1. Cost-Benefit Analysis Emphasizing the importance of opportunity costs in achieving public benefits and the principle that benefits must be considered relative to costs. How do we estimate costs & benefits? Extremely complex process

2. 1. Identify relevant impacts –Geographic targets –Spillover/externalities –Persons and Preferences Do our political institutions articulate all the relevant preferences? Children, vulnerable populations, future generations –Reprise of Standing Issues Who has standing regarding this issue (citizenship, constituency, political representation) If part of the problem is a debate over standing, CB may not be an appropriate method of analysis.

3. 2. Monetizing Impacts –Valuing Inputs Opportunity costs The value of the required resources in their best alternative use. Unintended monetary impact Remedial reading program, doesn’t effect price of books, but could effect demand/wages for reading teachers in local market.

4. Deadweight loss: Example - an excise tax that raised the price of a good. Yes, the government received revenue, but the consumers had to pay more and because of the new inefficiency, government revenue did not offset consumer costs. But if there are other spillover effects, i.e. tax on alcohol reduces car accidents, then we can include those benefits.

5. Valuing Outcomes –Willingness to pay –Government Day Care: direct benefit of those in program, indirect benefit of shifting supply schedule to the right. –Secondary markets need to be considered Stocking lake with game fish example Sales of bait and equipment go up, but golfing goes down Stadium Example

6. Estimating the demand for nonmarket goods –Hedonic Price Models Public safety; quality schools increase housing value, but how do we put a price on a specific public good? Statistical techniques; control variables –Opinion Surveys Ask people how much they value a good Difficult to describe goods accurately Hypothetical not really forcing respondent to make an economic choice –Activity Surveys Survey respondents on their behavior Regional park example: examine travel, time, distance costs to estimate value.

7. 3. Discounting for Time & Risk The concept of Present Value –Most of us would be unwilling to loan someone $1000 today for a promise of repayment for $1000 next year. Why? –Formula: (B t -C t )/(1+d) t –How do we calculate d? In an efficient market the market interest rate is an appropriate estimate. –In the next example, we take current costs, adjust for predicted inflation, and adjust for our calculated discount rate over time (1+interest rate) t [In this case 0.10]

8. City Trash Truck Example

9. Expected Value Expected Value adds another level of complexity. –The value of improving the levies in New Orleans depends on the probability of a hurricane and the expected damage –Need a Risk Assessment: Past occurrences, past damage, estimate probabilities –Dam Example: 1 major flood every 20 years, avoiding damage = $25 million. What if no flood happens. –(.33)($25 million) + (.67)(-$5million) = $4.9 million

10. 4. Choosing among Policies Cost-Benefit Ratio –Pick the policy that has the best cost ratio –A million dollar project produces a net benefit of 10 million, but another costs $10 million and produces $20 million in net benefits. –This takes into account risk and physical and budgetary constraints Feasibility –disaggregate benefit/cost by interest groups

11. Pareto Optimal –At least one person is better off and no person is worse off Kaldor-Hicks –Requires only that policies have the potential to produce Pareto improvements; it does not require that people actually be compensated for the costs that they bear. –Sometimes we expect different people to bear costs under different policies so that over the broad range of public activities few, if any, people will actually bear net costs.

12. Taxing Alcohol to Saves lives Who bears the cost? Who bears the benefits? How will consumers respond to a tax increase? Demand schedule q = ap -b Where q=quantity demand; p=price; - b=elasticity; Literature review suggests elasticity= -0.5

13. 1988 a beer costs $0.63, 54 billion sold in a year. What if we impose a $0.19 tax increase? Plug in the numbers to calculate a for current quantity and price and then calculate new quantity for new (higher price) = 47.4 billion drinks This brings in almost $9 billion in gov. revenue But adds a consumer cost of $9 billion + deadweight loss (calculated to be $0.586 billion)

14. q = ap -b (ap) n = a n x p n a -n = 1/a n a 1/2 = √a So ap -0.5 = 1/√ap q= ap -0.5 = q = 1/√ap 54√ap = 1 = 2916ap = 1 2916(.63) = 1/a = 1837.1 = 1/a a= 0.000544 q= 1/√ap = 1/√(.000544).82 q= 47.33 billion

15. Deadweight Loss and Tax Revenue Tax revenue Quantity 0 Price PBPB Q2Q2 PSPS Supply Demand Q1Q1 Deadweight loss

16. Reductions in Fatalities, Injuries, property damage Reduction varies by age, why? Estimates based on state data (autopsies, blood alcohol levels in all highway fatalities) Found 30% increase in price would result in 40% reduction in the deaths of those 16-21 years of age Also need to include Health and Productivity gains

17. Monetizing these benefits What is the Value of a Life?: EPA has lowered the Value of Life. 11 percent lower than a few years ago. Each person is worth 6.9 million dollars. How do economists value life? riskier job should be paid more. Survey questions about risk. "how much someone is willing to pay to reduce their risk" Estimates range from $600,000 to $8 million (in 1986) Why do we do this? to compare apples to apples. A policy could save 10,000 lives but costs 10 billion dollars, is it a good policy. We need a value of life.

