1. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Environmental Economics and Management: Theory, Policy, and Applications 6e by Scott J. Callan and Janet M. Thomas Slides created by Janet M. Thomas 1

2. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. BENEFIT-COST ANALYSIS IN ENVIRONMENTAL DECISION MAKING Chapter 9

3. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Benefit-Cost Analysis in Practice Two major steps follow the estimation of environmental benefits and costs 1. Making time adjustments  Benefits and costs must be adjusted to account for how their values change over time 2. Assessing relative values  Benefits and costs must be systematically compared to determine feasibility to choose among feasible options based on a decision rule 3

4. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Time Adjustments Purpose of these adjustments Benefits and costs do not accrue to society at the same time Benefits and costs often accrue in the future Two types of adjustments Present value determination  accounts for the opportunity cost of money Inflation correction  accounts for changes in the general price level 4

5. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Present Value Determination Discounts a future value (FV) into its present value (PV) by accounting for the opportunity cost of money (its highest valued alternative use, which is the rate of return (r) on investment) Explains why money loaned in the present must be paid back in the future with interest Further explains why the present value of monies received in the future is discounted 5

6. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Present Value Determination General formula PV = FV(1/[1 + r] t ) where: (1/[1 + r] t ) is the discount factor t is number of time periods r, the discount rate, is the only variable called the social discount rate in public policy r should reflect the social opportunity cost of funds PV determination is the means by which future environmental benefits and costs are adjusted 6

7. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inflation Correction Adjusting for movements in the general price level Convert a real variable today to its future nominal value to account for expected inflation Nominal value period x+t = Real value period x  (1 + p) t, where p is the expected inflation rate Converting a nominal value to its real value Real value period x = Nominal value period x + t  (1 + p) t Known as deflating 7

8. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Deriving Time-Adjusted Benefits and Costs Present value of benefits (PVB) is the time-adjusted magnitude of incremental benefits associated with an environmental policy change PVB in real dollars is PVB =  (b t /[1+r s ] t )  where b t represents real benefits Present value of costs (PVC) is the time adjusted magnitude of incremental costs associated with an environmental policy change PVB in real dollars is PVC=  (c t /[1+r s ] t )  where c t represents real costs 8

9. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Benefit-Cost Analysis in Policy Step 1: Determine if an option is feasible Step 2: Select from among feasible options 9

10. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step One Determining Feasibility Use the benefit-cost ratio If PVB/PVC > 1  option is feasible OR Use the present value of net benefits (PVNB), which equals (PVB – PVC) If PVNB > 0  option is feasible 10

11. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Step Two Select Among Feasible Options Decision rule: To achieve allocative efficiency Maximize PVNB =  ([b t – c t ]/[1+r s ] t ) for all t periods, among all feasible alternatives Decision rule: To achieve cost-effectiveness : Minimize PVC =  (c t /[1+r s ] t ) for all t periods, among all feasible alternatives that achieve a predetermined benefit level 11

12. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Benefit-Cost Analysis of CAA1990-2020 Cost or Benefit CategoryPresent Value ($millions) COSTS Electric Utilities$ 53,000 Industrial Point Sources46,510 Onroad Vehicles and Fuels237,958 Nonroad engines and Fuels4,867 Other65,547 Total Costs$411,018 MONETIZED BENEFITS Avoided Mortality$11,898,000 Avoided Morbidity443,467 Ecological and Welfare Effects335,304 Total Benefits$12,980,000 Net Benefits$12,980,000 Benefit/Cost Ratio32/1 12 Source: U.S. EPA, Office of Air and Radiation. The Benefits and Costs of the Clean Air Act from 1990 to 2020: Final Report. (March 2011),

13. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reservations About the Use of Benefit-Cost Analysis Measurement Problems Estimation is particularly problematic due to intangibles Implicit costs Equity Issues Distribution of benefits and costs may be skewed 13

14. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Federal Government Support President Reagan’s Executive Order 12291 Explicitly called for maximizing net benefits (allocative efficiency) and choosing the least-cost alternative (cost-effectiveness) Detail of potential benefits and costs to be given in a Regulatory Impact Analysis (RIA) Applicable to any “major rule,” i.e., a regulation expected to have an annual impact of at least $100 million 14

15. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Federal Government Support President Clinton’s Executive Order 12866 Explicitly refers to adopting/proposing regulations for which benefits justify costs (allocative efficiency) and designing regulations in most cost-effective manner Applicable to any “significant regulatory actions,” including those expected to have an annual impact of at least $100 million Detail to be given in an Economic Analysis (EA) 15

16. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Federal Government Support President Bush’s Executive Order 13258 Makes minor amendments to Clinton’s Executive Order 12866 Extends the use of economic criteria in policy design and evaluation through an Economic Analysis 16

17. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Federal Government Support Obama’s Executive Order 13563 Obama’s Executive Order 13563 Reaffirmed and enhanced President Clinton’s Executive Order 12866 Requires the following:  that a regulation can be proposed or adopted only if the benefits justify the costs.  that, if choosing among alternative regulatory initiatives, the one that maximizes net benefits should be chosen 17

18. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Regulatory Impact Analysis (RIA) Lead in Gasoline Estimated incremental benefits included health effects and nonhealth effects, such as increased fuel economy Estimated incremental costs were estimated using an engineering cost model of the refinery industry The resulting PVNB over the 1985 - 1992 period (excluding blood pressure effects) was estimated to be $5.9 billion ($1983) and supported the proposed new lead standard 18

19. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. UK Impact Assessment (IA) Climate Change Act 2008 The IA presented cost and benefit estimates for the proposal from the present to 2050 Estimated benefits range from:  £457 billion to £1020 billion or $739 billion to $1,649 billion Estimated costs range from:  £324 billion to £404 billion or $524 billion to $653 billion Estimated Net Benefits range from £53 billion to £696 billion (or $86 billion to $1,125 billion) 19