost and net health benefit are connected but are not the same quantity.

When a threshold k represents health opportunity cost, incremental net health benefit can be expressed as:

INHB = ΔE − (ΔC / k)

where:

• ΔE is incremental health produced by the intervention;
• ΔC is incremental cost; and
• k is the relevant cost-effectiveness threshold.

The term ΔC / k represents estimated health opportunity cost only when that interpretation of the threshold is appropriate.

A positive INHB indicates that expected health gained exceeds the estimated health-equivalent cost under the stated assumptions. A negative INHB indicates the reverse.

Opportunity cost is the value forgone. Net health benefit compares health gained with the health-equivalent value of resources forgone.

Opportunity cost outside the healthcare budget

The relevant opportunity cost depends on analytical perspective.

Under a healthcare-system perspective, analysis may focus on health and resources displaced within healthcare.

Under a broader public-sector or societal perspective, relevant consequences may include:

• patient time;
• caregiver time;
• productivity;
• education;
• social care;
• public expenditure outside healthcare; and
• effects on households or other sectors.

Resources displaced in different sectors may produce different kinds of value. These consequences should remain identifiable rather than being combined without explanation.

Opportunity cost of time

Time is a scarce resource for patients, caregivers and healthcare professionals.

The opportunity cost of time is the value of its best alternative use forgone.

Examples include:

• clinician time that could have been used to treat another patient;
• patient working or leisure time used to attend an appointment;
• caregiver time that could have been used for paid work, rest or another responsibility; and
• operating-theatre time that could have been assigned to another procedure.

The opportunity cost of time is not necessarily equal to a wage rate. The valuation method should reflect the perspective and the relevant alternative use.

Opportunity cost and capacity constraints

A service may face limited capacity even when funding is available.

Important constraints can include:

• workforce shortages;
• unavailable beds;
• operating-theatre schedules;
• diagnostic capacity;
• supply limitations;
• training requirements; and
• implementation time.

If additional funding cannot expand the binding resource, expenditure alone will not reveal the relevant displacement.

For example, purchasing equipment may not increase service output when trained staff are unavailable. Opportunity cost may arise because staff are redirected from another service rather than because of the equipment's purchase price.

Opportunity cost and efficiency

Opportunity cost is central to both technical and allocative efficiency.

Technical efficiency concerns producing the greatest possible output from available resources or producing a specified output with the fewest resources.

Improving technical efficiency can release resources for alternative uses. Those improvements create additional value only when resources can genuinely be released or redeployed.

Allocative efficiency concerns distributing resources among competing activities in a way that best advances the decision-maker's objectives.

An intervention may be delivered efficiently within its own programme but still represent an inefficient allocation if another feasible use would produce greater value from the same resources.

Opportunity cost and equity

Opportunity-cost analysis does not determine how benefits should be distributed.

Alternative allocations may have different consequences for:

• total health;
• disease severity;
• unmet need;
• disadvantaged populations;
• access;
• geographical equity; and
• financial protection.

An allocation that maximises aggregate health may conflict with another equity objective.

Equity considerations may modify the decision, but they do not make opportunity cost disappear. The forgone benefits should remain visible so decision-makers can understand the trade-off being accepted.

Identifying what is displaced

In practice, the exact displaced service or patient group may be difficult to observe.

Displacement can occur through:

• reduced service volume;
• longer waiting times;
• delayed investment;
• restricted eligibility;
• lower staffing elsewhere;
• reduced quality;
• slower adoption of another intervention;
• removal of an existing service; or
• many small reductions spread across the system.

The displaced activity may not be the programme whose formal budget is reduced.

Analysts should distinguish directly observed displacement from displacement inferred through thresholds, productivity estimates or modelling assumptions.

Opportunity cost under uncertainty

Opportunity cost is often uncertain because decision-makers may not know:

• which activities will be displaced;
• how quickly displacement will occur;
• what outcomes those activities would have produced;
• whether resources can be transferred;
• whether budgets or capacity will change; or
• whether estimated thresholds apply to the decision.

