AGEC 604 Natural Resource Economics

Transcription

1 AGEC 604 Natural Resource Economics Cost Benefit Analysis Part I Guidelines for Preparing Economic Analysis U.S. Environmental Protection Agency September 2000 Click for Report Cost Benefit Analysis (CBA) Introduction Relationships - Economic Analyses Cost Benefit Analysis Financial Analysis Cost Effectiveness CBA Objective CBA Objective Identify all relevant benefits and costs to determine if the present value of the benefits are greater than the present value of the costs Distribution of costs and benefits Potential Pareto Improvement provides the basis for the CBA objective 1

2 Criteria Criteria Many Criteria Proposed Key All based on Potential Pareto Improvement Net Present Value Will always work NPV Net Present Value NPV = (B 0 -C 0 ) + (B 1 -C 1 ) / (1+r) 1 + (B 2 -C 2 ) / (1+r) (B n -C n ) / (1+r) n where NPV - net present value B i represents the benefits in period t C i represents the costs in period t r is the discount rate n is the total number of periods Benefit / Cost Ratio Benefit Cost Ratio B/C = 3 [(B t / (1+r) t ) / (C t / (1+r) t )] Where 3 represents the summation over all periods t Flaw is in comparing two projects Project B0 B1 C0 C1 B/C NPV One Two

3 Structure Structure of the Decision Problem Two mutually exclusive forms Accept only one project Pick the project with the largest NPV Several projects of many are to be accepted Example Pick the bundle of projects with the largest NPV Project NPV Initial Capital Cost One Two Three Four Issue Independence Is not how to do CBA and the criteria other than distributional aspects but rather how to identify and quantify costs and benefits along with picking the appropriate discount rate. Project Independence Independent Dependent Mutually exclusive Seven Tenets Cost Measurements are Founded on Opportunity Costs Producer Benefits are Measured as Changes in Producer Surplus Consumer Benefits are Measured as Changes in Consumer Surplus Zero-Sum Transfers are Ignored Temporal Aggregation will Employ Discounting Intangibles and Incommensurables Should Not be Ignored Full Disclosure 3

4 Costs Cost Measurements Are Founded on Opportunity Costs Three situations for price Market price exists and reflects social values Perfectly competitive market with little unemployed resources Market price exists but does not reflect social values Unemployed resources Market failures Market prices do not exist Externalities Public goods Sunk costs Producer Benefits Producer Benefits are to be Measured as Producer Surplus Changes Example - assume project will shift the MC or supply curve outward MC b Price MC a PS b = PS a = )PS = p b p a q b q a D Quantity Consumer Benefits Consumer Benefits are to be Measured as Consumer Surplus Changes Example - assume project will shift the MC or supply curve outward Price MC b MC a CS b = 3 CS a = )CS = p b p a q b q a D Quantity 4

5 Zero Sum Transfers Zero - Sum Transfers of Benefits and Costs are to be Ignored Example - project scope Port One increase of $10 in net benefits Port Two decrease of $10 in net benefits Transfer payments Do not represent the production of goods and services Temporal Aggregation Temporal Aggregation Will Employ Discounting Problem is choosing the appropriate rate - social discount rate Argument for a lower social rate Government must view itself as a trustee for the future, therefore, it should impose a lower rate than shortsighted individuals would deem best Arguments for a higher social rate Must consider the true opportunity of a government project and the discount rate should reflect the true opportunity cost of using the resources in the project Reality Mandate Sensitivity analysis Intangibles and Incommensurables Intangibles and Incommensurables Should Not be Ignored Commensurable impact - is an effect on human welfare that can be valued using reasonable economic techniques Incommensurable - effect that can not be valued using reasonable techniques, but can be physically measured Intangible - effect that can be neither counted nor economically valued How to handle? Key - must be reported and discussed 5

6 Full Disclosure Full Disclosure of All Assumptions, Data, Techniques Used, etc. Self explanatory Detailed discussion of how the costs and benefits will be distributed The Road Continues AGEC 604 Natural Resource Economics Cost Benefit Analysis Part II Guidelines for Preparing Economic Analysis U.S. Environmental Protection Agency September 2000 Click for Report 6

7 Other Issues CBA - Science As Well As An Art Doubling Counting Primary vs. Secondary effects Primary - effects that can be directly attributed to the project Secondary - ripple effects because of linkages in the economy Example - counting secondary effects If draw from an unemployed resource count as a benefit If full employment - don t count you as just rearranging resources Importance CBA Importance Most important aspect is the identification of all relevant costs and benefits Second in importance is quantification of the costs and benefits and discounting Aid to Decision Making Process and NOT the Final Word Pros / Cons Critical Appraisal Pro When done correctly CBA can provide valuable information Con Distributional aspects are not taken into account Problems with estimating costs and benefits Future generations are not represented 7

8 Cost Benefit Analysis Steps Define the Problem Design the Analysis Collect Data Perform the Analysis Present the Results Performing a CBA Define the Problem Project scenario Baseline scenario Scope / define society Constraints of the project Discount rate Time horizon Data sources Format of results Performing a CBA - 2 Designing the Analysis Preliminary identification of costs and benefits Sensitivity analysis to be performed Necessary data Collect Data 8

9 Performing a CBA - 3 Perform the Analysis Quantify the costs and benefits Revision of costs and benefits Obtain NPV Present the Results Other Techniques Impact Analysis Benefit Risk Analysis Arose out of recognition of problems with Cost Benefit Analysis Impact Analysis Required by Law Two Types of Analysis Social Impact Analysis Effects on the distribution of income, as well as, the psychological, social, and well being of individuals impacted by a project Environmental Impact Analysis Changes in our physical and biological surroundings as they are perceived to impact the quality of life 9

10 Impact Analysis - 2 Analysis Should Provide a broad representation of the concerns and how they interact Produce a manageable set of decision indicators Scenarios for alternatives should be reviewed Terminology must be understandable Benefit Risk Analysis Opposite of Cost Effectiveness Benefits are easier to get at than the costs or risks Usually applied to problems dealing with life or health Example Valuing a life Pesticide Used Introduced into the Environment Human Exposure / Risk Ecosystem 10