Cost-effectiveness analysis refers to a method for combining appropriate measures of outcomes with costs so that program and policy alternatives can be ranked according to their effectiveness relative to resource use. It differs from its close relation, cost-benefit analysis, which requires monetary measures of impact relative to costs. (Levin, 2001: 56-57)
Cost-effectiveness analysis consists of three steps: (a) The costs of the alternatives must be carefully measured, for example expenditure on teacher salaries, books and learning materials in each type of school; (b) the outcomes or educational effectiveness of the alternatives must be measured, for example by standardized test scores of pupils in each school; finally, (c) costs and effectiveness measures are combined to calculate a cost-effectiveness ratio, for example by dividing the effectiveness of each alternative by its cost to show the unit cost of achieving a particular objective, such as a 1 per cent improvement in pupil achievement. Such a ratio is described in one cost-effectiveness study as "the achievement gain per dollar spent" (Harbison and Hanushek, 1992: 140). The most cost-effective alternative can then be identified - for example the school that produces the greatest improvement in pupil achievement for a given cost or alternatively the school where pupils achieve the required examination results at least cost (Woodhall, 2004: 26).