Flashcards in Week 7: Benefit-Cost Analysis Deck (38)
Why do Benefit-Cost Analysis?
If benefits are larger than cost, social surplus increases (the size of the pie is bigger); benefits>cost implies that net benefits are greater than zero
Can we put a price on everything?
Humans make choices between different options; utility functions are simple index functions (more is better); monetized values keep utility constant and show tradeoffs (more/less of a good in return for less/more money); pricing is useful to compare alternatives
How can we determine what range of interest rates produce net benefits?
Environmental, health, and safety regulation
Benefit-cost analysis in legislation
Some prohibit, some require; executive order has required usage - Carter, Reagan, Bush, Clinton, Bush, Obama
What's the largest component of environmental benefit cost analysis?
Statistical value of a life
value of reducing mortality risk; Reducing mortality risk by 1 in 10,000 for a cost of $600 = 10,000 x 600 = $6 million
What's the risk in not placing a value on the cost to saving a life?
Same budget could have been used to save more lives or the same number of people could have been saved for less money
Why would benefit cost analysis be prohibited?
Perhaps some question the morality of putting a price on life or on environment; questions of equity; questions of authority
Should decisions be bound to benefit-cost analysis outcomes?
No, there may be uncertainties in how it is determined, or different normative values that people have that don't align with the analysis
The more external reviewers of BCA the better. Who should they be?
Citizens, Stakeholders, Academics
What are the key variables in BCA?
social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.
What makes BCAs valuable and comparable across projects?
A common set of assumptions (e.g. discount rate, $ value of different costs and benefits)
What discount rate to use?
Market versus social? Range of discount rates? Best to use a range to identify the sensitivity of the analysis. Also, it is important to keep the discount rate low enough so as to not discount future impacts too greatly.
What is BCA missing that a good analysis will include?
Damages of climate change are convex meaning...
increasing marginal cost
A small percentage change with a huge risk associated should be heavily weighed in the analysis. From time to time, something occurs that is outside the range of what is normally expected. This is called a tail event in the sense that it is way out the tail of a probability distribution. This issue has been analyzed by Martin Weitzman, who has proposed a dismal theorem. The theorem’s general point is that under limited conditions concerning the structure of uncertainty and preferences, society has an indefinitely large expected loss from high-consequence, low-probability events and that standard economic analysis does not apply.
What is the expected consumption level?
Weighted average of possible consumption levels
What is the expected utility?
Weighted average of expected utilities related to expected consumption levels
What is the certainty equivalent?
The consumption level that gives utility u(c1)
Direct use value e.g. breathing clean air; Indirect use value e.g. fish from oceans; Option value: it pays to wait until uncertainty is resolved
Existence value e.g. nature conservancy without visiting; Bequest value e.g. willingness to pass on to next generation; Option value: it pays to wait until uncertainty is resolved
Things that can be observed and purchased directly in the market
Goods that cannot be purchased directly e.g. demand for clean air; Hedonic e.g. how do we tell how much someone values something by price e.g. differential in house prices for clean air; Travel cost method - how much will people pay to go to different places; Contingent valuation method: use of surveys
Hedonic indirect measures
how do we tell how much someone values something by price e.g. differential in house prices for clean air
Travel cost method
recreational demand model; tradeoff between price to go to site and number of visits
Contingent valuation method
Use of surveys to understand peoples valuation process; the only way to measure existence values
Challenges in establishing link between pollution and health
- Exogenous source of variation in pollution - endogenous adaptation and sorting; - Accurate measurements of pollution exposure - measurement errors; - Short-run adaptation - stay indoors during bad days; - Long-run adaptation - install air filters or move somewhere else
What should the appropriate measure of environmental regulatory costs be?
The transition costs of employees who are forced to switch jobs because of the regulation; compare wages of workers in regulated and unregulated firms over time