Slide 1Cost-Benefit Analysis: IntroductionIntroductionExample #1MEASURING THE COSTS OF PUBLIC PROJECTS: Transportation ExampleSlide 6Valuing Public Benefits and CostsMeasuring Current CostsSlide 9Slide 10Slide 11Slide 12Measuring Future CostsPresent Value: Future Dollars into the PresentSlide 15Present Value: Present Dollars into the FutureSlide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23MEASURING THE BENEFITS OF PUBLIC PROJECTSValuing Driving Time SavedValuing Driving Time SavedSlide 27Slide 28Problems with contingent valuationSlide 30Slide 31Valuing time savingsValuing Saved LivesValuing LivesGreat Britain systemComparative-Effectiveness ResearchSlide 37Slide 38Valuing lifeSlide 40Slide 41Slide 42Slide 43Slide 44Slide 45Slide 46Slide 47CBA CriticismsSlide 49Slide 50As U.S. agencies put more value on a life, businesses fretCosts and Benefits of Government RegulationsDiscounting Future BenefitsCost-effectiveness AnalysisSlide 55Slide 56PUTTING IT ALL TOGETHERProject EvaluationSlide 59Slide 60Slide 61Slide 62Valuing Public Benefits and Costs: other considerationsFigure 11.1Other Issues in Cost-Benefit AnalysisSlide 66Slide 67Budgetary CostsSlide 69Recap of Cost-Benefit AnalysisCost Benefit exampleCost-Benefit Analysis8.4 Conclusion8.3 Putting It All Together8.2 Measuring the Benefits of Public Projects8.1 Measuring the Costs of Public ProjectsChapter 8cost-benefit analysis The comparison of costs and benefits of public goods projects to decide if they should be undertaken.Cost-Benefit Analysis: Introduction•Cost-Benefit Analysis is a practical technique for determining the relative merits of alternative government projects over time.•The government uses cost-benefit analysis to compare the costs and benefits of public goods projects and decide if they should be undertaken.•Essentially 3 steps:1. Enumerate all costs and benefits of proposed project2. Evaluate all costs and benefits in dollar terms3. Discount future net benefitsIntroduction•In principle, such an analysis is an accounting exercise. (tracking cost expenditures and benefits)•In practice, cost-benefit analyses are rich economic exercises that combine theory and empirical work.Example #1•Consider the monorail project in Seattle, which was narrowly approved in 2002.–The costs consisted of construction and equipment, buying permission from some landowners, ruined views, noise near the train, and traffic delays during construction.–The benefits consisted of reduced travel time, saved parking fees, reduced car maintenance, more reliable commuting times, fewer accidents and fatalities, better views for monorail passengers, and reduced noise from busses.•Analysts found that the monorail’s benefits were about $2.07 billion, while its costs were $1.68 billion.•The $390 million net benefit helped swing public opinion toward the project.MEASURING THE COSTS OF PUBLIC PROJECTS: Transportation Example•Consider the example of renovating a turnpike that is in poor shape, with large potholes and crumbling shoulders that slow down traffic and pose an accident risk.•Should you repair the road?•Table 1Table 1 shows the factors to consider.Control-Benefit Analysis of Highway Construction ProjectQuantity Price or ValueTotalCost Asphalt 1 million bagsLabor 1 million hoursMaintenance $10 million/yearFirst-year cost:Total cost over time:BenefitsDriving time speed500,000 hoursLives saved 5 livesFirst-year benefit:Total benefit over time:Benefit over time minus cost over time:Table 1Valuing Public Benefits and Costs•For private company:–Benefits = revenues received–Costs = firm’s payments for inputs•For public sector, market prices may not reflect social benefits and costs.–Externalities, for example•Several ways of measuring benefits and costs–Market prices–Adjusted market prices–Consumer surplus–Inferences from economic behavior–Valuing intangiblesMeasuring Current Costs•The first goal is to measure current costs. The cash-flow accounting approach to costs simply adds up what the government pays for all the inputs.•This does not represent the social marginal cost we used in the theoretical public goods analysis, however.Measuring Current Costs•The social marginal cost of any resource is its opportunity cost–the value of that input in its next best use.–This is not necessarily its cash costs, but by what else society could do with the input.–For the asphalt, the next best use is to sell the bag to someone else. The value of the alternative use is the market price.Measuring Current Costs•If the labor market is perfectly competitive, the same logic applies–the value of an hour of labor used on the project is simply the market wage.•If there are imperfect markets, however, then there could be unemployment.–For example, there could be a “living wage” ordinance that mandates a $20/hour wage rate.–This mandate, in turn, could lead to unemployment.•Imagine that those who were involuntarily unemployed had a reservation wage of $5/hour; thus, they value their leisure at $5/hour, or $10.Measuring Current Costs•In this case, the “alternative activity” is not working at another job, but rather being unemployed.–This alternative activity only has an opportunity cost of $10/hour, not $20/hour.–This lowers the economic costs of the project (but not the accounting costs).•The unemployed workers derive rents, which are simply payments to resource deliverers that exceed those necessary to employ the resource.•The Table 2Table 2 illustrates this.Control-Benefit Analysis of Highway Construction ProjectQuantity Price or ValueTotalCost Asphalt 1 million bags $100/bag $100.0 mLabor 1 million hours½ at $20/hr½ at $10/hr$12.5 mMaintenance $10 million/yearFirst-year cost:Total cost over time:BenefitsDriving time speed500,000 hoursLives saved 5 livesFirst-year benefit:Total benefit over time:Benefit over time minus cost over time:Table 2The accounting cost equals $20/hour x 1 million hours, or $20 million.Measuring Future Costs•The asphalt and labor costs are immediate costs, but the last one–maintenance–is a stream of costs over time.•This cost is $10 million per year into the indefinite future. We translate this into current dollars using present discounted value.Present Value:Future Dollars into the Present•Suppose someone promises to pay you $100 one year from now.•What is the maximum amount you should be willing to pay today for such a