effect, if any, of the composition of services, that is, the product-mix? Finally, are costs at the departmental
level determined by the same factors as costs at the aggregate level, and are there any economies of scale and
scope present in the provision of health?
Costs are related to the scale of outputs. While considering the relationship between cost and output it is
necessary to distinguish between marginal cost (the cost of producing an additional unit of output) and the
average cost (the total cost of all units divided by the total units produced). Since fixed costs cannot be
avoided, it is more relevant to look at marginal costs than average costs. The marginal cost will be lower
than average cost so long as the capacity created by the fixed cost is not fully utilised. In the long run the
impact of output on marginal and average costs will depend on whether economies of scale existed for the
production technology or not. If economies of scale existed up to a certain level in the production of
hospital services the average and marginal costs will fall up to this level succeeded by diseconomies.
Estimating the link between scale of production and average and marginal costs help in planning to take
advantage of scale up to the point at which they begin to rise.
There are two methods of cost analysis - the accounting method and the statistical method (Barnum and Kutzin
1993). The accounting method can be applied usefully to a single hospital and can involve a labour-intensive,
detailed examination of hospital accounts, staffing patterns, and admissions. Less detailed data are needed in
the statistical method, but it requires observations of costs and service use for many hospitals. Statistical studies
provide insights into cost issues - the relation between marginal and average cost, and the degree to which
hospitals exhibit economies of scale and scope - that accounting method do not reveal as readily. Ideally, the
information used for the statistical analysis would be derived from a large number of detailed and well-
documented observations. In actuality this is not often possible, and inferring a general pattern of costs from a
reasonably large number of observations must compensate for the lesser quality of data in a statistical analysis.
Thus, the accounting method and the statistical method yield different but complementary views of costs.
Whichever method is used, estimation of a cost function in the health sector confronts a number of problems.
These include problems related to output measurement, definition of input prices and definition of cost and its
components.
Measurement of output: Unlike the cases of industrial and agricultural output, it is difficult to measure the
output of health sector, as the concept of output is ambiguous. Provision of health services aims at improving