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Dr. Ahmed-Refat AG Refat
Cost Benefit
Analysis CBA
SBCM-MCC 22/02/2015 1Dr.Ahmed-Refat 2015
DEFINITION
An economic technique
applied to public
decision−making that
attempts to quantify the
advantages (benefits) and...
Private vs Social cost and benefit
• it is important to correctly measure
costs and benefits.
• We must identify the priva...
• The social costs and benefits are often
spread out across society, rather than
being paid directly to the organization
t...
Externalities
• When non-market impacts do not occur in the
transactions between the producer and the
direct users of the ...
A procedure for comparing
alternative courses of
action by reference to the
net social benefits that they
produce for the ...
‘Net Social Benefit’
• = difference between social
benefits and social costs.
• Cost-benefit analysis
proceeds by estimati...
Intangibles
• Inevitably, some costs and benefits
resist the assignment of dollar values.
• These costs and benefits, know...
CBA- Aim
• The aim of an CBA is to estimate
the benefits, in monetary terms, of
proposed policy changes in order to
inform...
USES
• CBA is most commonly used
for public decisions– policy
proposals, programs, and
projects, e.g., dams, bridges,
traf...
•Accepting or rejecting a single project;
•Choosing the appropriate scale and/or timing
for a project;
•Choosing one of a ...
CBA –strengths
• Systematic way of thinking and
analysis
• Focus on use of scarce
resources
• Strong methodological basis
...
Limitations
One approach to assess the
efficiency of policy/program
Uncertainty of all parameters
used
Estimated values of...
Benefit-Cost Analysis (BCA)
• Benefits and costs measured in a
common unit, typically monetary .
• Some benefits & costs m...
Cost-Effectiveness Analysis
(CEA)
• Benefits measured in “natural” (non-monetary)
units
• – Health effect (e.g., "lives sa...
Cost Effectiveness Analysis:
• CEA does not require the monetization of
either the benefits or the costs (usually the
bene...
CEA
• What is the cost per unit of
output/impact that can be bought by
intervention A?
• Cost per youth trained
• Cost per...
Theory of Cost-Benefit Analysis
• Choose the level of service to
maximize net social benefits
(NSB)
• NSB = TSB – TSC wher...
Basic Steps CBA
1. Define scope of the project
2. Identify the type of costs and benefits
3. Put monetary values on costs ...
Calculating net benefits
The outcomes of NSB depends on :
1. What is included in the categories of
costs and benefits
2. H...
Categories of Costs
• When economists estimate
the costs of a policy or
project for the purpose of
conducting a CBA, they
...
Costs
•The costs of the policy/project falls
into five broad categories:
1. Real−resource costs, Including
compliance cost...
1-Real−resource cost
• All of the resources that are used up
to implement the program or policy.
• Compliance costs: all o...
2- Government regulatory
cost
• includes the monitoring,
administrative, and
enforcement costs
associated with the policy,...
3- Social welfare losses
• The consumer and
producer losses
associated with possible
rises in prices or
decreases in outpu...
4- Transitional social costs
• include the value of all the resources
that are displaced by the policy, and
the private
• ...
Estimation of the Benefits
• The correct way to
measure the benefits of a
proposed policy/PROJECT
is to ask the beneficiar...
WTP/WTA
• WTP is one method that we can use to
determine the price of a good.
• This is useful in cases where price is not...
A. Market Approaches
• In some cases, it is possible
to determine the WTP for the
proposed policy by using
information ava...
Non market approaches
• In many cases, WTP
cannot be measured easily
using market prices,
because the impacts of the
polic...
Stated preference methods
• A direct survey approach to
estimating the value placed on
non-market goods or services.
They ...
Revealed−preference
Methods
• Revealed−preference
studies use information
about actual individual
behavior to infer the va...
Net present value
• The correct criterion for reducing
benefits and costs to a unique
value is the net present value
(NPV(...
Benefit/cost analysis
• If B/C ≥ 1.0, project is economically
justified at discount rate applied
• If B/C < 1.0, project i...
Static efficiency is defined as maximization
of net benefits for a single time period.
Many economic decisions that occur ...
A dynamic decision is one in which current
decisions have impacts on net benefits
arising in the future.
Many economic dec...
Key Point
Decisions are typically not made on the
basis of BCA alone…
but BCA can be useful for providing
information on e...
Dam construction
Costs:
Materials = $500,000
Labor = $600,000
Total Cost = $1,100,000
BCA in a timeless world
38Dr.Ahmed-R...
Dam construction
Benefits:
Recreation = $400,000
Flood control = $300,000
Electricity = $500,000
Total Benefit =$1,200,000...
