Benifit cost analysis

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Benifit cost analysis

  1. 1. COST – BENEFIT ANALYSIS (CBA) OMKAR APHALE
  2. 2. • We want our environment to be clean and safe. • But ‘how much’ clean and safe ? • How to measure environmental benefits and costs ? • There is no free lunch.
  3. 3. Total Cost Total Benefit Maximum Net Benefit Q1 Q*Q0 Q2 Most Efficient Resource Distribution • Our aim is to attain the ‘most efficient’ resource distribution. •We will select the option with the ‘maximum’ net benefit
  4. 4. • Net Present Value (NPV) NPV = • Internal Rate of Return (IRR) = Technical Evaluation ( b – c )t ( 1 + r )t ( b – c )t ( 1 + i )t ∑ ∑ Ct ( 1 + i )t ∑ t= 1 t= 1 nn n t = 1
  5. 5. • Benefit – Cost ration (BCR) Technical Evaluation continued …. ( b – c )t ( 1 + r )t ∑ n t = 1 Ct ( 1 + i )t ∑ t= 1 n =BCR
  6. 6. • CBA aims to value the effects of a project as they would be valued in money terms by individuals affected. • 2 steps, - List all parties affected by the project - Value the effects on their welfare as it would be valued in money terms by them. Cost Benefit Analysis (CBA)
  7. 7. • We describe a project as ‘efficient’ if, 1. Benefits gained fully compensate the losers. 2. Gainers, in principle, compensate the losers, even if they do not. 3. Doing a small number of efficient projects produces more benefits as a whole than doing a collection of efficient and inefficient projects. An ‘Efficient’ project
  8. 8. • Project cost = cost of resources + cost imposed on third parties • Include only incremental costs • Do not include – interest payments, depreciation Project costs
  9. 9. • Use and Non-use values • Use values = all use benefits to man • Non-use values = Direct or Indirect use benefits + option values + existence values Project benefits
  10. 10. Environmental values
  11. 11. • Risk is attached to all decisions • Uncertainty about demand and supply in future • Pay more to insure demand or supply • Option value = value that an individual is willing to pay in excess to expected use value to preserve an asset Option values
  12. 12. • Amount that people would pay to preserve the natural environment or a species above any use benefits • Pure existence • Altruistic existence • Vicarious existence Existence values
  13. 13. • Result from primary benefits of the project • e.g. project > higher wages to employees > higher expenditure > improve quality of life • Not included in CBA • Viewed as transfer between communities rather than net addition to community income Secondary benefits
  14. 14. • Value of a resource = marginal opportunity cost = highest amount that someone is willing to pay for it in an alternative use • Value of a benefit = amount that someone is willing to pay for it • Willingness to pay (WTP) values Basic Valuation Principles
  15. 15. • WTP = P + CS Willingness to Pay (WTP) P0 Q0 Producer Revenues P’ $ Quantity Consumer Surpluses Demand (WTP) Q’
  16. 16. • Although income remains constant, welfare changes with rise / fall in prices • Marshallian demand curves • Need compensation for change in price fall or rise • Hickinson demand curve • M.D. curve is much easier to use Income and welfare
  17. 17. • Fairer and more appropriate • Compensating variation principle - considers existing situation desirable • Equivalent variation principle - considers project situation desirable Willingness to Accept (WTA)
  18. 18. • In practice, CBA studies prefer WTP because, - WTP more observable - WTA have wide value ranges - Difference between WTA and WTP values is usually very small - Who has the right to claim compensation ? WTP vs. WTA
  19. 19. • Quantified and Unquantified impacts • Need to reduce risk of wild exaggerations • Expected value approach • ENPV = • In risk- neutral case, project with highest ENPV should be preferred. Uncertainty ( Eb – Ec )t ( 1 + r )t ∑ n t = 1
  20. 20. Uncertainty continued …. Project A Project B ENPV $ 1.5 M P = 1 P = 0.5 P = 0.5 $ 5 M $ - 1 M $ 2 M $ 2.5 M $ 1.5 M $ - 0.5 M //
  21. 21. • Imperfect competition - monopoly, subsidy, govt. regulation, taxes • Domestic vs. International markets • No market • SP = MP x CF • Surrogate or Proxy prices Shadow Prices
  22. 22. • Fiscal policies fail to distribute income fairly • WTP values > rich get the edge over poor • Sustainable development principle • Need to identify social groups • Converting WTP values into utility values by use of weights Distributional Issues
  23. 23. • People require reward for forgoing consumption now • Positive real rate of return • Present value of future money • Example, Accept $ 100 today or $ 110 next year If accepted $ 110 – we forgo $ 100 today We say that the discount rate is 10%. Discount Rates
