Because lung cancer is a major health care problem in Canada, it would be useful to identify the direct health care costs of diagnosing and treating this disease and to create an analytic framework within which diagnostic and therapeutic options can be assessed. This paper describes a method of modelling the costs of care for lung cancer. The perspective of the costing model is that of the government as payer in a universal health care system. Clinical algorithms were developed to describe the management of non-small cell (NSCLC) and small cell (SCLC) lung cancer. Patients were allocated to the treatment algorithms in the model, based on a knowledge of the stage distribution of cases within provincial cancer registries and an estimate of the use of therapeutic modalities, according to lung cancer experts. A microsimulation model (POHEM) developed at Statistics Canada was used to integrate data on risk factors, disease onset and progression, health care resource utilization and direct medical care costs. The model incorporates survival data on patients, according to cell type and stage, based on published studies. Relapse and terminal care costs were assigned during the year of death, in order to determine the cost of continuing care and the cumulative cost of lung cancer management over time. Patients surviving five years were assumed to be cured. The model estimates that the total five year cost to provide care to the 15,624 cases of lung cancer diagnosed in Canada in 1988 was in excess of $328 million. Over 82% of this total was spent in the first year for diagnostic tests, therapy (surgery, chemotherapy, radiation therapy, or combinations of these), hospitalization and follow-up costs. The average five year cost per case was $21,000, and ranged from a high of $29,860 for limited disease SCLC, to a low of $16,500 for Stage IV NSCLC. The actual cost of providing care, including the management of complications, is unknown and our estimates should be regarded as an idealized estimate of the cost of lung cancer management. However, the POHEM model has a level of sophistication which, we believe, reasonably reflects the cost per case and total costs of treating lung cancer by stage and therapeutic modality in Canada.