Cost Benefit Analysis

Question 1

Cost Benefit Analysis

Answer 1

This is a method used by governments to decide whether a project would beneficial for society. To undertake a CBA the procedure involves:

1. All costs and benefits need to be identified. These include both monetary and non-monetary costs and benefits.
2. Future costs should be identified and calculated; this will involve putting a net present value on these costs.
3. A common monetary value needs to be placed on the various external benefits and external costs.

Question 2

What are the problems with using a Cost - Benefit Analysis? 1

Answer 2

1. Difficult to convert external benefits into a common monetary value, e.g. it is difficult to agree on the value of a beautiful landscape.
2. Cost Benefit Analysis cannot effectively include the unpredictable events, such as a nuclear accident at a nuclear power station.
3. Prices may be distorted by monopoly power or taxes.
4. Planning takes a long time and costs may change frequently. Also revenues may be difficult to predict. Often big projects end up costing much more than anticipated.

Question 3

What are the problems with using a Cost - Benefit Analysis? 2

Answer 3

5. Difficult to choose a discount rate for future benefits and costs.
6. With any project there will be winners and losers. Even if there is a net gain to society, some people may lose out significantly, e.g new airport may increase net welfare for society, but people living underneath flight path will lose out.
7. The cost of implementing a cost benefit analysis
   • However, there are few alternatives to a cost-benefit analysis, and at least it helps provide more information for making a more informed decision.

Question 4

Additional

Answer 4

Money in the future is worth less than money now and prices have to be put on economic activities where there is no market price.
Relate CBA to government failure