Dam construction
Total Benefit =$1,200,000
Total Cost = 1,100,000
Net Benefit = 100,000
Benefit exceeds cost, so dam appea...
BCA as “Approach”
To know whether society should build the
dam, other information may be needed:
1. Are there non-economic...
Opportunity costs
• Opportunity cost is the cost of
what has to be given up to gain
some good or service
When choosing one...
Time and
Discounting
Often the benefits and costs of a project accrue
at different times. The technique used to deal
with ...
Discounting
Discounting is a technique used to convert all
benefits and costs to a common point in time,
usually the prese...
Discounting
• Discounting is based on the idea that
a dollar of benefit received today is
worth more than a dollar of bene...
Discounting
The rate at which a current value is
compounded is called the interest rate.
The rate at which a future value ...
Computing a present
value
PV = Pt / (1 + r)t
PV = present value
Pt = value at time t
r = interest (discount) rate
t = year...
Dam revisited
Total Benefits accrue
when dam is finished
(t = 1)
Total Costs accrue at
start of construction
(t = 0)
Disco...
Total Benefits accrue when dam is finished (t = 1), so
Pt = $1,200,000 and PV of benefit is:
$1,200,000 / (1+0.10)1 = $1,0...
Total Benefits accumulate in the future (i.e. when
dam is finished). The process of discounting
reduces the value of those...
Whenever benefits and costs accumulate at different
points in time, amounts should be converted to
present values for comp...
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Benefit cost analysis bca

An economic technique applied to public decision−making that attempts to quantify the advantages (benefits) and disadvantages (costs) associated with a particular project or policy.

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Benefit cost analysis bca

  1. 1. Dr. Ahmed-Refat AG Refat Cost Benefit Analysis CBA SBCM-MCC 22/02/2015 1Dr.Ahmed-Refat 2015
  2. 2. DEFINITION An economic technique applied to public decision−making that attempts to quantify the advantages (benefits) and disadvantages (costs) associated with a particular project or policy. 2Dr.Ahmed-Refat 2015
  3. 3. Private vs Social cost and benefit • it is important to correctly measure costs and benefits. • We must identify the private costs and benefits versus the social costs and benefits 3Dr.Ahmed-Refat 2015
  4. 4. • The social costs and benefits are often spread out across society, rather than being paid directly to the organization that is undertaking a project/service Private vs Social cost and benefit 4Dr.Ahmed-Refat 2015
  5. 5. Externalities • When non-market impacts do not occur in the transactions between the producer and the direct users of the services but fall on third parties, these impacts are defined as externalities. • The social costs are therefore externalities; they must be included in the decision-making process to ensure greatest efficiency. 5Dr.Ahmed-Refat 2015
  6. 6. A procedure for comparing alternative courses of action by reference to the net social benefits that they produce for the community as a whole. DEFINITION 6Dr.Ahmed-Refat 2015
  7. 7. ‘Net Social Benefit’ • = difference between social benefits and social costs. • Cost-benefit analysis proceeds by estimating hypothetical dollar amounts that reflect real economic values. 7Dr.Ahmed-Refat 2015
  8. 8. Intangibles • Inevitably, some costs and benefits resist the assignment of dollar values. • These costs and benefits, known as ‘intangibles’, are separately presented to the decision-maker for assessment in conjunction with the quantified estimate of the net social benefit of the activity. 8Dr.Ahmed-Refat 2015
  9. 9. CBA- Aim • The aim of an CBA is to estimate the benefits, in monetary terms, of proposed policy changes in order to inform decision making. • Estimating benefits in monetary terms allows the comparison of different types of benefits in the same units, 9Dr.Ahmed-Refat 2015
  10. 10. USES • CBA is most commonly used for public decisions– policy proposals, programs, and projects, e.g., dams, bridges, traffic circles, and anything else the government might fund. 10Dr.Ahmed-Refat 2015
  11. 11. •Accepting or rejecting a single project; •Choosing the appropriate scale and/or timing for a project; •Choosing one of a number of mutually exclusive projects; •Choosing a number of discrete alternative projects from a larger number of discrete alternative projects; •Evaluating government policies, notably though not only related to government regulations; and •Evaluating projects or policies post- rather than pre- USES 11Dr.Ahmed-Refat 2015
  12. 12. CBA –strengths • Systematic way of thinking and analysis • Focus on use of scarce resources • Strong methodological basis • Monetary measurement provides comparison • Appeal to policy makers 12Dr.Ahmed-Refat 2015
