Economic Policy - Cost Benefit Analysis Flashcards
A policy-maker will typically be choosing amongst several options and will have to assess the likely outcomes. For example, in the case of price discrimination, there is increased profit to the producer but increased cost to (at least some) consumers and a judgement might have to be made about the ________ of these.
A policy-maker will typically be choosing amongst several options and will have to assess the likely outcomes. For example, in the case of price discrimination, there is increased profit to the producer but increased cost to (at least some) consumers and a judgement might have to be made about the balance of these.
Externalities I
As well as the costs and benefits accruing to the parties directly involved, third parties might be affected by an __________ _________.
For example, child vaccination against measles not only benefits the child vaccinated, but all other children benefit from the reduced circulation and risk of transmission of measles.
If one farmer uses a lot of fertilizers and pesticides, this might contaminate a river which runs through the farmland and affect the quality of water available to those downstream
As well as the costs and benefits accruing to the parties directly involved, third parties might be affected by an economic activity.
For example, child vaccination against measles not only benefits the child vaccinated, but all other children benefit from the reduced circulation and risk of transmission of measles.
If one farmer uses a lot of fertilizers and pesticides, this might contaminate a river which runs through the farmland and affect the quality of water available to those downstream
Externalities II
The social benefit of an activity or policy consists of …
The social cost of an activity or policy consists of …
The social benefit of an activity or policy consists of the direct benefits of consumption/use plus any consumption externalities.
The social cost of an activity or policy consists of the direct costs of production plus any production externalities.
Cost Benefit Analysis I
The discussion of economic policy has implied that the ____________/______-maker ought to make an ____________ of the _____and _______arising from a situation, including any _______ _____ and ________.
The formal method to make this evaluation is known as Cost Benefit Analysis.
The discussion of economic policy has implied that the government/policy-maker ought to make an evaluation of the gains and losses arising from a situation, including any social gains and losses.
The formal method to make this evaluation is known as Cost Benefit Analysis.
Cost Benefit Analysis II
The government/policy-maker would like to add up all of the benefits (direct gains to ___________ and ____________ plus ___________ externalities, now and in the future) and then subtract all of the costs (direct _________to _________and _________plus _________externalities, ___and in the ________) in order to arrive at an overall measure of the outcome of a policy or situation
When comparing different policies it is common to …
This is a simple idea, but what raises several technical issues
The government/policy-maker would like to add up all of the benefits (direct gains to consumers and producers plus beneficial externalities, now and in the future) and then subtract all of the costs (direct losses to consumers and producers plus harmful externalities, now and in the future) in order to arrive at an overall measure of the outcome of a policy or situation
When comparing different policies it is common to calculate not benefits − costs but the ratio benefits/costs
While this is a simple idea, practical analysis raises several technical issues
CBA - common units
In order to compare values, it is necessary to express all of the benefit and cost items in a _____ ____.
For example, suppose that the policy of culling badgers to reduce the spread of bovine tuberculosis (ignoring the issue of how we assess the likely efficacy of such a policy, which is a further difficulty of applying this analysis) would cull three badgers and save five cows: 5 cows - 3 badgers = ?.
The usual solution to this is to express all items in monetary terms. There is a market price for cattle, but this is the market price, not necessarily inclusive of any externalities. For badgers there is no market price. Depending on the policy under consideration, it might not be appropriate to attempt to determine monetary values.
In order to compare values, it is necessary to express all of the benefit and cost items in a single unit.
For example, suppose that the policy of culling badgers to reduce the spread of bovine tuberculosis (ignoring the issue of how we assess the likely efficacy of such a policy, which is a further difficulty of applying this analysis) would cull three badgers and save five cows: 5 cows - 3 badgers = ?.
The usual solution to this is to express all items in monetary terms. There is a market price for cattle, but this is the market price, not necessarily inclusive of any externalities. For badgers there is no market price. Depending on the policy under consideration, it might not be appropriate to attempt to determine monetary values.
