Magnetic resonance imaging (MRI) has excellent specificity and sensitivity for the diagnosis of internal derangement of the knee (IDK). The use of MRI to screen patients with suspected IDK could avoid unnecessary arthroscopies with a reduction in costs. The purpose of this study was to evaluate the use of arthroscopy among patients with IDK, and to estimate the potential cost-effectiveness of MRI in these patients to avoid unnecessary arthroscopies. The study was based on a retrospective cohort of all patients attending three orthopedic clinics between April and September 1993 with a new diagnosis of IDK. Charts were reviewed in 1994 to allow for a follow-up of more than 6 months. An economic evaluation was performed based on cost-effectiveness ratios (per averted arthroscopy), including direct and indirect costs. There were 241 patients with a new diagnosis of IDK (67% males, mean age 35 ± 12 years), and 110 (46%) underwent arthroscopy. The remaining patients received conservative therapy and were not scheduled for arthroscopy within the period of observation. Using a priori established criteria, 10% of the arthroscopies could be considered diagnostic only (e.g., normal knee) and 27% were of doubtful efficacy from a therapeutic perspective (e.g., debridement alone). Many of these arthroscopies could have been avoided by performing a prior MRI. Using these findings, we conducted decision tree analyses of the use of MRI among patients requiring arthroscopy of the knee. A sensitivity analysis was performed to evaluate the various model assumptions. In general, MRI appeared to be a cost-effective diagnostic procedure for patients with IDK requiring arthroscopy of the knee, and there were cost savings associated with it in some of the models tested.