Sub: Economics Topic: Micro Economics

Question:

Costs benefit analysis.

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Cost-benefit analyses have been conducted for six proposed projects. None of these projects
are mutually exclusive, and the agency has a sufficient budget to fund those that will make
society better off. The following findings from the CBAs are summarized in millions of dollars:

Net Social Net Group I Net Group II

Benefits Benefits Benefits
Project A $2 $2 $0
Project B 6 8 -2
Project C 4 12 -8
Project D -1 -3 2
Project E -2 -1 -1
Project F -2 4 -6

Group I consists of households with annual incomes over $15,000, whereas Group II consists of
households with annual incomes under$15,000.
a. According to the net benefit rule, which of these projects should be funded?
b. For which of the projects might distributional considerations be an issue?
c. Compute internal distributional weights for the projects you selected in part b. using these
weights, indicate the circumstances under which each project might actually be undertaken.
d. Recomputed social net benefits for the six projects using a distributional weight of 1 for
Group I and a distributional weight of 2 for Group II. Using these weight-adjusted net social
benefit estimates, indicate the circumstances under which each project might actually be
undertaken. In doing this, assume that the distributional weight for Group II is an upper bound
– That is, it probably overstates society’s true generosity toward low-income households.

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 Sub: Economics Topic: Micro Economics

Solution:

According to net benefit rule, project B should be funded. Project B is having maximum net
social benefit ($6)
Distributional constraint may be an issue for projects B and C. Both these projects generate
positive net social benefits and positive net group 1(households with annual income over
$15000) benefits. These projects have negative net group 2 benefits (households with annual
income under $15000).
Internal weights are computed as an alternative to the approach used in distributional
weighting. This scheme works best if there are two pertinent groups, one of which is relatively
disadvantaged (Group 2 in this case) and the other relatively advantaged (Group 1 in this case).
Internal weight for project B is 8/2 = 4

Internal weight for project C is 12/8 =1.5

These two values indicate the weight at which the project will break even. However, because
the “true’ weights of the participants is unknown, policy makers would have to make
judgmental decision on giving a higher value or lower value than implied by the computed
internal weights.

d. Net social benefits without weights Net social benefits after weights

Group 1(weight = 1) Group2 (weight =2)

Project B = 6 (8*1+ -2*1) Project B = 4(8*1+ -2*2)
Project C = 4 (12*1+ -8*1) Project C = -4 (12*1+ -8*2)

Project B is cost beneficial to the society. Group 2 can be compensated for the losses they
encounter through the gains from Group 1. Project C not cost beneficial to the society since it is
generating a negative return. However in terms of social welfare this project can be selected
where the loss from group 2 is covered to a larger extent by group 1 profit.

** End of the Solution **

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