1. PPA 502 – Program Evaluation
Lecture 7 – Benefit-cost Analysis in Program Evaluation

2. Benefit-cost and Cost-effectiveness Analysis
Benefit-cost analysis is an applied branch of economics that attempts to assess service programs by determining whether the total societal welfare has increased (in aggregate more people have been made better off) because of the project or program.
Steps.
Determine the benefits of a proposed or existing program and place a dollar value on those benefits.
Calculate the total costs of the program.
Compare the benefits and costs.

3. Benefit-cost and Cost-effectiveness Analysis
Simple steps pose real challenge, especially estimating intangible benefits.
Procedure still useful in uncovering assumptions and estimating value of intangibles.

4. Benefit-cost and Cost-effectiveness Analysis
The major costing alternative to benefit-cost analysis.
Relates the cost of a given alternative to specific measures of program objectives.
For example, dollar per life saved on various highway safety programs.
Often the first step in a benefit-cost analysis.
Especially useful if analyst cannot quantify benefits, but has fairly specific program objectives.
Key problem: situation where there are multiple benefits. Results often very subjective.
2nd key problem: does not produce a bottom line number.

5. Benefit-cost and Cost-effectiveness Analysis
A private sector analogy.
Benefit-cost analysis similar to financial analysis in private sector.
Should the firm have done the project at all, i.e., Is the project producing a satisfactory rate of return?
Public version: is the program a success, i.e., Has it improved social welfare?
What other options are there for the use of the firm’s resources?
Public version: should the program be continued when weighed against alternative uses for the government’s funds.

6. Benefit-cost and Cost-effectiveness Analysis
A private sector analogy.
Benefits and costs do not occur simultaneously in either private or public sector.
R&D costs, marketing, capital investment, training.
Government not priced, thus benefits are more broadly defined.
Alternative uses of resources (opportunity costs).

7. Benefit-cost and Cost-effectiveness Analysis
Benefit-cost illustration.
Costs
Year
R & D
Capital
O & M
Total
Benefits 1
$1500
$2000 $0
$3500 2
500
2000
4500
3500 3
2500
5500 4
3000
5000
6500 5
8500
Totals
$10000
$11000
$23000
$24000
Benefit-Costs
Present Value, Benefits-Costs (10%)
($3500)
(1000)
(909)
1000
826
1500
1127
2049
$1000
($407)
Net Present 10% ($407)
Net Present 5%

8. Benefit-cost and Cost-effectiveness Analysis
Formula for net present value.
Formula sensitive to choice of rate of return.
Could also use return on investment.
Discount rate that would make the present value zero.

9. Benefit-cost and Cost-effectiveness Analysis
Continuing or not continuing the project.
Costs
Year
R & D
Capital
O & M
Total
Benefits 6
$500
$400
$4500
$5400
$9000 7
400
5000
5400
8500 8
6000
6400 9
7500
7900
8000 10
8400
Totals
$2000
$31000
$33500
$41500
Benefit-Costs
Present Value, Benefits-Costs (10%)
$3600
3600
3100
2818
2100
1736
100 75
(900)
(615)
$8000
$7614
Net Present 10% $7614
Net Present 5% $7803

10. Benefit-cost and Cost-effectiveness Analysis
Total versus marginal benefits and costs.
When considering the overall profitability of a project, an agency will consider the total costs involved in getting the project started through its operation’s cycle.
But at any point in time, when an agency is continuing or discontinuing a project or program, it only considers the marginal costs or benefits.
Definitions.
Marginal cost: incremental cost of producing one more unit of output.
Marginal benefit: incremental benefit of that one unit of output.
Public sector usually does not do it on the basis of a single unit, but what are the benefits being generated now versus the costs now?

11. Benefit-cost and Cost-effectiveness Analysis
Public-private sector differences and similarities.
Similarities – alternative uses for funds, one-time costs, recurring costs, land, labor, capital.
Differences.
Distributional considerations.
Spillovers.

12. Framework for Analysis
Benefit
Indicator
Measure
Dollar value
Assumptions
Real
Direct
Tangible
Intangible
Indirect
Cost
Transfers

13. Framework for Analysis
Real benefits and costs versus transfers.
Real: net gains and losses to society.
Transfers: merely alter the distribution of resources in society.

14. Framework for Analysis
Direct and indirect benefits and costs.
Direct costs and benefits are closely related to the primary objectives of the project.
Direct costs – personnel, facilities, equipment, material, project administration.
Indirect costs and benefits are byproducts, multipliers, spillovers, or investment effects.
Indirect costs are unintended costs that result from government action.
Indirect benefits might include benefits of space exploration.

15. Framework for Analysis
Tangible and intangible benefits and costs.
Tangible benefits and costs can be converted readily into dollar figures.
Intangible benefits and costs are those things that cannot be directly assigned an explicit price.
Determining the geographic scope of analysis.
Spillover effects may determine true geographic jurisdiction.

16. Framework for Analysis (Agricultural Dam Example)
Real Benefits
Nature of Benefit/Cost
Direct
Tangible
Increased farm output
New supply of water
Intangible
Maintaining family farms
Indirect
Reduced soil erosion
Preservation of rural society
Real Costs
Construction material, labor, operations and maintenance, direct program supervision by agency
Loss of recreational value of land or river
Administrative overhead of government
Diversion of water and its effects
Increased salinity
Loss of wilderness area
Transfers
Relative improvement of profit for farm implement industry
General taxpayers may be subsidizing farmers.

17. Measuring Benefits
Evaluation problem difficult for government because of multiple benefits and intangibles.

18. Measuring Benefits Sources of data.
Existing records and statistics kept by agency.
Feedback from clients.
Ratings by trained observers.
Experience of other governments or private or nonprofit corporations.
Special data gathering.
Whenever possible analyst should use market value or willingness to pay.

19. Measuring Benefits Valuing benefits. Cost savings. Time saved.
Lives saved.
Increased productivity or wages.
Recreational benefits.
Land values.
Alternatives to market prices.

20. Measuring Costs Cost categories. One-time, fixed, or up-front costs.
Ongoing investment costs.
Recurring costs.
Compliance costs.
Mitigation measures.

21. Measuring Costs Valuing indirect costs. Flat overhead figure.
Does the project actually costs increased administrative burden?
Costs to the private sector.
Valuing the use of capital.
Valuing the damage effects of government programs.
Other cost issues.
Sunk costs.
Interest costs.

22. Analysis of Benefits and Costs
Framework.
Retrospective.
Snapshot.
Prospective.

23. Analysis of Benefits and Costs
Importance of using present value.
Choice of an appropriate discount rate.
Private sector rate.
Low social discount rate.
Long-term treasury bill rates.
Adjustment for inflation.

24. Analysis of Benefits and Costs
Presenting the results.
Net present value (B-C).
Benefit cost ratio (B/C).
Return on investment (discount rate to reduce present value to zero).
Appropriate perspective.
Costs and benefits vary across stakeholders.
May conduct analyses from several perspectives.

25. Analysis of Benefits and Costs
Sensitivity analysis.
Use spreadsheet analysis to vary the assumptions.
Intangibles.
Relate intangibles to dollar results: if there are net costs, do the intangible benefits overcome the deficit?
Particular problems.
Equity concerns (weighting of values).
Multiple causation and co-production problems.