BENEFIT-COST ANALYSIS
BASICS
Monetary Measures of Utility
 How much is a gallon of gas worth to a person?
 Expenditure at going price (“value in exchange”)
 Value above price/expenditure?
 Suppose you can buy as much gasoline as you wish
at $1 per gallon once you enter the gasoline market.
 Q: What is the most you would pay to enter the
market?
 Q: How would you depict this graphically?
 Q: How could you depict this value and the
consumer expenditure on a demand graph?
Consumer’s Surplus
(with competitive supply)
p1
p Max
CS = ½* qm(pmax - pm)
Expenditure= qm * pmarket
pm
MC = Supply
q1
q
“Value in Use” = E + CS = “Impact Study”
Benefit-Cost Analysis
Policy Change: Excise tax imposed of $t
p1
t
pm
Deadweight Loss =
½ *(p1-pm)*(qm-q1)
CS
Tax
Revenue
Marginal Cost
Seller
Revenue
q1
qm
Benefit-Cost Analysis
Expenditure of tax revenues in
Market 2
p2
Added CS + Expenditure =
Pm2(q2-qm2) + ½ p2(q2-qm)
t
pm2
MC
qm2
q2
General Equilibrium CBA
 Preceding graphic provides measure of welfare
loss in single market
 Total effect takes into account gain in welfare from
expenditure of funds in new market(s)
 Net Welfare Change in $ =
½ *(p1-pm)*(qm-q1) – P2m(q2-qm2) ½ p2*(q2 –
qm2)
Compensating Variation and
Equivalent Variation
 Two additional dollar measures of the total
utility change caused by a price change are
 Compensating Variation: the least income
that, at the new prices, just restores the
consumer’s original utility level?
 Equivalent Variation: the least income that, at
the old prices, just restores consumer’s utility
level
BCA with Pricing Power
Producer’s Surplus
Output price (p)
Producer Surplus =
q1*pm - VC
Supply =
Marginal Cost
pm
Producer
Variable costs =
q1
q (output units)
BCA with Pricing Power
pb
Deadweight
Loss
CS
Tax
Revenue
t
ps
PS
q1
q0
Benefit-Cost Beyond the Basics


GE/Externality Issues (MN Recycling Case)


Are market prices/cost accurate reflection of values?
Markets involved; degree of development; subsidies; secondary costs
Non-market goods
 WTP Methods
 Hedonic regressions
 Implicit Values


Time Valuation
Life Valuation

Future projects
 Projections of use/demand for project (see impact studies)
 Surveys; Simulations (Portland Traffic case; Seattle Rail)
 Projection of impacts on related goods/services
 Simulations; Existing studies
 Projections of cost
 Direct v. Secondary costs
 Time Aspects
 Discounting rates
 Time Horizons

Special Topics—Basis of Big Errors

Impacts Over (under) Estimated (See Impact Study Discussion)


Double counting: “jobs created”
Market Prices v. Consumer Surplus
 Poor Cost Estimates
 Poor Use/Demand Estimates