Cost-effectiveness analysis and health care resource allocation: decision rules under variable returns to scale

We argue that health programs are administered in settings that often violate the frequently stated assumption of constant returns to scale in the provision of health services. Three types of returns to scale are identified from the general economic literature: returns to scale with respect to population, effectiveness, and quality. We show that decision rules based on incremental cost-effectiveness ratios or cost-benefit tests are not optimal if returns to scale are not constant. We derive the optimal decision rules under variable returns to scale using optimization techniques, and employ several examples to illustrate the concepts and methods.