In recent years, cost–effectiveness analysis has been the most prevalent type of economic evaluation of health care interventions, including pharmaceuticals (Torrance 1986; Eisenberg 1989; Detsky and Naglie 1990; Freund and Dittus 1992). Unlike cost–benefit analysis, which requires that health outcomes be valued in monetary units in order to calculate the net economic benefit of a program, cost–effectiveness analysis requires only that a quantitative measure of health effectiveness, or utility, be defined. Typically, effectiveness is measured by life years (LYs) or quality-adjusted life years (QALYs). The cost–effectiveness ratio (dollars per LY or dollars per QALY) serves as a yardstick for measuring the relative priority of health interventions that compete for limited resources.

Perhaps because it avoids translating health consequences into dollars, cost–effectiveness analysis has been more favorably received by the medical community than cost–benefit analysis and has been favored by government agencies that have proposed or adopted economic criteria for funding of health programs or paying for new drugs (Klevit et al. 1991; Henry 1992). Although economic valuation of health consequences is avoided in the analysis per se, the problem of deciding in absolute terms whether a program is worth funding or not rests on whether a particular value of the cost–effectiveness ratio (e.g., $100,000 per QALY) is acceptable.

Following a review of the theoretical framework that leads to the use of the cost–effectiveness ratio as a decision criterion, this chapter addresses three issues in interpreting cost–effectiveness ratios and in translating them into criteria for resource allocation.