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Updated:09/03/2007 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 4

Updated:09/03/2007 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 4. ECONOMIC VALUATION OF TRADABLE GOODS & SERVICES. Tradable Commodities Classification of a Project’s Inputs and Outputs.

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Updated:09/03/2007 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 4

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  1. Updated:09/03/2007 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 4

  2. ECONOMIC VALUATIONOF TRADABLE GOODS & SERVICES

  3. Tradable CommoditiesClassification of a Project’s Inputs and Outputs A good or service is considered tradable when an increase in demand (or supply) by a project does not affect the amount demanded by domestic consumers • An increase in demand for an IMPORTABLE commodity results in an increase in demand for imports • An increase in demand for an EXPORTABLE commodity results in a reduction in exports • An increase in supply of a tradable commodity by a project will cause either a reduction in imports or an increase in exports An Importable commodity includes imported goods and domestically produced goods that are close substitutes for imported goods An Exportable commodity includes exported goods and close substitutes for exported goods

  4. Measuring the Economic Values of Tradable Goods: Four Cases • Economic value of importable good production • Economic cost of importable input • Economic cost of exportable input • Economic value of export production

  5. Price S Domestic Supply Distorted World Supply Price Pm Em* PCIF* (1+Tm) + Fm D Domestic Demand Quantity per year so do Q Q so do Imports = Q - Q Em= Market Exchange Rate FM = Domestic Freight to Market Tm = Rate of Import Tariff PCIF = Price of imports at entry point to country, including international freight and insurance charges expressed in units of foreign currency Importable Good

  6. Price S domestic S w/ project Em * PCIF* (1+Tm) + Fm S world D domestic Qs0 Qs1 Qd0 Quantity Project Supplies More of an Importable Good Project reduces quantity imported. No change in domestic consumption.

  7. Estimating The Economic Prices of Tradable Goods 1. Adjust for commodity - specific trade distortions • Financial prices for the commodities demanded (or supplied) by a project must be adjusted for commodity-specific distortions and costs that drive a wedge between their international prices and their domestic market prices • Taxes and Subsidies are transfers between consumers, producers, and the government. Therefore, they are not part of the real resources consumed or produced by a project. 2. Value the foreign exchange at the economic (shadow) exchange rate (Ee) • Multiply the CIF and FOB prices at the border by the economic price of foreign exchange (Ee). • Alternatively, add a foreign exchange premium [(Ee/Em) - 1], or [(Ee/OER) - 1], per unit of foreign exchange demanded (or supplied) by a project. 3. Adjust for handling and transportation costs • The economic costs of handling and transportation that are necessary to move commodities to or from the point of entry must be included. • In the case of imported commodities, these costs should be added to the CIF price. • In the case of exported commodities, these costs should be subtracted from the FOB price.

  8. Visayas Communal Irrigation Project Basic Facts • The National Irrigation Administration (Philippine National Agency) proposes to rehabilitate 55 damaged communal irrigation systems and to build 25 new systems in Visayas. • The project’s additional components include water protection and erosion control, the strengthening of irrigation association, and the development of agricultural extension services. • The goal of the project is to alleviate poverty, while improving environmental sustainability of the region. • The life of project is 20 years. • The economic benefits arise from the increased production of rice and corn, which must otherwise be imported. • The foreign exchange premium is 24.6%. • The project is expected to cost approximately 480.910 million pesos (US$19.78 million). • The project will be financed with US$15.1 million loan from the International Fund for Agricultural Development, and remaining funding would be provided by the Philippine government.

  9. Adjusted Value Financial Adjustment Tradable Non-Tradable Economic Value of Forex Premium Value of SPNTO Premium Price For Taxes Content Content Value (A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G) 314.8 CIF World (US$) CIF per metric ton of rice 7659 1 7659 100% 0% 1884 0.00 9543 PLUS Transportation and Handling Charges 205 1 205 30% 70% 15.13 1.44 222 Trading Margin 472 0.68 321 10% 90% 7.90 2.89 332 Wholesale Price in Manila 8336 8185 10096 LESS Transport cost, rice mill to Manila 515 1 515 30% 70% 38 3.61 557 Ex-mill price of rice 7821 9540 LESS Net milling cost 346 1 346 50% 50% 43 1.73 390 Pre-milled value 7475 9150 Palay equivalent (65%) 4859 5947 LESS Grain dealer margin (4% margin) 194 0.68 132 10% 90% 3 1.19 137 Transport and handling cost, farm to mill 130 1 130 30% 70% 10 0.91 141 Farmgate price of palay 4534 5670 Conversion Factor 1.25 Table 1: Project Supplies an Importable Good (Rice)

  10. Measuring the Economic Values of Tradable Goods: Four Cases • Economic value of importable good production • Economic cost of importable input • Economic cost of exportable input • Economic value of export production

  11. Price S domestic Em * PCIF * (1+Tm) + Fm S world D w/ project D domestic Qs0 Qd0 Qd1 Quantity Project Demands More of an Importable Good Project requirements will be met by additional imports (world supply). Domestic consumption is not affected.

