Chapter 3: Conceptual Foundations of Cost-Benefit Analysis

Question 1

Pareto efficiency

Answer 1

An allocation of goods is Pareto efficient if no alternative allocation can make at least one person better off without making anyone else worse off.

Question 2

Pareto improvement

Answer 2

Anything that is pareto efficient in comparison with the status quo (grey triangle inside the pareto frontier)

Question 3

Willingness to pay (WTP)

Answer 3

WTP is the maximum amount that an individual or an organization is willing to pay (or to receive) to get something (product, policy, etc.)

Question 4

Opportunity Cost

Answer 4

The dollar value of inputs required to implement policies. The opportunity cost of an input is its value in its best alternative use

Question 5

Potential Pareto efficiency rule

Answer 5

If all policies are independent, the decision maker should adopt all policies with positive net benefits.

If policies are dependent(policies interfere each other), the decision maker should adopt the combination of policies that maximizes net benefits.

Question 6

Maximization of the net benefits rule

Answer 6

The effect of combining projects should also be taken into account. Interactions between projects can affect the joint net benefits (net benefit = benefits -cost).

Question 7

Willingness to pay rule

Answer 7

If all impacts are valued in term of WTP and all required inputs in terms of opportunity costs then the sign of net benefits indicates if there is room for Pareto improvement.

Question 8

3 Major limitations from WTP

Answer 8

1. Theoretical limitation of WTP as basis for social order.
2. Dependence of WTP on the distribution of Wealth.
3. Dependence of net benefits on assumptions about standing.

Question 9

Theoretical limitation of WTP as basis for social order

Answer 9

It is easy to rank the preferences of an individual for different projects. But, it is not as easy when we aggregate those rankings and there is a tie, who gets preference?

Question 10

Dependence of WTP on the distribution of wealth

Answer 10

The WTP of a person depends on his/her current level of wealth.

Question 11

Dependence of net benefits on assumptions about standing

Answer 11

The standing matter a lot because it determines which WTP should be counted in the CBA. ie Jurisdictional membership ( include legal non-citizens?, illegal aliens?) ie. Social unacceptable preferences (criminals) ie. future generations