CBA - information
With non-market direct effects and externalities, it is difficult to assess their value. For example, suppose that a congestion charge reduces traffic and that this reduces air pollution - what is the monetary value of the increase in health?
One common approach to this is to use surveys to try to calculate ‘society’s’ valuation via willingness-to-pay (how much people would be willing to pay to __________ a ____of __________ ______________) or willingness-to-accept (how much people would require as ____________ for a ___ of _________ ____________).
This is still imperfect, as people might…
It is also likely that WTP and WTA will not be independent of a person’s ________/_______. The issue of ‘_________ _____’ is also relevant here
It is also likely that WTP and WTA will not be independent of a person’s ________/________. The issue of ‘__________ ______’ is also relevant here.
With non-market direct effects and externalities, it is difficult to assess their value. For example, suppose that a congestion charge reduces traffic and that this reduces air pollution - what is the monetary value of the increase in health?
One common approach to this is to use surveys to try to calculate ‘society’s’ valuation via willingness-to-pay (how much people would be willing to pay to achieve a set of beneficial externalities) or willingness-to-accept (how much people would require as compensation for a set of negative externalities).
This is still imperfect, as people might not have a clear/correct judgement of their valuation once the policy is actually implemented.
It is also likely that WTP and WTA will not be independent of a person’s income/wealth. The issue of ‘minority rights’ is also relevant here
CBA - uncertainty
Cost benefit analysis will be based on the ___________ effects of a _______, but the _______ outcomes are ____________and bound to be at least slightly different to what was expected.
For most forecasts the margin of error increases as the length of time increases. For projects such as HS2 or Hinkley Point C there might be ten or twenty years between the decision and the outcome - in twenty years almost anything could happen.
Cost benefit analysis will be based on the expected effects of a policy, but the actual outcomes are uncertain and bound to be at least slightly different to what was expected.
For most forecasts the margin of error increases as the length of time increases. For projects such as HS2 or Hinkley Point C there might be ten or twenty years between the decision and the outcome - in twenty years almost anything could happen.
CBA - discounting I
In addition to the issue of uncertainty about the future, it is also likely to be the case that the _____ and _________ will _____ _____ _____:
a clear example of this is policy related to climate change - costs of emissions reductions will be incurred now while the benefits of reduced emissions (avoided climate change) will be experienced mostly by people in the future.
Suppose that you had a choice of £10 today or £10 next week. Presumably you would prefer to have the money sooner - this implies that individuals discount the future. Suppose that you were indifferent between £10 today or £11 in one week - this would imply that you discount monetary amounts at a rate of __% per week.
In addition to the issue of uncertainty about the future, it is also likely to be the case that the costs and benefits will occur over time:
a clear example of this is policy related to climate change - costs of emissions reductions will be incurred now while the benefits of reduced emissions (avoided climate change) will be experienced mostly by people in the future.
Suppose that you had a choice of £10 today or £10 next week. Presumably you would prefer to have the money sooner - this implies that individuals discount the future. Suppose that you were indifferent between £10 today or £11 in one week - this would imply that you discount monetary amounts at a rate of 10% per week.
CBA - discounting II
Discounting in this manner is often used to compare future ____ and _________ with costs and benefits today. However, the ethical issue which arises is that such an analysis is not comparing current costs and benefits with future costs and benefits for the same person, but
rather for different people (generations). Is it justified for us to discount a future generation’s ‘present’ relative to our present?
An alternative justification is that discounting at the rate of interest equates future costs and benefits to the equivalent amount which we would have to save now.
Discounting in this manner is often used to compare future costs and benefits with costs and benefits today. However, the ethical issue which arises is that such an analysis is not comparing current costs and benefits with future costs and benefits for the same person, but
rather for different people (generations). Is it justified for us to discount a future generation’s ‘present’ relative to our present?
An alternative justification is that discounting at the rate of interest equates future costs and benefits to the equivalent amount which we would have to save now.
