Economic Valuation and Opportunity Costs: Steps and Principles in Analysis

1. Valuation: commodities, foreign exchange, labour (I) R. Jongeneel Curry & Weiss chapters 4, 5

2. Lecture Plan • Steps in the analysis • Example: two points of view • The issue of transfer • Economic analysis and opportunity costs • Shadow price-principle (CR’s) • Numeraire choice

3. Steps in the analysis • Who is the client? • What are the goals of the analysis? • What is the objective? • What are the alternatives? • What are the consequences of each of the alternatives? • How are the consequences to be valued? • Efficiency and beyond ? (distribution)

4. D S Pdom c a support b d Pwm Example: two points of view • Agricultural price support policy & nature conservation

5. Example: two points of view Project owner Fundamental points of view national economy Possible points of view (NB): • farmer (+a+b+c) • consumer (-a-b) • minister of agriculture (a+b+c-a-b)? • minister of finance (-b-c-d) • national economy ….?

6. Example: two points of view National economy W = CS+PS+GR+EE = -(a+b)+(a+b+c)-(b+c+d) = -(b+d)

7. D S’ S Pdom Cnat= output loss Pwm Foregone output Example: two points of view Question: nature conservation project: what is appropriate valuation? Benefit Bnat Assume: more nature, less agriculture  leftward shift supply Which price to use…?

8. Economic valuation: issue of transfers • Rule: transfers should be omitted from economic calculations • Question: what are transfers? • Examples: • payment of sales tax • receipt of cash subsidy • unemployment benefit • and …. social security (welfare state) …??

9. Economic valuation: issue of transfers Demarcation criterion: A payment or receipt is a transfer if it is a pure re-distributive financial stream and no charge for the use of resources or related to particular services Rule: If ‘transfer’ isrelated to economic activity it may not be omitted from BC-analysis

10. Economic valuation: issue of transfers • Pure income redistributive taxes • rent (land, no maintenance) NO • special taxes • land tax (landscape, infrastructure) • water tax (covers cost of water system) • direct payment (agr. Cross compliance) YES • receipt, repayment of loan, paid interest • indirect costs and benefits

11. Economic analysis and opportunity costs • Economic analysis: value inputs and outputs w.r.t. their contribution to the national economy • Key-word: opportunity costs • can be market prices • more generally shadow prices • Example (I): labour surplus economies: migration out of agr. into industry (opp. costs vs. wage)

12. Economic analysis and opportunity costs Example (II): exchange rate regime in 1950s and 1960s. Bretton Woods-system with fixed exchange rates relative to US dollar. Influences import-intensity and export competitiveness of production

13. Economic analysis and opportunity costs • Information: put world prices in operational terms • import cif price (imports) • export fob price (exports) • project location (border parity pricing) • indirect method for non-tradables Assumption: fixed prices

14. Economic analysis and opportunity costs • Conversion factor (CF) • Calculate NPV taking into account CF; and appropriate discount rate

15. Numeraire choice • Implicit objective (opp cost principle): maximize net resources available to the economy • Numeraire: shadow prices can be expressed in either a domestic numeraire or directly in foreign exchange units

16. Lessons • valuation: “agent” - dependent • valuation: context - dependent • transfers: omit or not-omit • shadow price: opp. cost principle • evaluation: financial & economic