Uncertainty can be examined through:

• sensitivity analysis;
• scenario analysis;
• alternative threshold values;
• explicit displacement scenarios;
• budget and capacity modelling;
• probabilistic analysis; and
• value-of-information analysis.

A single opportunity-cost estimate should not be presented with greater precision than its evidence and assumptions support.

Opportunity cost in prevention and long-term investment

Preventive programmes and long-term investments may consume resources now while producing benefits later.

Their evaluation should consider:

• the activities displaced when resources are committed;
• timing of future benefits;
• intervention duration;
• implementation requirements;
• future resource use;
• uncertainty;
• discounting; and
• whether resources released later can genuinely be redeployed.

Costs, benefits and forgone alternatives should be compared using consistent timing assumptions.

Opportunity cost of conducting research

Research also consumes scarce resources and time.

The opportunity cost of additional research may include:

• research expenditure;
• researcher and participant time;
• delayed access to a beneficial technology;
• continued use of an ineffective technology; and
• other research that cannot be funded.

Value-of-information analysis can help assess whether the expected benefit of reducing uncertainty justifies the resources and delay required to obtain additional evidence.

Common mistakes and how to avoid them

• Do not equate opportunity cost with expenditure. Expenditure records money spent; opportunity cost is the value of the best alternative forgone.
• Do not add every rejected alternative together. Opportunity cost concerns the next-best feasible alternative.
• Do not assume a cost-saving intervention has no opportunity cost. It may still consume scarce staff, capacity, time or implementation resources.
• Do not assume displaced activity can always be observed directly. Displacement may be diffuse or inferred.
• Do not assume every cost-effectiveness threshold measures health opportunity cost. Its interpretation depends on the decision framework.
• Do not equate affordability with opportunity cost. Affordability concerns accommodating expenditure; opportunity cost concerns what is displaced.
• Do not allow sunk costs to determine prospective choices. Relevant opportunity costs concern avoidable future resources and consequences.
• Do not confuse opportunity cost with net health benefit. Opportunity cost is value forgone; net benefit compares value gained with value forgone.

What should be reported

Report:

• the decision and alternatives;
• the scarce resources being allocated;
• the analytical perspective;
• the next-best feasible alternative;
• additional resource use;
• the activity or outcome expected to be displaced;
• whether displacement is observed or modelled;
• any threshold or productivity estimate used;
• what that threshold represents;
• non-financial constraints;
• timing and discounting;
• distributional and equity consequences;
• uncertainty and sensitivity analyses; and
• limitations affecting the estimate.

Financial cost, budget impact, opportunity cost, health displaced and net health benefit should remain clearly distinguished.

Key distinction

Scarcity makes choice necessary.

Opportunity cost is the value of the next-best feasible alternative forgone because of that choice.

Financial cost records expenditure.

Budget impact describes changes in spending.

Health opportunity cost estimates health displaced elsewhere when that interpretation is supported.

Net health benefit compares expected health with the health-equivalent value of expected costs.

These concepts are connected, but they are not interchangeable.

Sources

• Drummond MF, Sculpher MJ, Claxton K, Stoddart GL, Torrance GW. Methods for the Economic Evaluation of Health Care Programmes. Oxford University Press.
• Palmer S, Raftery J. Opportunity cost. BMJ. 1999.
• Claxton K, Martin S, Soares M, et al. Methods for the estimation of the cost-effectiveness threshold for the NHS. Health Technology Assessment. 2015.
• Briggs A, Claxton K, Sculpher M. Decision Modelling for Health Economic Evaluation. Oxford University Press.
• Culyer AJ, Newhouse JP, editors. Handbook of Health Economics. Elsevier.
• National Institute for Health and Care Excellence. Health Technology Evaluations: The Manual.