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Medical treatments and strategies are increasingly being subjected to evaluations of economic efficiency. Although the reasons for this are many, it is becoming ever more important for physicians to have an understanding of the uses and limitations of such evaluations. Cost effectiveness analysis (CEA) is a technique that measures the cost of medical technology per unit of a defined health output, usually life years saved with an adjustment for quality of survival. CEA is a popular method of economic evaluation for policy markers, because it can provide direct comparisons among many medical technologies, resulting in a ranked order of procedures based on economic efficiency. The proper interpretation of a CEA requires an understanding of the component parts of the analysis, their theoretical bases, and their limitations. The components of a CEA include the determination of relevant costs, an appropriate analysis viewpoint, the use of discounting for both costs and benefits, and a sensitivity analysis of the assumptions and probabilities that drive the analysis. Marginal and incremental CEAs are techniques that help to address the cost effectiveness of different amounts of a particular treatment and the differential costs and benefits of competing strategies, respectively. A review is presented of the theoretical basis of CEA and its component parts. Emphasis is placed on generating an understanding of the method rather than providing a step-by-step protocol for the undertaking of such studies.