AbstractWe present a model of the labor market effects of health impairments. In particular, we describe several economic models in which health affects worker productivity and the demand for and supply of market labor services. These models provide a framework for estimating the social cost of prevalent health impairments – a necessary step in conducting cost–benefit analyses and in determining the cost‐effectiveness of potential health interventions from a broader social perspective. Our approach suggests that several measures used in the literature provide an incomplete and systematically biased assessment of the economic impact of health impairment or of the treatment of illness and impairment. The problem arises because of the reliance on an approximation at the firm level and from the bias from the neglect of the effect of impairment in shifting the labor market equilibrium. If the illness is prevalent, the effects on labor market equilibrium wage rates could be substantial. In addition, many analyses also ignore the effects of illness on producers' surplus. Copyright © 2003 John Wiley & Sons, Ltd.