AGEC 608 Lecture 01, p. 1

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AGEC 608 Lecture 1

• Objective Introduction to main concepts
• Readings
• Boardman, Chapter 1
• Kankakee, summary of Draft Assessment
• Homework Chapter 1, problem 1 Chapter 2,
  problem 2 Chapter 2, problem 4 due Feb. 27

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What is Cost-Benefit Analysis?
A method for assessing and comparing
policies Relies on valuing impacts in monetary
terms objection interpersonal
comparisons? objection are those costs or
benefits? objection present and future?
Bottom line NSB B C Note CBA and BCA are
interchangeable terms
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Purpose and types of CBA
Purposes Improve decision making Learn
about projects and processes Types Ex Ante
(before the project) Ex Post (after the
project) In media res (during the project)
Comparative (ex ante vs. ex post)
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History of Cost-Benefit Analysis
1808 - Gallatin (Sec. Of Treas.) issues report on
the costs and benefits of water projects 1844 -
Jules Dupuit writes On the Measurement of
the Utility of Public Works 1936 - Passage of
U.S. Flood Control Act 1950 - Economics Analysis
of River Basin Projects (green book) 1973 -
Principles and Standards for Planning Water
and Related Land Resources Water
Resources Council 1981 - Reagan issues executive
order requiring regulatory impact analysis 1995
- U.S. House passes even stringent
CBA requirements
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Questions that must be answered

• What are the project objectives?
• What happens in the absence of the project?

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Public Policy Objectives

• Developed country
• 1) National economic development
• 2) Environmental quality
• 3) Quality of life
• 4) Regional development

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Public Policy Objectives

• Developing country
• 1) Increase aggregate consumption
• 2) Income redistribution
• 3) Growth of national income
• 4) Employment
• 5) Self-reliance (balance of payments
• 6) Merit goods (education, health care)

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Questions that CBA can answer

• What is the projects fiscal impact?
• Is the project financially sustainable?
• What is the environmental impact?
• Is it a good (economically beneficial) project?
• Is this project the best alternative?
• Can separable components stand alone?
• How risky is the project?
• Who are the winners and losers?

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Example Water Projects

• Objectives often include
• Flood control
• Navigation
• Power generation
• Recreation
• Irrigation
• Water supply
• Concerns typically also include
• History, culture, ecology, and health

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Perspectives for Project Analysis

• For the economy as a whole
• For a regional economy affected by a project
• For the government budget
• For people affected by the project
• Financial analysis
• Distribution analysis
• Key Different perspectives give different
  results

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US Requirements for CBA

• Executive Order 12866 (1996) requires
• statement of need for proposed action
• examination of alternative approaches
• analysis of the social benefits and costs
• discussion of equity effects

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Key Assumptions in CBA

• Price measures the benefit of each marginal unit
  to the demander
• Marginal cost measures the opportunity cost of
  each marginal unit for the supplier
• The value to society as a whole is the difference
  between benefits and costs
• See Figure 1

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Process of Economic Analysis

• Iterative process
• Construct with-without scenario (counterfactual)
• Start with financial analysis, then economic
• treatment of taxes/subsidies
• adjust values to opportunity costs
• Difference between economic financial results

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The Project Cycle

• Identification
• Preparation and analysis
• Appraisal
• Implementation
• Evaluation

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9 Basic Steps in CBA
1. Specify portfolio of alternative
projects/policies 2. Decide whose benefits and
costs count (standing) 3. Catalogue potential
(physical) impacts and selected measurement
indicators. 4. Predict quantitative impacts over
the life of the project. 5. Monetize (attach
dollar values to) all impacts. 6. Discount for
time to find present values. 7. Compute NPV (add
up the benefits and costs). 8. Perform
sensitivity analysis. 9. Recommend the
alternative with the largest net social
benefits.