Chapter 1: Introduction to CBA

Question 1

What is the definition of a CBA?

Answer 1

Cost-Benefit Analysis (CBA) is a policy assessment method that quantifies the value of policy consequences (or impacts) in monetary terms to all members of society.

Question 2

What is the equation for a CBA?

Answer 2

A CBA calculates net social benefits(NSB)for each policy alternative: net social benefits equal social benefits(B) minus social costs(C): NSB = B -C

Question 3

What is the purpose of a CBA?

Answer 3

When markets fail and resources are used inefficiently, CBA can be used to clarify which of the potential alternative programs, policies or projects (including the status quo) is the most efficient.

Question 4

4 types of CBA analyses

Answer 4

1. Ex ante CBA
2. Ex Post CBA
3. In medias res CBA
4. Comparative CBA

Question 5

Ex ante CBA

Answer 5

conducted prior to the intervention. Useful to show whether resources should be used on a program or project.

Most current CBA used for decision making. Decision-makers base the decision to allocate resources on this type of analysis.

Question 6

Ex post CBA

Answer 6

conducted at the end of the intervention. Provides information about the particular class of intervention.

Cannot be used for decision making. Goal is to learn

Question 7

In medias res CBA

Answer 7

conducted during the intervention.

Can also be used for decision making but only to fix an ongoing project when it is still possible.

Question 8

Comparative CBA

Answer 8

compares the ex ante predictions to ex post results for the same project (very rarely done).

Question 9

Prediction error

Answer 9

Discrepancies between predicted and observed values of costs and benefits.

Question 10

9 Basic steps of a CBA

Answer 10

1. Specify the set of alternative projects
2. Decide whose benefits and costs count (standing)
3. Identify the impact categories, catalog them and select measurement indicators
4. Predict the impact quantitatively over the life of the project
5. Monetize (attach dollar values to) all impacts
6. Discount benefits and costs to obtain present values
7. Compute the net present value of each alternative
8. Perform sensitivity analysis
9. Make a reccomendation

Question 11

Step 1: Specify the set of alternative projects

Answer 11

CBA compares the net social benefits of a project with the net social benefits of the “counter-factual” (a hypothetical project) .–It is usually the status quo.

Question 12

Step 2: Decide whose benefits and costs count (standing)

Answer 12

Which benefits and which costs should be included in the CBA.

Standing is usually most appropriately specified at the level of relevance for the government.

Question 13

Step 3: Identify the Impact Categories, Catalogue them and select the measurement indicators.

Answer 13

• Identify the physical impact categories for the proposed alternatives.–The term impact is used for inputs (required resources) as well as output
• Catalogue them as benefits or costs.
• Specify the measurement indicator for each impact category.

Question 14

Step 4: Predict the impacts quantitatively over the life of the project

Answer 14

The goal is to quantify all impacts in each time period (difficult to predict)

Question 15

Step 5: Monetize (attach dollar values to) all impacts

Answer 15

The dollar value is measured in terms of “willingness to pay”.

Question 16

Step 6: Discount benefits and costs to obtain present values

Answer 16

If the project has impacts over years, we must discount for the time in order to aggregate costs and benefits over time. In that case, we compute the present value of the costs and the benefits.

Question 17

Step 7: Compute the net present value of each alternative

Answer 17

The net present value (NPV) equals the present value of benefits minus the present value of costs: NPV = PV(B) - PV(C)
•The decision-maker should select the project with the largest NPV

Question 18

Step 8: Perform sensitivity analysis

Answer 18

To deal with the uncertainty on the different impacts and monetary valuation, an analyst should perform a sensitivity analysis.

Question 19

Step 9: Make a recommendation

Answer 19

Generally, you should recommend the project with the largest NPV

Question 20

Guardians

Answer 20

Guardians consider projects with a revenue-expenditure view of the costs and benefits
–revenue inflows = “benefits”
–expenditure outflows = “costs”.

They tend to view CBA as naïve and impractical and as a tool of spenders.

The guardian perspectives makes project less likely to beat the status quo

Question 21

Potential consequences of the guardian perspective

Answer 21

Ignores non-financial social benefits (time saved, lives, etc.) and social costs (time spent, pollution).
•Misinterprets or ignore some of the financial costs.–Example: Labour costs –guardians take into account the total wage remuneration, while CBA focuses on the opportunity cost of the labor.–Ignores costs not borne by its own level of government.
•Considers subsidies from other levels of governments as benefits.–Federal government subsidies are not considered as costs but as benefits at the municipal and the provincial level.
•Public goods tend to be considered as free goods instead of considering their opportunity cost.
•Discount rates are usually too high –similar to financial market discount rates and that are not social discount rates

Question 22

Spenders

Answer 22

• Spenders consider expenditures on constituents as benefits rather than costs.
• Spenders focus on providing projects and services to particular groups in society
• The spender perspective makes project more likely to beat the status quo

Question 23

Potential consequences of the spender perspective

Answer 23

• Expenditures on constituents are viewed as benefits rather than costs.–Labour costs are viewed as benefits–Transfers received by constituents are also viewed as benefits.
• Public resources are viewed as having no cost.
• Users’ monetary outlays are viewed as costs.
• Favours large, irreversible, capital-intensive projects with big sunk costs. –Hard to cancel during or after completion of the project.–Example: Urban train system instead of bus services
• Discount rates are usually too low. –It raises the project probability of acceptance (raises the NPV).

Question 24

Analyst?

Answer 24

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