Public 1: CBA Flashcards
Suppose the First and Second Welfare Theorems hold. Is there any need for public CBA? What about private CBA?
If the first and second welfare theorems hold, private CBA is all that is needed to reach a Pareto-efficient allocation. Equitable distributions can be reached by lump-sum redistribution; the government may need to decide which of these is most desirable using a SWF, which is a form of CBA. Most current forms of public CBA will not be needed.
What is the net present value of a project?
The net present value of a project equals its capital outflow cost, plus the sum of its net benefits over time, each discounted by an interest rate. We consider costs and benefits up until a fixed time horizon n.
Why are discount rates applied to future costs and benefits?
Benefits in the future are worth less than benefits now. This is because there is an opportunity cost to waiting; we could instead invest the money and receive an r% market return. We may also have a pure rate of time preference that justifies impatience.
What is the internal rate of return?
The IRR is the value of r which solves NPV = 0.
What is an intangible benefit? Give an example of a direct intangible benefit, and an indirect intangible benefit.
Intangible benefits cannot be measured through observed prices and markets. For example, the value of cleaner air is a direct intangible benefit from shutting down a local coal-fired power station; improved reputation of the town may be an indirect intangible benefit.
If market prices for a good exist, are these a good guide to its costs?
Yes, on the condition that there are no significant externalities associated with the good, or market power in its market. For example, the market price of building materials are a good guide to the costs we should associate with it. However, the pretax market price of cigarettes are unlikely to be a good guide to its costs.
What is hedonic pricing? How can it be used to estimate the value of (for example) good local schools?
Hedonic pricing infers value from revealed preferences. For example, if we can find a neighbourhood similar to this one but without a good local school, we may think that the difference in house prices is a good guide to the value of the school. We should be careful to control for any other confounding variables.
How can staggered roll-out of policies help us evaluate their costs and benefits?
If the staggered roll-out is randomised, we can compare areas with and without the policy in a quasi-experimental way. All areas were equally likely to receive the policy, and so comparing the difference in mean outcomes provides an unbiased and consistent estimate of the causal effect.
What is the ‘value of a statistical life’? Why is it not infinite?
The value of a statistical life is the monetary value placed on saving each life in a CBA. For example, reducing speed limits on motorways to 50 would save x lives, so we should count x(VSL) as one of the benefits of the policy.
An infinite VSL would imply we should never do anything that comes with any risk to life. Speed limits should be below 10 everywhere, all weapons should be banned, and many people should not ever leave their houses. Since this is clearly absurd, we accept that we often have to trade off risks to life with other things we value.
Is estimating the wage premium to risky jobs a good way of estimating the VSL?
Risky jobs have an increased risk of death/injury. In a competitive labour market, this increased risk would be priced into compensation for the job, and we could infer the VSL from this premium.
There are two problems with this approach. Firstly, labour markets may not be competitive. If employers exert monopsony power, wages will be lower than they otherwise would have been. Potential employees may also be uninformed about the true risks of the job.
Secondly, there may be significant heterogeneity in perceived VSL across individuals. Those willing to take on risky jobs may have particularly low risk-aversion or particularly small VSL, leading us to underestimate the “social” VSL by only observing these jobs.
What is a social welfare function?
A social welfare function takes individual utility functions as arguments, and outputs a measure of social welfare. States of the world with higher social welfare are preferable to those with lower social welfare.
What is ‘cost-effectiveness analysis’? Is it preferable to CBA?
Cost-effectiveness analysis avoids putting a value on benefits, and instead seeks to find the least costly way to achieve some set goals.
