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Chapter 8

cost benefit analysis The comparison of the costs and benifts of public goods projects to decide if they should be undertaken

Measuring Current Costs

Notes from section Using the procedure of of cash flow accounting does not account for the social marginal benefit of a project. If a good is sold in a competitve market then the opurrtunity cost of that good is equal to the cost of the good. Price = marginal cost In the same way this applies to the labor markets as well. So if the cost to hire someone is $100 then the social cost is also $100. I like the statement on leisure time also having a cost, why work when what you do in your liesure time is much more important. So, if leisure time is worth $10 dollars to you and you are getting paid 20 your opportunity cost is 10. The other ten dollars is not counted as cost but a transfer and is not counted in the true economic cost of the project. Economic costs are only those cost associated with diverting the resourse from its next best use.

Vocab from this section Cash flow accounting Accounting method that calculates costs solely by adding up what the government pays for inputs to a project, and calculates benefits solely by adding up income or government revenue generated by the project. Opportunity cost: The social marginal cost of any resource is the value of that resource in its next best use. Rent Payments to resource delivers that exceed those necessary to employ the resource.

Measuring Future Costs

Notes on this section... The proper discount rate represents the opportunity cost of a private firm. So, what else could they have been doing with the money that they are using for this project and with the same funds. So, if the firm is currently doing a project that is worth 10% with a 50% tax rate the rate of return is 5% and therefore the opportunity cost of the project is 5% and this is the rate they should associate with any new project. In this case the opportunity cost to the government is 10%. But, be sure not add the two because in this case the government will be recivign the after tex from the firm and thus will cut the real expense down to 5%. The US uses The Offce Oof Management and Budget recommend in 1992 that the government

should use a tax rate of 7%. Vocab in this section... present discounted value (PDV) A dollar next year is worth 1 + r times less than a dollar now because the dollar could have earned r% interest if invested. The rate appropriate value of r to use in computing PDV for social benefit.

Social discount rate

Measuring the Benefits of Public Projects

Measuring the benefits associated with this project is more difficult than measuring the costs because it is more difficult to use the market values to place a value on the benefits.

Valuing Driving Time Saved

This project benefits two groups the people and the producers. The benefits to the producers arise from a reduction in the cost of supplying goods, because it takes less time for goods to move around this will lower the price and cause a rightward shift in the supply curve which raises the size if the social surplus. This increase in social surplus is the benefit of increasing social goods. Its is much more difficult to measure the benefits of time saved on for the consumers; How do we value the benefit of getting to one place more qucicly than another? What is needed is a measure of how society value of time.

Using Market-Based Measure to Value Time: Wages (pg. 210 )

Remember that in competitive models individuals set the value of their next hoer of leisure time equal to their wage. If the marginal utility if leisure time is above the wage, people will worked less and take more leisure. So, the value of market time is always wage. There are limitations however, because a person cannot set there hours and therefore the wage overstates the value of leisure time.

Using Survey-Based Measures to value Time: Contingent Valuation

Contingent valuation is asking a person how much they would value something that they don't have now. The problems of contingent valuation Isolation of issues matters. Order of issues matters The embedding effect

Using Revealed Preference to value Time

So, based on the issues above this does not give any accurate information. The natural way for economics to gain information about what an individuals time is worth the use revealed preference: let the actions of individuals reveals their valuation. Actually funny from the book: people may lie, but their actions result is utility maximization.

Using Wages to Value a Life

When dicieding how much a life is worth people when their leisure time is valued at their wage rate and then multiplied by the average life span. When people take jobs that are dangerous they are paid what is a compensating differential. Full definition is the additional or reduced wage payments to workers to compensate them for the negative or positive amenities of a job. Discounting Future Benefits A particularly thorny issue for cost-benefit analysis is that many projects have cost that are mostly immediate and benefits that are mostly long term Cost-effective analysis: the search for the most cost-effective approach to providing a desired public good.

Putting it All Together

Common Counting Misskates Counting Secondary benefits Counting labor as a benefit ( apart of the cost not the benefit) Double-counting benefits