PLCY 240 – July 11_ 2007

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					PLCY 240 – March 19, 2009
Introduction to Cost-Benefit Analysis
Basic Steps of CBA:

1) specify the set of        5) monetize impacts
   alternative projects      6) discount benefits and
2) decide whose benefits        costs to obtain present
   and costs count (who         values
   has standing)             7) compute NPV of each
3) list the impacts and         alternative
   determine how to          8) perform sensitivity
   measure them                 analysis
4) predict the impacts       9) make a recommendation
   quantitatively over the
   life of the project
Ethics and Efficiency: Cost-Benefit Analysis

Steven Kelman:
a professor of public management at

Steven Rhoads:
a professor of public policy at the
University of Virginia
Steven Rhoads, “Benefit-Cost Analysis”

• CBA is now required by many government
  agencies to assess the impact of proposed
  regulations or programs
• Costs may be fairly easy to calculate
• Calculating benefits is more difficult
  – estimate impact of programs
  – estimate value of impact
  – note that finding control groups can be difficult
Rhoads, cont.

• Difficulties can arise when attempting to
  estimate costs such as:
  – value of time
  – value of reduced illness
  – value of improved environmental conditions
  – value of a human life
Steven Kelman, “Cost-Benefit Analysis: An Ethical

• The conceptual framework for cost-benefit
  analysis is utilitarianism
  – implement the policy if the benefits are greater than
    the costs
• Kelman argues that some actions whose costs
  are greater than their benefits may still be
  morally correct (and vice versa)
• Depending on the duties and rights at stake and
  the importance attached to them, CBA may be
Kelman, cont.

• Much of CBA is based on estimates of
  “willingness to pay” (WTP)
• Criticisms of WTP estimates:
  – WTP for an increase in well-being versus
    willingness to accept (WTA) compensation for
    a decrease in well-being
  – WTP to avert a decrease in well-being versus
    WTA to forego an increase in well-being
     • in each case, the welfare loss is inflated because
       losses weigh more heavily than gains
     • losers value losses more than winners value gains
Kelman, cont.

• More criticisms of WTP estimates:
  – invariably based on private transactions; do
    not account for values based on collective
    public decisions
  – the very act of trying to assess a value on a
    non-market good may reduce the good’s
    intrinsic value
Kelman, cont.

• Robert Solow’s replies to Kelman’s criticisms:
  – WTP and WTA estimates are only used in the
    context of making decisions regarding public
  – CBA doesn’t purport to eliminate ethical
  – CBA does account for the inflated values of
    welfare losses
  – even Kelman acknowledges that some CBA is
    beneficial in policymaking
Rhoads, cont.

• Critiques of CBA criticisms:
  – CBA works both in favor of and against
  – uncertainty is part of economic analyses;
    doing away with CBA will not eliminate it
     • sensitivity analysis can help policymakers
       understand the effects of uncertainty
     • the range of plausible values is still not unbounded
  – even with non-quantified values, CBA can
    provide clear recommendations
Rhoads, cont.

• More critiques of CBA criticisms:
  – it’s true that government officials are unwilling
    to acknowledge that lives are being lost
    because the costs of saving them are too high
     • so do the analysis but do not expect public debate
  – analysts who do CBA do take equity seriously

• Overall, CBA does more good than harm

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