Follow by Email

Sunday, 30 October 2011

Cost-Benefit Analysis (CBA)


·     A method of decision making which attempts to take into account social costs and benefits and private costs and benefits of a given project.

·     Tries to place a monetary value on all benefits arising from a project, then compares the total value with the project’s total costs.

·     An approval technique à used to decide whether the project will go ahead or not

·     Incorporates externalities

Uses

·     Public projects: airports, roads, motorways, bridges, tunnels, dam...
·     Public health programmes: mass immunisation (e.g. preparing for swine flu, even though vaccinations were not required in mass scale, CBA could have been used to decide if this was the best option)
·     Introduction of congestions charge in London
·     Investment in environmental projects (e.g. wind farms)

Stages of CBA

1a. Calculate social costs and benefits (externalities)
  b. How likely is the outcome of the cost/benefit calculated? Uncertainties?

2. Discounting the future: Calculate the monetary value now of costs and benefits expected in the future. Monetary value falls over time (because of inflation) therefore costs/benefits will be lower. Individuals also enjoy benefits now rather than later, leading to a fall in the value of costs/benefits for the future.

3. Compare costs to benefits to determine the net social rate of return.

4. Compare the net rate of return with different projects and decide which ones should go ahead.

Price shadowing: Prices being put on economic activities where there is no market price – artificial prices. They are used to reflect the time social costs and benefits, because charged prices do no always reflect the true marginal social cost of resources.

Criticisms of CBA

·     Putting a monetary value on externalities since they are delivered and received outside the market and have no market price. E.g. impact on environment.

·     Problems choosing the rate at which to discount the future and setting shadow prices accurately

·     Not all stakeholders are taken into account when calculating costs and benefits. E.g. non human stakeholders and future generations

·     Future costs and benefits are hard to forecast due to demand and supply changes, population, inflation rate, development of new technologies…

·     The costs and benefits are different to different income groups

·     A benefit to one party could be considered a cost to another, creating the need for value judgements and sometimes bias

·     The decision made to go ahead with a project is on the basis that benefits exceed costs, therefore the costs of the project are by passed

·     ‘Impartial experts’ making wrong decisions

·     Argued to be a ‘job creation scheme’ for economists and planners and a waste of time

·     Valuing human lives, for example for a proposed new road crossing. Is there a morality to calculating the value of someone’s life?

Case Study

The CBA was used with Heathrow Terminal 5

For:
Economic growth, jobs, increase competitiveness, boost economy, transport links improved, building on Brownfield sites.

Against:
More flights à more noise, traffic congestion, more air pollution, effects of wildlife

CBA was also used when deciding whether to have a national smoking ban in public places in 2004 in the UK