  12. Project Purchases Importable Inputs Input subject to Import Tariff D Price 0+P S D 0 0 = Em d w P P (1+t) World Supply After Tariff Em w P World Supply Quantity 0 s Q d d Q Q 0 1 0 Financial cost is EmPw (1+t) (Q1d-Q0d) Economic cost is EmPw(Q1d – Q0d) + Foreign exchange premium

  13. Economic cost of Importable Goods: With Tariff, Trade Margin and Domestic Freight Em

  14. Table 2: Project Uses an Importable Good (PESTICIDES). Adjustment Tradable Non-Tradable Economic Value of Forex Premium Value of SPNTO Premium Financial Adjusted Value Price For Taxes Content Content Value (A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G) 166 CIF World (US$) CIF per 1000 liters of pesticides 4038 1 4038 100% 993.35 5031 PLUS Tariff 201 0 0 0% 0.00 0 Port charges, handling and transportation to Manila 155 1 155 30% 70% 11.44 1.09 168 Importer Price, Manila 4394 5199 PLUS Transport cost, Manila to local market 515 1 515 30% 70% 38.01 3.61 557 Dealer's margin 201 0.68 137 10% 90% 3.36 1.23 141 Price at local market 5110 5897 PLUS Local transport cost 120 1 120 30% 70% 8.86 0.84 130 Price at farm gate 5230 6026 Conversion Factor 1.15

  15. Measuring the Economic Values of Tradable Goods: Four Cases • Economic value of importable good production • Economic cost of importable input • Economic cost of exportable input • Economic value of export production

  16. Price S Domestic Supply Em* PFOB* (1-tx) - Fx Distorted World Demand Price Pm Domestic Demand D Quantity per year do so Q Q so do Exports = Q - Q Em= Market Exchange Rate tx = Export Tax Fx = Freight and Trading Costs to Port PFOB= Price of exports at point of export from country in units of foreign currency Exportable Good

  17. Price S domestic Em * PFOB * (1-tx) - Fx D world D w/ Project D domestic Qd0 Qd1 Qs0 Quantity Project Demands More of an Exportable Good Project requirements will reduce quantity exported. Consumption of previous consumers remains unchanged.

  18. Table 3: Project Uses an Exportable Good (Seeds) Adjusted Value Adjustment For Taxes Financial Tradable Non-Tradable Economic Value of Forex Premium Value of SPNTO Premium Price Content Content Value (A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G) FOB per ton of PADDY SEED (pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882 LESS Port Handling and Transportation 155 1 155 30.00% 70.00% 11.44 1.09 168 From IRRI to port of Manila IRRI Exporter Price 6171 7715 PLUS 0.00 0.00 Transport Cost, IRRI to local market 515 1 515 30.00% 70.00% 38.01 3.61 557 Dealer's margin 235 0.68 160 10.00% 90.00% 3.93 1.44 165 Price at Local Market 6921 8436 PLUS Local transport cost from Market to farm (Project site) 120 1 120 30.00% 70.00% 8.86 0.84 130 Price at Farm Gate 7041 8566 Conversion Factor 1.22

  19. Measuring the Economic Values of Tradable Goods: Four Cases • Economic value of importable good production • Economic cost of importable input • Economic cost of exportable input • Economic value of export production

  20. Price S domestic S w/ Project Em * PFOB * (1-tx) - Fx D world D domestic Qd0 Qs0 Qs1 Quantity Project Supplies More of an Exportable Good Project increases exports. Domestic consumption remains unchanged.

  21. Project Produces Exportable Goods subject toExport Tax (No domestic transportation costs) Em Pd=EmPw(1-t) Financial benefit is EmPw (1-t) (Q1s-Q0s) Economic benefit is EmPw(Q1s – Q0s) + Foreign exchange premium Economic values of exportable goods are based on the FOB values of demand for exports

  22. Adjusted Value Adjustment For Taxes Table 4: IRRI Supply an Exportable Good (Seeds) Financial Economic Value of Forex Premium Value of SPNTO Premium Tradable Non-Tradable Price Content Content Value (A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G) FOB Port (US$) 260 FOB Port (Pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882 LESS Port Charges and transportation 155 1 155 30.00% 70.00% 11.44 1.09 168 from IRRI to Port IRRI Gate Price 6171 7715 Conversion Factor (EV/PV) 1.25

  23. SUMMARY Economic Value of Importable Good Production = CIF (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from Port to Market - Economic Cost of Local Freight from Project to Market Economic Cost of Imported Input = CIF (adj. For Economic Exchange Rate) + Economic Cost of Freight from Port to Project Economic Cost of Exportable Input = FOB (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from Export Producer to Project - Economic Cost of Local Freight from Export Producer to Port Economic Value of Exportable Production = FOB (adj. For Economic Exchange Rate) - Economic Cost of Local Freight from Project to Port

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