Efficiency, Surplus and Doing Benefit-Cost AnalysisMotivating Group ProjectA few other examplesGeneric ProblemCBA: main principleWhat others method to use?Basic measure of value is willingness-to-payConsumers Surplus (CS)Calculating benefits from MWTPExample – gross value of water from new dam (excluding costs)What about nonmarket goods?Environmental goodsCosts are simplerMarginal costs plus fixed costs add up to total costsProducer Surplus (PS)How are costs calculated?Put it togetherWhere is CS+PS maximized?Suppose goods supplied in fixed amountExample: Add a damSlide 21If captured all costs & benefitsCosts come in different flavors: Private, external and socialSocial vs. Private CostsSlide 25First Theorem of Welfare EconomicsImplicit Assumptions: DistributionImplicit Assumptions: IncomeImplicit Assumptions: CompletenessImplicit Assumptions: OtherTen Steps to doing and using a CBA1Efficiency, Surplus and Doing Benefit-Cost AnalysisHow can economics help determine the optimal size of a project or extent of a regulation?2Motivating Group Project2001 Actual Group Project (Advisors—Profs. McAusland and Kendall):A Cost-Benefit Analysis of Public Law 99-625: Sea Otter-Shellfishery Conflicts in Santa Barbara and Ventura Counties 2001 Actual Group Project (Advisors—Profs. McAusland and Kendall):A Cost-Benefit Analysis of Public Law 99-625: Sea Otter-Shellfishery Conflicts in Santa Barbara and Ventura Counties 2001 Actual Group Project (Advisors—Profs. McAusland and Kendall):A Cost-Benefit Analysis of Public Law 99-625: Sea Otter-Shellfishery Conflicts in Santa Barbara and Ventura Counties3A few other examplesWhat should be the CO concentration standard in tailpipe emissions?What is the appropriate level of GHG emission reduction worldwide?How large should the Channel Islands marine reserve be?Can we measure loss to recreationists of the Forest Adventure Pass?Add another lane to Hwy 101? Close Mission Canyon to cyclists?What habitat to buy to protect endangered species (eg, Least Bell’s Vireo – bird)4Generic ProblemCharacterize an Environmental Policy or Action (or multiple policies or actions)Estimate the Consequences of that policy or actionEstimate the pluses (benefits) and minuses (costs) of that policy or actionReach conclusions5CBA: main principleQuantify all costs and benefits in a common measure (usually $)Common metric need not be $ eg, health- health analysis, with health as metric•Benefits directly measured in terms of lives saved•Costs indirect: costs increase deaths since •Regs make people poorer•lower incomes lead to higher mortality ($13 million in extra costs results in 1 statistical death)•Eg, Compare risks in lower and higher income countries•Compare projects based on net effects on health.6What others method to use?Cost-effectiveness AnalysisWeighted cost-benefit analysisMultigoal analysis7Basic measure of value is willingness-to-payDemand curve is marginal willingness to payQuantity of waterMWTPFirst units very valuableLast units less valuable8Consumers Surplus (CS)D(x)x$qpCS(q)9Calculating benefitsfrom MWTPDemand, D(x), measures MB.Consumers Surplus is the total benefit to consumers minus their cost.qpqdxxDqCS0)()(10Example – gross value of water from new dam (excluding costs)Acre-feet of waterPriceDemand for waterNew dam. . . . . . . . . . . . . . .. . . . . . . . .Add’l Value11What about nonmarket goods?Air qualityPriceSuppose there were a market:Demand for air qualityBUT, NO MARKET: price similar to MWTP12Environmental goodsDemand for env goods just as real as demand for market goods – just harder to measureDemand is a measure of intensity of preferences13Costs are simplerSome units are cheap to produce“Marginal” units are most expensiveCosts consist ofFixed costsMarginal costs14Marginal costs plus fixed costs add up to total costsQuantityMCFirst units cheapestLast units pricey15Producer Surplus (PS)x$pqPS(q)MC(x)16How are costs calculated?Supply, S(x), is same thing as MC.Producer Surplus is the total revenue to producers minus their cost.qd xxSpqqPS0)()(17Put it togetherQP. . .. . . . . . .. . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . .Total Surplus18Where is CS+PS maximized?Demand, D(x)Supply, S(x)q1 q*px$CSPSTension: Too little producedAt too high price. CS low, PS high19Suppose goods supplied in fixed amountLandPriceSupply of landProducer surplus (goes to land owners)Consumer surplusDemand for landMarketPrice20Example: Add a damQ WaterPriceStatus quo water availabilityXXXXXXXXXXXX ##################PS: Before: # and X After:CS: ??21Example: Add a damQ WaterPriceSupply of water increases; price falls.What happens to PS? CS?XXXXXXXXXXXX $$$$$##################PS: Before: # and X After: X and $CS: ??22If captured all costs & benefitsThen we want to maximize CS + PS which would occur where Supply = Demand.Challenge is to capture all costs and benefits to accurately measure MC & MB.23Costs come in different flavors:Private, external and socialIn principle, need to capture all costs and benefits.Social costs may exceed private costs.Difference is the “external cost” – the monetized cost of the externality.$/galGallonsOf GasolineMPCQ0P024Social vs. Private CostsIn principle, need to capture all costs and benefits.Social costs may exceed private costs.Difference is the “external cost” – the monetized cost of the externality.$/galGallonsOf GasolineMPCMECQ0P025Social vs. Private CostsIn principle, need to capture all costs and benefits.Social costs may exceed private costs.Difference is the “external cost” – the monetized cost of the externality.$/galGallonsOf GasolineMSCMPCMECQ*P*Q0P026First Theorem of Welfare EconomicsIn a competitive marketSurplus is maximized at a market equilibriumImplicationsCan rely on market if we are sure of competitive market27Implicit Assumptions: DistributionDistributional consequences ignoredCompensation Principle28Implicit Assumptions: IncomeRestaurant mealsPriceY=$30,000 per yearY=$50,000 per yearDemand and thus surplus depend on income distributionTherefore: Change in income distribution will change results of CBATO USE CBA, MUST BELIEVE INCOME DISTRIBUTION IS OK29Implicit Assumptions: CompletenessWhat happens with difficult to monetize benefits?Eg, clear view of