  24. 24. • Based on WTP values • 3 ways 1. Observe prices in various markets 2. Observe individual expenditures of money and time 3. Ask people what they are willing to pay for goods Valuation of benefits and cost
  25. 25. 1. Market Price Method (MPM) 2. Hedonic Pricing Method (HPM) 3. Travel Cost Method (TCM) 4. Contingent Valuation Method (CVM) 5. Contingent Choice Methods (CCM) 6. Contingent Ranking Method (CRM) Valuation methods (Market based)
  26. 26. • Environmental change causes change in outputs or inputs • Market based approach • Uses economic values of ecosystem products and services for evaluation • e.g. soil erosion > output falls > input increases • Only used for market goods and services Market Price Method (MVM)
  27. 27. • Evaluation based on housing prices • e.g. reduction in noise> increase in residential property prices • Reflects value of local environmental attributes • Only measures environmental benefits related to housing prices Hedonic Pricing Method (HVM)
  28. 28. • Cost of access • How much people are willing to pay to travel or visit the site • To value recreation sites • Example, Evaluation of annual preservation value of a park Travel Cost Method (TCM)
  29. 29. Zone Trips per 1000 persons per annum Average consumer costs ($) Average consumer surplus ($) Populati on (thousa nd) Trips per annum Total consumer surplus ($) X 150 5.0 7.5 10 1500 11250 Y 100 10. 5.0 20 2000 10000 Z 50 15.0 2.5 50 2500 6250 all 100 10 5.0 80 6000 30,000 TCM continued…. Maximum Travel Cost = $ 20
  30. 30. • Relies on survey techniques • Hypothetical change in environmental resources • Elicitation methods include, I. Open ended / Direct Questions II. Bidding Game III. Dichotomous Choice Method IV. Double Bonded Dichotomous Choice Method • Useful for marketed and non-marketed goods Contingent Valuation Method (CVM)
  31. 31. • Asks people the WTP values for an environmental asset • Most widely used for non-market goods • Exxon Valdez case CVM continued ….
  32. 32. • Prone to bias • Types of Biases I. Strategic Bias II. Information Bias III. Starting Point Bias IV. Hypothetical Bias V. Sampling Bias VI. Non-response Bias CVM continued ….
  33. 33. • Trade-offs between environmental systems • Used for use and non-use values • Example, Wilderness or Hospital ? Scenic beauty or Mobile network ? • Difficult for some respondents to respond Contingent Choice Method (CCM)
  34. 34. • Referendum method • Ranking of environmental attributes • Easy for the respondent • Example, • Confusion if too many choices Contingent Ranking Method (CRM) Choice # Savings in travel time (in minutes) Cost of saving (in dollars) 1 10 0.50 2 20 1.50 3 30 2.20 4 40 3.00
  35. 35. • Government judgments • Example, I. Compensation for accidental death II. Zoning regulations • Inconsistent with individual preferences • Basis of decision not clearly stated • Need more research Valuation based on public decisions
  36. 36. • Precautionary expenditure • Corrective expenditure • e.g. Smoke detectors, seatbelts • Routinely included in project expenditures • Marginal cost of pollution Valuation based on defensive expenditure
  37. 37. • Present value of future output or consumption forgone = human capital method of evaluation • U.S. = 350 000 $ (1990s) • Depends on age and earnings • Value of life of a newborn = 0 $ • Risk of death – accept or reject ? • Hedonic wedge equation W = W (S, X, R) Value of life
  38. 38. • Risk of death – how to calculate ? • 0.44 million – 14.9 million US dollars • Wedge / Risk studies should be combined with other valuation methods like CVM • Value depends on I. Individual preferences II. Risk aversion III. Level of risk assumed Value of life continued ….
  39. 39. • Cost – effectiveness analysis - Useful finding option with the least cost • Environmental Impact Assessment - Describes physical & social impacts of the project • Multi-criteria Decision Analysis - Identifies and apply weights to likely impacts to determine a preferred option Alternatives to CBA
  40. 40. • Morally unacceptable to put value on nature • Not practical – how to measure visual beauty ? • CBA does not deal with social values • Based on income, thus biased • Individuals have different preferences • Narrow outlook to environment Criticisms to CBA
  41. 41. • CBA provides systematic and consistent evaluation method • CBA gives clear results • CBA highlights trade-offs and opportunity cost • ‘One person one vote’ is more preferred ‘over one dollar one vote’ Conclusion
  42. 42. 1. Project Appraisal and Valuation of the Environment - Peter Abelson, Chp. 2, 3, 4 2. Cost-Benefit Analysis and the Environment – Cass R. Sunstein 3. Cost Benefit Analysis of Environmental Systems by Applying Contingent Valuation Method – S.U Ahmed, K. Gotoh References
  43. 43. Thank You !

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