18. Monetizing these benefits Uninformed demand: assumes that people do not consider the accident, health and productivity costs of drinking Informed demand: people take into consideration these costs and adjust for them, willingly, with lower wages, higher insurance premiums, paying for damages, etc. Best Guess: some people are informed, others are not (10% young people are informed; 90% of older people)

19. Findings With a conservative estimate of human life $1 million Assuming everyone is informed (don’t include death of drinkers or property damage or health and productivity benefits) There are still net benefits of the alcohol tax (barely) Benefits change depending on size of tax (and assumptions made).

21. The Strategic Petroleum Reserve Example Shows how Cost Benefit analysis is done in a political/bureaucratic setting Background –Oil dependency is an old issue –1959 US regulated imports and domestic production to prevent direct vulnerability to changes in world oil markets –But this policy of regulation became ineffective because of changes domestically and internationally.

22. 1960s and 1970s we saw great use and need of oil at the same time domestic production capacity was at its maximum This led to policy experts to recommend stockpiling oil reserves in case of a shortage that could effect the economy. By 1973 there were several proposal for US stockpiling In October 1973 Egypt attacked Israeli positions along the Suez Canal. When US began to supply arms to Israel, OAPEC embargoed oil shipments to the US and lowered production.

23. Not a perfect policy plan –Overly optimistic about cost of storage –Unrealistic expectations about need and time Purchasing oil before storage facilities were ready –Lots of red tape: SPR office; Federal Energy Administration; Newly created Department of Energy; EPA; Army Corps of Engineers; Energy Research and Development Administration –Plan was accelerated by Carter’s energy advisor

24. Besides some of the implementation problems, was it a good policy? Measuring the Impact of a Stockpiling Program –Expenditure effects –Market effects Small but steady oil purchases should only modestly inflate prices Sell large sums during disruptions should greatly lower prices –Political effects Large stockpile may deter embargoes –Collateral effects May discourage private stockpiling

26. Quantifying Costs & Benefits How expensive will it be to store oil? –Cost of storage –Cost of oil at the time How big is the social surplus of selling stored oil during a disruption? –Depends on level of dependence –And on how oil markets influence secondary markets (transportation, shipping, petroleum products)

27. Role of Policy Analysis in SPR FEA plan in 1976 included a cost- effectiveness analysis in support of a 500- million barrel reserve Really this was a compromise between FEA and OMB 1977 Carter’s advisor roles out the billion barrel plan (with no analysis to support it) Proposal has wide support from Congress and President

28. OMB not convinced. 1978 organizes a study of the plan. Office of Contingency Planning in the Policy and Evaluation Office of the DOE, the Special Studies Division for Natural Resources, Energy, and Science in the OMB, and the Council of Economic Advisors (CEA) were all involved. Some dispute over assumptions for the model to estimate costs and benefits Even though the DOE made concessions on the assumptions, the analysis basically supported the idea of a billion barrel policy

29. Still not enough, 1979 OMB pressured DOE to participate in another joint study on the policy. DOE committed 20 staff months of professional time and $80,000 for consultants for the study. Report suggested a policy of 2.1 billion barrels was desirable. 1980 Separate agency, Office of Oil, saw flaws in the study and asked an economist at MIT to look into it using a better methodology (Dynamic programming formulation-DPF).

30. Over a range of scenarios and assumptions DPF found that anywhere from 800 million to 4.4 billion barrels was the ideal policy. OMB was still not satisfied, argued that DPF was to complicated. But, by November of 1980 it was clear that the OMB was not going to oppose the policy. So why was the OMB so resistant to the policy and why did it finally allow the policy to proceed?

31. Postscript In 1991, an SPR draw down of 17 million barrels was initiated to moderate prices during the 1 st Gulf War. SPR held 610 in mid-2003 The Energy Policy Act of 2005 directed the Secretary of Energy to fill the SPR to its authorized one billion barrel capacity In 2010 there was 727 million barrels