Chapter 6: Benefit-Cost Analysis

Based on the Socially Efficient Scale (graph), if there is a reduction in emissions from 15 to 12, what are the costs and what are the benefits?

-Benefits: will be the area under that is lost under the marginal damages curve (a+b) -Costs: will be the area that is lost under the MAC (b) The Benefits outweigh the Costs, therefore the policy of emissions reduction to 12 tonnes should be implemented.

Whats the difference between Public and Private Discount Rates?

-Public Discount Rates: governments use social discount rates (SDR) for lower costs of borrowing to invest in immediate projects. (LOW) -Private Discount Rates: individuals use private discount rates (PDR) which are generated by capital markets. (HIGH)

What differs between risk neutral and risk averse decisions?

-risk neutral: decisions made strictly based on expected values (higher amount but greater probability for loss) Utility curves off toward asymptote -risk averse: make decisions based on utility (average amounts but much less probability for loss). ppl with lower incomes are generally risk averse because a loss in $, is s much greater loss in utility for someone poor than someone rich. utility curves exponentially upwards unto infinity.

What are the 4 components for the basic framework of BCA?

1) Clearly specify project or program, including scale and perspective of study 2) Quantitively describe the inputs and outputs of the program (these metrics are required to see if your policy is effective) 3) Estimate the social cost and benefits of these inputs and output 4)Compare the benefits and costs. If Benefit>Cost (or B/C>1), the policy is worthwhile.

Give an example for BCA framework with electric cars.

1) The program is to increase the number of electric cars available to the general public of montreal and increase the number of electric car kms in the region. 2) inputs: the purchasing of cars by the public outputs: the number of electric car kms 3) the initial costs of purchasing electric cars might be quite a financial burden for the general public, however the social benefits in the long term will outweigh the current costs. 4) longterm benefits outweigh current costs of electric car implementation, especially if there is government subsidies on the cars.

What is a discount rate and what does a high vs low rate reflect?

A discount rate reduces the value of a good in future compared to its current value. Based on the discount rate chosen, reflects temporal preferences (i.e. how patient are we?) -low discount rates mean that current and future values are equivalent/similar -high discount rates mean that future value is very little to its current value.

What is a Cost Effective analysis and why use it over BCA?

Cost Effective analysis is only half of BCA, considering only costs, but it aims to achieve the greatest level of benefit for the lowest cost. It is used when it is difficult to measure the benefits of a program (i.e. perhaps in env considerations) so only the costs are considered.

What is the equation for Uncertainty in expected present value?

ENPV= Sigma(Emt/(1+r)^t) where ENPV=expected net present value E=amount you invest m=amount you will receive*the probability of it occurring r=interest rate t=time *the higher the risk, the greater the expected return

What is a limitation to Governmental BCA?

In attempting to consider welfare and wellbeing, the government simply assigns monetary value. This is problematic because it wellbeing doesnt not equate to the amount of money one has.

What is a Benefit Cost Analysis?

Involves measuring, adding, and comparing all benefits and costs of a program. -analytical quantification of the potential effectiveness of a decision by estimating net positive or neg result. Costs include: implementation, enforcement, adding up all costs to society.

Why use Benefit Cost Analysis?

It allows society to make informed decisions from the perspective of society instead of from that of a firm, considering all social input and outputs that wouldn't necessarily fall under market transactions. -also funds are usually limited, so taking on one project means not doing another. -- difficulty in quantifying environmental components, thus not evenly considered in BCA.

What is the equation for determining Net Present Value (i.e. the amount of discounting)?

NPV= Sigma((B-C)/(1+r)^t) Where NPV= Net Present Value B=Benefits C=costs r=interest rate used t=time if NPV=neg, Cost>Benefits if NPV=pos, Benefits>Costs

What is the function of Discounting in BCA?

To aggregate future benefits to reflect the benefit of investing in a project right now. -allows economists to determine net benefits over time.

How do we account for uncertainty in the future?

We can assign probabilities based on previous data and expert advice for the likelihood of a future occurrence (to better understand the risks involved).

What are the 3 types of Net Benefit Distributions seen in society?

the efficiency and equitability of a program's benefits and costs must be accounted for by governments, there are 3 distributions: 1)Proportional: considers equal proportions of income from rich and poor 2) Progressive: higher proportion of benefits go to poor. 3) Regressive: higher proportion of benefits go to the rich