AGEC 608 Lecture 01, p. 1 AGEC 608: Lecture 1 Objective: Introduction to main concepts Readings: –Boardman, Chapter 1 –Kankakee, summary of Draft Assessment Homework: Chapter 1, problem 1 Chapter 2, problem 2 Chapter 2, problem 4 due: Feb. 27

AGEC 608 Lecture 01, p. 2 What is Cost-Benefit Analysis? A method for assessing and comparing policies Relies on valuing impacts in monetary terms objection: interpersonal comparisons? objection: are those costs or benefits? objection: present and future? Bottom line: NSB = B – C Note: CBA and BCA are interchangeable terms

AGEC 608 Lecture 01, p. 3 Purpose and types of CBA Purposes: Improve decision making Learn about projects and processes Types: Ex Ante (before the project) Ex Post (after the project) In media res (during the project) Comparative (ex ante vs. ex post)

AGEC 608 Lecture 01, p. 4 History of Cost-Benefit Analysis Gallatin (Sec. Of Treas.) issues report on the costs and benefits of water projects Jules Dupuit writes “On the Measurement of the Utility of Public Works” Passage of U.S. Flood Control Act Economics Analysis of River Basin Projects (green book) “Principles and Standards for Planning Water and Related Land Resources” Water Resources Council Reagan issues executive order requiring regulatory impact analysis U.S. House passes even stringent CBA requirements

AGEC 608 Lecture 01, p. 5 What are the project objectives? What happens in the absence of the project? Questions that must be answered:

AGEC 608 Lecture 01, p. 6 Public Policy Objectives Developed country 1) National economic development 2) Environmental quality 3) Quality of life 4) Regional development

AGEC 608 Lecture 01, p. 7 Public Policy Objectives Developing country 1) Increase aggregate consumption 2) Income redistribution 3) Growth of national income 4) Employment 5) Self-reliance (balance of payments 6) Merit goods (education, health care)

AGEC 608 Lecture 01, p. 8 Questions that CBA can answer: What is the project’s fiscal impact? Is the project financially sustainable? What is the environmental impact? Is it a good (economically beneficial) project? Is this project the best alternative? Can separable components stand alone? How risky is the project? Who are the winners and losers?

AGEC 608 Lecture 01, p. 9 Example: Water Projects Objectives often include: Flood control Navigation Power generation Recreation Irrigation Water supply Concerns typically also include History, culture, ecology, and health

AGEC 608 Lecture 01, p. 10 Perspectives for Project Analysis For the economy as a whole For a regional economy affected by a project For the government budget For people affected by the project –Financial analysis –Distribution analysis Key: Different perspectives give different results

AGEC 608 Lecture 01, p. 11 US Requirements for CBA Executive Order (1996) requires: –statement of need for proposed action –examination of alternative approaches –analysis of the social benefits and costs –discussion of equity effects

AGEC 608 Lecture 01, p. 12 Key Assumptions in CBA Price measures the benefit of each marginal unit to the demander Marginal cost measures the opportunity cost of each marginal unit for the supplier The value to society as a whole is the difference between benefits and costs –See Figure 1

AGEC 608 Lecture 01, p. 13 Process of Economic Analysis Iterative process Construct with-without scenario (counterfactual) Start with financial analysis, then economic –treatment of taxes/subsidies –adjust values to opportunity costs Difference between economic & financial results

AGEC 608 Lecture 01, p. 14 The Project Cycle Identification Preparation and analysis Appraisal Implementation Evaluation

AGEC 608 Lecture 01, p Basic Steps in CBA 1. Specify portfolio of alternative projects/policies 2. Decide whose benefits and costs count (standing) 3. Catalogue potential (physical) impacts and selected measurement indicators. 4. Predict quantitative impacts over the life of the project. 5. Monetize (attach dollar values to) all impacts. 6. Discount for time to find present values. 7. Compute NPV (add up the benefits and costs). 8. Perform sensitivity analysis. 9. Recommend the alternative with the largest net social benefits.