1. 1 Civil Systems Planning Benefit/Cost Analysis Scott Matthews Courses: 12-706 and 73-359 Lecture 16 - 11/4/2002

2. 12-706 and 73-3592 Administrivia  PS 3 due Wednesday!

3. 12-706 and 73-3593 Another Type of Model  Last few lectures dealt with ‘solving’ problems with multiple (more than 2) “criteria”  Recall criteria could be cost, social values, …  Also dealt with formulating these problems  In simpler models, what happens when we cannot/will not monetize all aspects?  Example: what if we are evaluating options/policies with cost, a benefit is lives or injuries saved?  Do we place a value on these benefits?  Are there other ways to ‘solve’ this?

4. 12-706 and 73-3594 Cost-Effectiveness Testing  Generally, use when:  Considering externality effects or damages  Could be environmental, safety, etc.  Alternatives give same result - e.g. ‘reduced x’  Benefit-Cost Analysis otherwise difficult/impossible  Instead of finding NB, find “cheapest”  Want greatest bang for the buck  Find cost “per unit benefit” (e.g. lives saved)  Allows us to NOT include ‘social costs’

5. 12-706 and 73-3595 Why CEA instead of CBA?  Similar to comments on MCDM  Constraints may limit ability to perform  Monetizing maybe difficult or controversial  Easy to find lives saved, hard to judge value  Monetizing can’t capture total social value or distorts its value

6. 12-706 and 73-3596 The CEA ratios  CE = C/E  Equals cost “per unit of effectiveness”  e.g. $ per lives saved, tons CO2 reduced  Want to minimize CE (cheapest is best)  EC = E/C  Effectiveness per unit cost  e.g. Lives saved per dollar  Want to maximize EC  No real difference between 2 ratios

7. 12-706 and 73-3597 An Obvious Example

8. 12-706 and 73-3598 Interesting Example

9. 12-706 and 73-3599 Lessons Learned  Ratios still tend to hide results  CEA used with constraints?  Minimize C s.t. E > E*  Min. effectiveness level (prev slide)  Find least costly way to achieve it  Minimize CE s.t. E > E*  Generally -> higher levels of C and E!  Can have similar rules to constrain cost

10. 12-706 and 73-35910 Sample Applications  Cost-effectiveness of:  New drug/medical therapies  Pollution prevention  Safety regulations

11. 12-706 and 73-35911 Why is CEA so relevant for public policy analysis?  Limited resources!  Opportunity cost of public spending  I.e. if we spend $100 M with agency A, its $100 M we cannot spend elsewhere  There is no federal rule saying ‘each million dollars spent must save x lives’

12. 12-706 and 73-35912 Another CEA Example  Automated defribillators in community  http://www.early-defib.org/03_06_09.html http://www.early-defib.org/03_06_09.html  What would costs be?  What is effectiveness?

13. 12-706 and 73-35913 Specifics on Saving Lives  Cost-Utility Analysis  Quantity and quality of lives important  Just like discounting, lives are not equal  Back to the developing/developed example  But also: YEARS are not equal  Young lives “more important” than old  Cutting short a year of life for us vs  Cutting short a year of life for 85-year-old  Often look at ‘life years’ rather than ‘lives’ saved.. These values also get discounted