  13. 13. Limitations One approach to assess the efficiency of policy/program Uncertainty of all parameters used Estimated values of objects at risk Probabilities of the hazard 13Dr.Ahmed-Refat 2015
  14. 14. Benefit-Cost Analysis (BCA) • Benefits and costs measured in a common unit, typically monetary . • Some benefits & costs may be difficult to measure in monetary units. • 14Dr.Ahmed-Refat 2015
  15. 15. Cost-Effectiveness Analysis (CEA) • Benefits measured in “natural” (non-monetary) units • – Health effect (e.g., "lives saved," asthma cases averted • (QALYs, DALYs) • – Exposure (e.g., peak ozone concentration( • – Emissions (e.g., tons of CO2) • Allows comparison of costs per unit benefit (efficiency). • Judgment of whether benefits justify costs (and optimal level of control) is external to analysis. 15Dr.Ahmed-Refat 2015
  16. 16. Cost Effectiveness Analysis: • CEA does not require the monetization of either the benefits or the costs (usually the benefits). • CEA does not show whether the benefits outweigh the costs, but shows which alternative has the lowest costs (with the same level of benefits). • CEA is often applied when the norm for a certain level of safety has been set. • CEA analyzes which types of solution is the ‘cheapest’ given a certain level of safety standard. 16Dr.Ahmed-Refat 2015
  17. 17. CEA • What is the cost per unit of output/impact that can be bought by intervention A? • Cost per youth trained • Cost per life saved • Cost per children without nutrition problems • Cost per DALY / QALY 17Dr.Ahmed-Refat 2015
  18. 18. Theory of Cost-Benefit Analysis • Choose the level of service to maximize net social benefits (NSB) • NSB = TSB – TSC where • TSB = total social benefits • TSC = total social costs 18Dr.Ahmed-Refat 2015
  19. 19. Basic Steps CBA 1. Define scope of the project 2. Identify the type of costs and benefits 3. Put monetary values on costs and benefits 4. Compare costs and benefits 5. Calculate profitability indicators/decision criteria 6. Sensitivity analysis 7. Make recommendations. 19Dr.Ahmed-Refat 2015
  20. 20. Calculating net benefits The outcomes of NSB depends on : 1. What is included in the categories of costs and benefits 2. How each of the goods/services are valued 3. The discount rate(s) 4. Risks and uncertainty 5. Choice of “prices”: current/real/shadow. 20Dr.Ahmed-Refat 2015
  21. 21. Categories of Costs • When economists estimate the costs of a policy or project for the purpose of conducting a CBA, they refer to the Social Costs of the Policy. 21Dr.Ahmed-Refat 2015
  22. 22. Costs •The costs of the policy/project falls into five broad categories: 1. Real−resource costs, Including compliance costs, 2. Government regulatory costs 3. Social welfare losses 4. Transitional costs 5. Indirect costs. 22Dr.Ahmed-Refat 2015
  23. 23. 1-Real−resource cost • All of the resources that are used up to implement the program or policy. • Compliance costs: all of the resources that must be expended for complying with the regulatory aspects of the program. • 23Dr.Ahmed-Refat 2015
  24. 24. 2- Government regulatory cost • includes the monitoring, administrative, and enforcement costs associated with the policy, especially when the latter has a regulatory aspect • 24Dr.Ahmed-Refat 2015
  25. 25. 3- Social welfare losses • The consumer and producer losses associated with possible rises in prices or decreases in output that occur as a result of the policy. 25Dr.Ahmed-Refat 2015
  26. 26. 4- Transitional social costs • include the value of all the resources that are displaced by the policy, and the private • costs of reallocating these resources. • 5- Indirect costs 26Dr.Ahmed-Refat 2015
  27. 27. Estimation of the Benefits • The correct way to measure the benefits of a proposed policy/PROJECT is to ask the beneficiaries what is their willingness to pay (WTP) for it. 27Dr.Ahmed-Refat 2015
  28. 28. WTP/WTA • WTP is one method that we can use to determine the price of a good. • This is useful in cases where price is not known, e.g. noise pollution . • This method tries to determine the price that people are willing to pay for the good. 28Dr.Ahmed-Refat 2015
  29. 29. A. Market Approaches • In some cases, it is possible to determine the WTP for the proposed policy by using information available in regular markets. 29Dr.Ahmed-Refat 2015
  30. 30. Non market approaches • In many cases, WTP cannot be measured easily using market prices, because the impacts of the policy are not traded in regular markets. 30Dr.Ahmed-Refat 2015
  31. 31. Stated preference methods • A direct survey approach to estimating the value placed on non-market goods or services. They rely on information obtained through surveys rather than on the indirect valuation through revealed preference methods. 31Dr.Ahmed-Refat 2015
