Cost-Benefit Analysis
Expected Costs: an example Jonathan got a knee injury after a football game, his physicians predicts 60% chance he will have to visit the ER once, 20% twice, 20% three times. The ER cost is $50 each time. What is the expected costs for ER visits due to Jonathan's knee injury?
$80 is a weighted average, where the weights are the probabilities that alternative cost values will occur. That is, if $50 will occur with probability 0.6, $100 will occur with probability 0.2, and $150 will occur with probability 0.2, then E(C)=.6 (50)+.2 (100)+.2 (150)= 80
How will an individual decide on an action? List the two ways.
Benefits (B) > Costs (C) or Net Benefits (NB) = B - C > 0.
What is CBA most commonly used for? give an example. What can CBA be used to rank?
CBA is most commonly used for public decisions for example, if the government of NYC should provide free HIV Prevention and Education programs to Hispanic/African American communities. CBA can be used to rank alternative projects as well as evaluating the social value of one particular project.
What is the third Problem with human capital approach?
Does not account for labor market imperfections, e.g., discrimination. Such as some people with higher education and skills are not paid well
Example: Mauskopf, J.A. et. al, "Economic Impact of Treatment of HIV-Positive Pregnant Women and their Newborns with Zidovudine: Implications for HIV Screening," JAMA 276: 2, 132-8, July 10, 1996. Probability of maternal-to-fetal transmission when the mother is HIV-positive No Treatment = 25.5% With Zidovudine Treatment = 8.3% Lifetime cost of treatment of an infected child from birth = $98,915
Expected value of cost of a lifetime pediatric HIV infection = probability of transmission lifetime treatment costs No Treatment = .255 × 98,915 = $25,223 With Treatment = .083 × 98,915 = $ 8,210 Expected benefits of treatment = Expected costs averted by treatment = 25,223 - 8,210 = $17,013 Cost of Zidovudine treatment = $1,045 Expected Net Benefits = 17,013 - 1,045 = $15,968 per HIV-positive pregnant woman
Method often used in court cases, e.g., court awards the family of a man who dies at 35 in a car accident the amount of his expected PV of lifetime earnings = $650,000
If he was alive and retired at 65 the he would have an extra 30 years to work. Suppose this man earns 650000/30 per year =21667
Conclusions from previous slide. What will the mother do if medical expenses are paid privately?
If medical expenses are paid privately, the woman will choose the treatment. If the child will be on public assistance for medical care (e.g., Medicaid-OHP), it benefits society to treat the mother with Zidovudine.
What is the second Problem with human capital approach? Is this approach true?
Implies that people with higher wages have higher social value. Not true, Many people have higher wages just because they were born rich
What is the Theory of Cost-Benefit Analysis Whats the formula?
Public Policy Objective: Choose the level of output of a good or service to maximize net social benefits (NSB) NSB = TSB - TSC where TSB = total social benefits TSC = total social costs
What is the human capital approach?
Value of life
What doe Value of life equal? What three sides does it have?
Value of life = present value of lifetime earnings (= lifetime productivity in competition) represents productivity gains from extending life (benefit side) or productivity losses from early death (cost side) for society as a whole, represents a loss in national output due to mortality
Expected Benefit. What is it? Expected value of a benefit equation is what?
When values of costs or benefits are not known with certainty, but are known with probability, expected values are used. E(B) = prob(B=b) * b where prob(B=bi) is the probability that the positive outcome will occur, b is the benefit of the positive outcome expressed in monetary terms
Cost-benefit Analysis (CBA) What is it?
is the assessment of the benefits and costs (i.e., pros and cons, advantages and disadvantages) associated with a particular choice.
The first problem with human capital approach implies that People who are not working for pay (e.g., homemakers, students, retirees) are valued at 0. Is this true for even employed people even when they are not working?
yes