Cost Benefit Analysis

Question 1

What is Cost Benefit Analysis?

Answer 1

When governments make decisions, you want to figure out if it does make sense. If the government wanted to build something, they would just think about the costs, not much about the benefits. A lot of times these decisions were based on ideology. As we progressed, we included benefits.

Question 2

What are the costs and benefits of building a road?

Answer 2

Costs: labor, materials, maintenance
Benefits: saved lives, land values next to the road would increase.

Question 3

Is emoloyment cost or a benefit? Why?

Answer 3

Labor is always a cost. We take into consideration opportunity cost (you could be doing something other in your leisure time).

Question 4

What is cash-flow accounting?

Answer 4

Measuring all the money that is coming in and going out.

Question 5

What are the costs (cash-flow accounting terms)?

Answer 5

What the government pays for inputs to a project.

Question 6

What are benefits (cash-flow accounting)?

Answer 6

Adding up income or government revenues generated by the project.

Question 7

Let’s say the government got asphalt as a donation, would you consider it a cost and would count in the analysis?

Answer 7

Yes, because we could be using this asphalt for something else. We should think of its market value and put it as a cost when performing CBA (including opportunity costs).

Question 8

What is an opportunity cost?

Answer 8

The social marginal cost of a resource is the value of the resource in its next best use.

Question 9

What is present discounted value (PDV)?

Answer 9

A euro next year is worth 1 + r times less than euro now because the euro could earn r in interest if invested.

Question 10

How we assume the lifespan when calculating costs of a road, for example?

Answer 10

We assume that it is going to last forever (perpetual annuity).

Question 11

Maintenance costs are market with letter?

Answer 11

F

Question 12

What is the formula for future maintenance costs?

Answer 12

F/r

Question 13

Why Lord Stern uses discount rate of 1.4% for calculating future impact?

Answer 13

He uses lower discount rate because he presumes that majority of the population will be in poorer countries in the future and those countries have lower discount rates due to lower growth

Question 14

What is long-run growth rate of the economy?

Answer 14

1.3%

Question 15

What are two reasons for discounting 1 EUR in future relative to 1 EUR now?

Answer 15

1) Discounting: people prefer 1 EUR now than 1 EUR in one year.
2) Economic growth: makes future generations richer, so 1 EUR extra means less for them than for us.

Question 16

What is Lord Stern’s opinion on paying money to fix problems in the future?

Answer 16

We should be paying now. If we think that we will have high levels of economic growth, then we should use high discount rates. If we think that we will have low economic growth, we should use low discount rates.

Question 17

What EU recommends to use long run discount rate for Cohesion countries? What for other Member states?

Answer 17

5% and 3%

Question 18

When future money is worth more than the present, your discount rate is?

Answer 18

Low

Question 19

When present money is worth more than the future money, your discount rate is?

Answer 19

High, you might assume that you are going to die next year. Or this is common for countries with low life expectancy.

Question 20

What we assume in economics when workers work up until the point where their marginal benefit from extra income is….?

Answer 20

equal to the marginal costs with providing that labor.

Question 21

What are the problems when it comes to valuing time?

Answer 21

We don’t know how much worth is marginal hour for people, we know only their average hour.

Question 22

What are the ways to value time?

Answer 22

1) Using Market-based measures: wages
2) Contingent valuation: suing survey-based measures

Question 23

What is contingent valuation?

Answer 23

Survey-based approach that involves asking individuals how much they are willing to pay and how much they are willing to accept in compensation.

Question 24

Why there are issues with contingent valuation?

Answer 24

1) People can exaggerate value
2) Things presented first have more value than when they are presented later
3) Embedding effect (economic behaviours and decisions are influenced by their context or government).

Question 25

What are the ways to value human life?

Answer 25

1) Lost earnings - we can value life based on how much money you would have earned.
2) Compensating differentials: how much money you are willing to be paid in order to change your job into more dangerous one?
3) Revealed preference: how much individuals are willing to pay to reduce their odds of dying?

Question 26

What revealed value of life is on average (based by US studies)?

Answer 26

9.3 million, Aras said that right now it is about 10 million dollars

Question 27

What are common counting mistakes when analyzing costs and benefits?

Answer 27

1) Counting secondary benefits - a new road will increase business and tax revenues, but people will spend their money just elsewhere, we did not create a new form.
2) Counting labor as a benefit (labor is a cost!!!)
3) Double counting benefits (project increase value of land and income for farmers, why did their income increase? Because the land value increased.

Question 28

What are distributional concerns when it comes to analyzing CBA?

Answer 28

The costs and benefits do not necessarily go to the same individuals (it can massively benefit millionaires). For example, if we take VAT taxes and build a bridge in wealthy neighbourhood. Therefore, money from tax payers benefit rich people.

Question 29

What are the uncertainties when it comes to CBA?

Answer 29

We have no idea what is going to happen the more we go into the future.