Unit 3 (cont.): Economic Analysis—

Meaning of Cost-Benefit Analysis



What is Cost-Benefit Analysis?

Meaning of Cost-Benefit Analysis

Definition:



“… is a useful approach to assess whether decisions or choices that affect the use of scarce resources promote efficiency… [The] analysis involves systematic identification of policy consequences, followed by valuation of social benefits and costs and then application of the appropriate decision criterion” (Fuguitt & Wilcox, 1999: 35).

Meaning of Cost-Benefit Analysis

 Entails comparison of costs & benefits of a single project or alternative projects  NOT just about financial analysis of revenues and expenditures but “social’’ costs and “social” benefits  —the gains and losses of a project as viewed from the standpoint of society as a whole  It is used to inform decisions

Meaning of Cost-Benefit Analysis



Where in the Project Life Cycle do we Need to do Cost-Benefit Analysis (CBA)?



Who does Cost Benefit Analysis?

Who does Cost Benefit Analysis?

 Government—its goal is to promote public interest and increase social welfare  Private corporations—some private decisions have social goals in mind; or government may demand it  Non-profit organizations—most of them have social goals or depend on public funds (e.g. environmental NGOs)

Examples of Areas Where CBA can be Applied

 Water resource projects  Transportation projects  Education programs  Pollution control projects  Endangered species preservation  Etc, etc, etc



What is the main rationale behind Cost-Benefit Analysis as a decision-making tool?



What is it intended to achieve?

Rationale for Cost Benefit Analysis

EFFICIENCY is at the heart of CBA

 whether benefits derived are worth the costs  used to identify most EFFICIENT alternative

What is Efficiency?

 option that yields the most outputs for a given amount of inputs  used as basis for economically rational allocation of scarce resources

Meaning of Costs and Benefits

What is Cost?

 the opportunity cost of all resources to be used for a project  Opportunity cost = the value that would have been derived from these resources had they been allocated to the next best alternative foregone

Meaning of Costs and Benefits



Benefits

 positive outcomes of a project  manifestations of project objectives, plus unintended positive consequences

Meaning of Costs and Benefits What are Disbenefits?

 undesirable (negative) consequences (disadvantages) suffered by society or a section of society as a result of a project, e.g. economic losses, pollution, nuisance, etc  usually unintended outcomes

“With & Without” vs“ Before & After”

 CBA deals with incremental benefits and

incremental costs

 not a before-and-after analysis: i.e. not estimation of difference in costs and benefits b/n the time before (baseline scenario) and the time after the project  Incremental benefits = (benefits with the project) minus (benefits without the project)  Incremental costs = (costs with the policy) minus (costs without the project)

Basic Steps of CBA

 Define alternatives to be evaluated  Identify all expected social costs and social

benefits

 Value social benefits and costs in monetary terms  Determine appropriate CBA decision criterion(a)  Assess alternatives based on CBA decision criteria chosen  Describe consequences that can not be valued in monetary terms  Report results for consideration by decision makers

Decision Criteria in Cost-Benefit Analysis



Three common CBA-based decision criteria:

1.

Net Present Value (NPV) 2.

Cost-Benefit Ratio (CBR) 3.

Internal Rate of Return (IRR)

 a discount rate such that NPV = 0  Desirable if IRR > actual discount rate  WHY?