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140 Section IV. EconomicsA Few Basic Economic ToolsDuring his Pentagon days in the early 1960s, economist Alan Enthoven 4 commentedthat most of the economic analysis tools used in the Department of Defense (DOD)were taught in introductory economics courses; however, the DOD had to hire Ph.D.economists to perform analyses because their analysts didn’t really believe in the techniquesand acquire a vested interest in them until they had a Ph.D. in the subject. Fortyyears later, Enthoven’s comments are still relevant. We can perform some very powerfuleconomic analyses in the health informatics area without resorting to arcane techniquesor complex mathematics, always keeping the following basic tools and conceptsin mind.Sunk CostsIn economic analyses of what actions to take, sunk costs are irrelevant. The only relevantissue is a comparison of the future cost-benefit options. Unfortunately, past expendituresare often not irrelevant in psychological or organizational terms. Abandoninga poor prior decision may be a personal admission of failure, or we may fear that itwill diminish us in the eyes of others. Influenced by these forces, we may continue topour good money after bad.Fixed and Variable CostsWhen analyzing or forecasting costs, we need to make a distinction between which costsare relatively fixed, regardless of the volume of activities, and which costs vary with thelevel of activities. Part-time staff and consulting services are examples of variable costs.An equipment lease is a fixed cost.Average vs. Marginal CostA key economic cost concept is the difference between average costs and marginalcosts. Assume that we have a system with fifty users that costs $1 million annually. Ouraverage cost per user is then $20,000, a straightforward computation. The marginal costis the cost of adding one additional user. This cost might be much less than, equal to,or much greater than $20,000, depending on the relationship between fixed and variablecosts. In the informatics area, marginal cost is especially important whenever weencounter “modular” scenarios—or in economic terms, discontinuous cost functions.Suppose that a particular communications “box” costs $5,000 and will support up tosixteen users, with each of the users costing an additional $200 for a “card” to be added.The marginal cost of adding a fifteenth or a sixteenth user is relatively small—$200 ineach case. The marginal cost of a seventeenth user is relatively large because it wouldcost $5,000 for a second box plus $200 for a card, for a total of $5,200. Of course, themarginal cost for the eighteenth user would again be only $200. On the software side,vendor pricing schemes for site licensing often create similar cost scenarios.Diminishing Marginal ProductivityIf it were not for the law of diminishing marginal productivity, we could grow food forthe whole world in a flower pot. If we have fixed amounts of any resource and keepadding more and more of other resources, we will reach a point where the marginal