Cost Benefit Analysis

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  • Created by: Clodagh
  • Created on: 09-05-14 08:52
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  • Cost-Benefit Analysis
    • COBA is a technique for assessing the (monetary) social costs and benefits of an investment project over a given time period
      • A project is commercially viable if its private benefits exceeds its private costs, but a COBA attempts to establish whether the project carries a net social benefit
      • It is traditionally applied to big public sector projects such as new roads and tunnels, health programmes and new railways
      • The high administrative costs of carrying COBA out is sometimes a potential source of government failure
    • Process
      • 1. Identify all the costs and benefits and make a calculation using monetary values
      • 2. Discount the future value of benefits as individuals normally prefer benefits now rather than later
      • 3. Compare the costs and benefits to determine the net social rate of return
      • 4. Compare the net rate of return from different projects (opportunity cost)
    • Problems
      • Costs involved in the process of COBA can be substantial
      • Identifying specific winners and losers is subject to error and omission
      • Volatility of project costs (often way above forecast)
      • Placing monetary values on environmental costs and benefits is difficult
      • COBA has often relied on surveys and questionnaires
        • Respondents to questionnaires have little incentive to tell the truth
      • Problems in valuing time saved or lost and the value of human life
        • e.g improvements to road safety
      • Choice of Discount Rate - too high a discount rate reduces present  value of projects
      • Length of time over which costs and benefits are calculated can be arbitary
      • It may not cover everyone affected (third parties)
      • Distributional consequences - costs and benefits mean different things to different income groups. It is often a matter of opinion
        • The government may not possess the information required to identifiy accurately a cost or benefit
    • Using COBA
      • Public Subsidy
        • Thus it can be used to justify the maximisation of public welfare
      • Regulation
        • It can be used to show that negative externalities outweigh positive, thus giving a rational reason for pollution taxes or other direct controls
      • Planning
        • It can be used to resolve competing claims of different stakeholders and resolving controversial issues

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