Benefit cost analysis bca

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
disadvantages (costs)
associated with a particular
project or policy. 2Dr.Ahmed-Refat 2015

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

• 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

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.

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

‘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

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.

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

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.

•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

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

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

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.
•

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.

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.

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

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

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.

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.

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.

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

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.
•

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

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

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

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.

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.

A. Market Approaches
• In some cases, it is possible
to determine the WTP for the
proposed policy by using
information available in
regular markets.

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.

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

Revealed−preference
Methods
• Revealed−preference
studies use information
about actual individual
behavior to infer the value
of a non−market good.

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.

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
•

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

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

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.

Dam construction
Costs:
Materials = $500,000
Labor = $600,000
Total Cost = $1,100,000
BCA in a timeless world

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 appears to be a good
investment

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?
.

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.

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.

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.

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.

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.

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

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

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

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.
?

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

Benefit cost analysis bca

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Benefit cost analysis bca

Similar to Benefit cost analysis bca (20)

More from Ahmed-Refat Refat

More from Ahmed-Refat Refat (20)

Recently uploaded

Recently uploaded (20)

Benefit cost analysis bca