Cost-Benfit analysis- Final Exam

Cost-Benefit Analysis (CBA)

Assessment of the benefits and costs associated with a particular choice.

Benefits in CBA

Expressed in dollar terms.

Net Benefit (NB)

Benefits minus Costs (NB = B - C).

Project likely funded

When net benefit is greater than 0.

Project less likely funded

When net benefit is less than 0.

Individual chooses action

When Benefits > Costs or Net Benefits > 0.

Common use of CBA

Used for public policy decisions.

Public decision example

Whether NYC should provide free HIV prevention and education programs to Hispanic, African American communities.

Another use of CBA

Ranking alternative projects.

Expected Benefit

Probability-adjusted value of a benefit when outcomes are uncertain.

Expected Benefit Formula

E(B) = prob(B = b) × b.

prob(B = b)

Probability that the positive outcome will occur.

Why expected values are used

Because costs and benefits are uncertain.

Required probabilities in CBA

Must be mutually exclusive and collectively exhaustive.

Public policy objective of CBA

Choose the level of output that maximizes net social benefits.

NSB

Net Social Benefits.

NSB Formula

NSB = TSB - TSC.

TSB

Total Social Benefits.

TSC

Total Social Costs.

Human Capital Approach

Values life as the present value of lifetime earnings.

Human Capital benefit side

Productivity gains from extending life.

Human Capital cost side

Productivity losses from early death.

Early death for society

Loss in national output due to mortality.

Problem with Human Capital Approach #1

Non-paid workers (homemakers, students, retirees) are valued at zero.

Why valuing homemakers at zero is flawed

Homemakers still contribute value to society.

Problem with Human Capital Approach #2

Implies higher earners have greater social value.

Why wage = value is flawed

Income does not determine a person's worth to society.

Labor market imperfection issue

Discrimination can cause equally qualified people to earn different wages.

Willingness-to-Pay (WTP) Approach

Values life based on how much people will pay to reduce risk of dying.

Problem with WTP Approach

Estimates are subjective and vary between individuals.