Unit 3 (cont.): Economic Analysis— Cost-Benefit Analysis 1

1. Unit 3 (cont.): Economic Analysis—Cost-Benefit Analysis 1

2. Meaning of Cost-Benefit Analysis What is Cost-Benefit Analysis?

3. Meaning of Cost-Benefit Analysis Definition: • “… is a useful approach to assess whether decisions or choices that affect the use of scarce resources promote efficiency… [The] analysis involves systematic identification of policy consequences, followed by valuation of social benefits and costs and then application of the appropriate decision criterion” (Fuguitt & Wilcox, 1999: 35).

4. Meaning of Cost-Benefit Analysis • Entails comparison of costs & benefits of a single project or alternative projects • NOT just about financial analysis of revenues and expenditures but “social’’ costs and “social” benefits • —the gains and losses of a project as viewed from the standpoint of society as a whole • It is used to inform decisions

5. Meaning of Cost-Benefit Analysis • Where in the Project Life Cycle do we Need to do Cost-Benefit Analysis (CBA)?

6. Who does Cost Benefit Analysis?

7. Who does Cost Benefit Analysis? Government—its goal is to promote public interest and increase social welfare Private corporations—some private decisions have social goals in mind; or government may demand it Non-profit organizations—most of them have social goals or depend on public funds (e.g. environmental NGOs)

8. Examples of Areas Where CBA can be Applied Water resource projects Transportation projects Education programs Pollution control projects Endangered species preservation Etc, etc, etc

9. What is the main rationale behind Cost-Benefit Analysis as a decision-making tool? What is it intended to achieve?

10. Rationale for Cost Benefit Analysis EFFICIENCY is at the heart of CBA whether benefits derived are worth the costs used to identify most EFFICIENT alternative What is Efficiency? option that yields the most outputs for a given amount of inputs used as basis for economically rational allocation of scarce resources

11. Meaning of Costs and Benefits What is Cost? • the opportunity cost of all resources to be used for a project • Opportunity cost = the value that would have been derived from these resources had they been allocated to the next best alternative foregone

12. Meaning of Costs and Benefits • Benefits • positive outcomes of a project • manifestations of project objectives, plus unintended positive consequences

13. Meaning of Costs and Benefits What are Disbenefits? • undesirable (negative) consequences (disadvantages) suffered by society or a section of society as a result of a project, e.g. economic losses, pollution, nuisance, etc • usually unintended outcomes

14. “With & Without” vs“ Before & After” • CBA deals with incremental benefits and incremental costs • not a before-and-after analysis: i.e. not estimation of difference in costs and benefits b/n the time before (baseline scenario) and the time after the project • Incremental benefits = (benefits with the project) minus (benefits without the project) • Incremental costs = (costs with the policy) minus (costs without the project)

15. Basic Steps of CBA Define alternativesto be evaluated Identify all expected social costs and social benefits Valuesocial benefits and costs in monetaryterms Determine appropriate CBA decision criterion(a) Assess alternatives based on CBA decision criteria chosen Describe consequences that can not be valued in monetary terms Report resultsfor consideration by decision makers

16. Decision Criteria in Cost-Benefit Analysis • Three common CBA-based decision criteria: • Net Present Value (NPV) • Cost-Benefit Ratio (CBR) • Internal Rate of Return (IRR) • a discount rate such that NPV = 0 • Desirable if IRR > actual discount rate  WHY?