  32. 32. Revealed−preference Methods • Revealed−preference studies use information about actual individual behavior to infer the value of a non−market good. 32Dr.Ahmed-Refat 2015
  33. 33. Net present value • The correct criterion for reducing benefits and costs to a unique value is the net present value (NPV( or “net benefits” criterion. The correct rule is to adopt any project with a positive NPV and to rank projects by their NPVs. 33Dr.Ahmed-Refat 2015
  34. 34. Benefit/cost analysis • If B/C ≥ 1.0, project is economically justified at discount rate applied • If B/C < 1.0, project is not economically acceptable • 34Dr.Ahmed-Refat 2015
  35. 35. Static efficiency is defined as maximization of net benefits for a single time period. Many economic decisions that occur over time are a series of static decisions. Example: Shopping for Food Choose groceries each week, consume them, then start over again next week. Static vs. dynamic efficiency 35Dr.Ahmed-Refat 2015
  36. 36. A dynamic decision is one in which current decisions have impacts on net benefits arising in the future. Many economic decisions with environmental implications are dynamic. Example: Forestry If you choose to harvest trees this year, harvesting next year is no longer an option. Static vs. dynamic efficiency 36Dr.Ahmed-Refat 2015
  37. 37. Key Point Decisions are typically not made on the basis of BCA alone… but BCA can be useful for providing information on economic features of projects or activities, and can therefore be useful for informing the debate. 37Dr.Ahmed-Refat 2015
  38. 38. Dam construction Costs: Materials = $500,000 Labor = $600,000 Total Cost = $1,100,000 BCA in a timeless world 38Dr.Ahmed-Refat 2015
  39. 39. Dam construction Benefits: Recreation = $400,000 Flood control = $300,000 Electricity = $500,000 Total Benefit =$1,200,000 BCA in a timeless world 39Dr.Ahmed-Refat 2015
  40. 40. Dam construction Total Benefit =$1,200,000 Total Cost = 1,100,000 Net Benefit = 100,000 Benefit exceeds cost, so dam appears to be a good investment BCA in a timeless world 40Dr.Ahmed-Refat 2015
  41. 41. BCA as “Approach” To know whether society should build the dam, other information may be needed: 1. Are there non-economic impacts? 2. What is the opportunity cost of the dam? . 41Dr.Ahmed-Refat 2015
  42. 42. Opportunity costs • Opportunity cost is the cost of what has to be given up to gain some good or service When choosing one option over another. 42Dr.Ahmed-Refat 2015
  43. 43. Time and Discounting Often the benefits and costs of a project accrue at different times. The technique used to deal with this issue is discounting. 43Dr.Ahmed-Refat 2015
  44. 44. Discounting Discounting is a technique used to convert all benefits and costs to a common point in time, usually the present. The value of a project, expressed in terms of the present, is called the Present Value. 44Dr.Ahmed-Refat 2015
  45. 45. Discounting • Discounting is based on the idea that a dollar of benefit received today is worth more than a dollar of benefit received in the future. • Discounting is the opposite of compounding. 45Dr.Ahmed-Refat 2015
  46. 46. Discounting The rate at which a current value is compounded is called the interest rate. The rate at which a future value is discounted is called the discount rate. 46Dr.Ahmed-Refat 2015
  47. 47. Computing a present value PV = Pt / (1 + r)t PV = present value Pt = value at time t r = interest (discount) rate t = year in which Pt is realized 47Dr.Ahmed-Refat 2015
  48. 48. Dam revisited Total Benefits accrue when dam is finished (t = 1) Total Costs accrue at start of construction (t = 0) Discount rate = 10% Should the dam be built? BCA with discounting 48Dr.Ahmed-Refat 2015
  49. 49. Total Benefits accrue when dam is finished (t = 1), so Pt = $1,200,000 and PV of benefit is: $1,200,000 / (1+0.10)1 = $1,090,909 Total Costs accrue at start of construction (t = 0), so Pt = $1,100,000 and PV of benefit is: $1,100,000 / (1+0.10)0 = $1,100,000 PV(B) < PV(C) The dam shouldn’t be built. Dam construction revisited 49Dr.Ahmed-Refat 2015
  50. 50. Total Benefits accumulate in the future (i.e. when dam is finished). The process of discounting reduces the value of those benefits because they occur in the future. Because the merit of a project can hinge on the choice of discount rate, it can be a source of debate. There is no simple rule for choosing a discount rate. Often a “well known” interest rate is used. ? 50Dr.Ahmed-Refat 2015
  51. 51. Whenever benefits and costs accumulate at different points in time, amounts should be converted to present values for comparison. BCA is a decision-support tool, not a decision- making tool. Discounting can be used regardless of the length of time under consideration, but discounting has implications for equity. Key Points 51Dr.Ahmed-Refat 2015

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