Presentation on theme: "A Primer on Benefit-Cost Analysis Presented to: The Reclaimed Water Technical Committee June 2, 2006 By Bruce Flory, Ph. D. Seattle Public Utilities."— Presentation transcript:
A Primer on Benefit-Cost Analysis Presented to: The Reclaimed Water Technical Committee June 2, 2006 By Bruce Flory, Ph. D. Seattle Public Utilities
A Little History of BCA Idea of economic accounting – France, 1848 Foundational concepts - Alfred Marshall Practical development - Federal Navigation Act of 1936 –Required the U.S. Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project, to whomsoever they accrue, exceed the costs of that project. –The Corps developed methods without economists
History - continued Economists get in the act – 1950s –provide a rigorous, consistent set of methods BCA expands into new areas -1980s –all major new regulations Some technical issues of BCA still unresolved However, the fundamentals are well established.
General Definitions Benefit-cost analysis is a way of identifying, portraying and assessing the factors which need to be considered in making rational economic choices. BCA is a method of evaluating the relative merits of alternative public investment projects in order to achieve efficient allocation of resources. In principle, BCA entails adjusting conventional business profit-and-loss calculations to reflect social instead of private objectives, criteria, and constraints in evaluating investment projects.
Pearls from Tom Fox A benefit-cost analysis is a systematic evaluation of the advantages (benefits) and disadvantages (costs) of a set of investment alternatives. Typically, a base case is compared to one or more alternatives.
Another Pearl A full social cost accounting identifies and accounts for all the benefits and costs of a potential action, including economic, environmental and social costs and benefits, even those that do not have readily observable market values.
Some Useful Concepts Externalities Public Goods – Non-rival – Non-excludable – Non-rejectable
More Useful Concepts Scarcity Choice Opportunity Cost Opportunity cost: What we forego when we make a choice
Inefficient Use of Resources Scarce community resources Valuable community services Community well-being
Scarce community resources Valuable community services Community well-being Improved Efficiency (Most Bang for the Buck)
And More Still Sunk Costs Common Unit of Measure Present Value (Discounting the Future)
Ignore Sunk Costs Sunk costs are sunk, – they cannot be recovered Do not include them in BCA Do not use them to justify project
Common Metric Apples and Oranges –Capital costs ($) –Revenue ($) –Reduced traffic congestion (driver hours) –Reduced cancer risk (deaths per million) –Improved habitat for endangered species (spotted owls per acre) Ideal: Quantify all in $ terms
Present $ vs. Future $ Not all dollars are equal $1 a year from now < $1 now –Time preference –Risk –Opportunity cost of capital Discount future values to obtain…
Problems with BCA #1 Problem: Difficulty of quantifying all benefits and costs in $ Non-Market Valuation Methods –Stated Preference Contingent Valuation Conjoint Choice Analysis –Revealed Preference Hedonic Pricing Travel Cost Method –Benefits Transfer Method
So, What Do You Do? 80-20 Rule Sensitivity Analysis Cost Effectiveness Analysis
Cost Effectiveness (another pearl) The phrases cost effectiveness analysis and benefit-cost analysis are often confused. Cost effectiveness analysis involves specifying a set of benefits or level of service, then comparing the costs of various alternatives that can deliver those benefits. The alternative with the lowest life-cycle costs is the most cost effective.
Perspectives Analysis Who gains, who pays? BCA doesnt answer this question –Compensation Principle Ideally, design financing scheme to: –charge those who benefit –compensate those who lose