BENEFIT-COST ANALYSIS BASICS

Monetary Measures of Utility  How much is a gallon of gas worth to a person?

 Expenditure at going price (“value in exchange”)  Value above price/expenditure?     Suppose you can buy as much gasoline as you wish at $1 per gallon once you enter the gasoline market. Q: What is the most you would pay to enter the market?

Q: How would you depict this graphically?

Q: How could you depict this value and the consumer expenditure on a demand graph?

Consumer’s Surplus (with competitive supply)

p 1

p Max

CS = ½* q m ( p max p m ) E xpenditure= q m * p market

p m

MC = Supply

q q

1

“Value in Use” = E + CS = “Impact Study”

Benefit-Cost Analysis

Policy Change: Excise tax imposed of $t t CS p 1 p m Tax Revenue Seller Revenue Deadweight Loss = ½ *(p1-pm)*(qm-q1) q 1 q m Marginal Cost (output units)

Benefit-Cost Analysis

Expenditure of tax revenues in Market 2 p 2 t p m2 Added CS + Expenditure = P m2 (q 2 -q m2 ) + ½ p 2 (q 2 -q m ) MC q m2 q 2 (output units)

General Equilibrium CBA

 Preceding graphic provides measure of welfare loss in single market  Total effect takes into account gain in welfare from expenditure of funds in new market(s)  Net Welfare Change in $ = ½ *(p1-pm)*(qm-q1) – P2m(q2-qm2) ½ p2*(q2 – qm2)

Compensating Variation and Equivalent Variation  Two additional dollar measures of the total utility change caused by a price change are  Compensating Variation: the least income that, at the new prices , just restores the consumer’s original utility level?

 Equivalent Variation: level the least income that, at the old prices, just restores consumer’s utility

BCA with Pricing Power Producer’s Surplus

Output price (p) Producer Surplus = q 1 *p m - VC Supply = Marginal Cost p m Producer Variable costs = q 1 q (output units)

BCA with Pricing Power

t CS p b Tax Revenue p s PS Deadweight Loss q 1 q 0 (output units)

Benefit-Cost Beyond the Basics     GE/Externality Issues (MN Recycling Case)  Are market prices/cost accurate reflection of values?

 Markets involved; degree of development; subsidies; secondary costs Non-market goods  WTP Methods  Hedonic regressions  Implicit Values  Time Valuation  Life Valuation Future projects  Projections of use/demand for project (see impact studies)  Surveys; Simulations (Portland Traffic case; Seattle Rail)   Projection of impacts on related goods/services  Simulations; Existing studies Projections of cost  Direct v. Secondary costs  Time Aspects  Discounting rates  Time Horizons Special Topics—Basis of Big Errors  Impacts Over (under) Estimated (See Impact Study Discussion)  Poor Cost Estimates    Poor Use/Demand Estimates Double counting: “jobs created” Market Prices v. Consumer Surplus