MEC

MASTER OF ARTS
(ECONOMICS)

ASSIGNMENTS 2019-20
Second Year Courses
(For July 2019 and January 2020 Sessions)

School of Social Sciences

Indira Gandhi National Open University
Maidan Garhi, New Delhi-110 068
 Master of Arts (Economics)
(TMA)

(2019-20)

Dear Student,

As explained in the programme guide for MEC, assignments carry 30 per cent weightage
in a course and it is mandatory that you have to secure at least 40 per cent marks in
assignments to complete a course successfully. Note that you have to submit the
assignments before appearing in Term End Examination of a course.

Before attempting the assignments please read the instructions provided in the
programme guide sent to you separately. In this booklet we have included the
assignments for all the courses pertaining to the second year. In each course there is a
Tutor Marked Assignment (TMA). You have to do the assignment for those courses for
which you have registered. Do remember that you have to prepare and submit the
assignments separately for each course. Make sure that you submit the assignments well
in time for those courses in which you plan to appear in the Term End Examination.

Submission

For July 2019 session, you need to submit the assignments by March 31, 2020, and for
January 2020 session by September 30, 2020 for being eligible to appear in the term-
end examination. Assignments should be submitted to the Coordinator of your Study
Centre. Obtain a receipt from the Study Centre towards submission.

2
 MEC-008: ECONOMICS OF SOCIAL SECTOR AND ENVIRONMENT
Assignment (TMA)

Course Code: MEC-008

Assignment Code: MEC-008/AST/2019-20
Maximum Marks: 100

Note: Answer all the questions. While questions in Section A carry 20 marks each (to be
answered in about 500 words each) those in Section B carry 12 marks each (to be answered
in about 300 words each). In the case of numerical questions word limits do not apply.

Section A

1) With a suitable illustration, show that when externalities are present, the price-taking profit
maximising behaviour of a producer will not necessarily lead to an efficient allocation of
resources. Also, suggest remedies in such situation.

2) In case of forestry, outline how the optimal harvesting age is determined? Discuss how in
this situation, Hartman’s model yields higher rotation age than that of Faustmann’s.

Section B

3) Bring out the crux of the concept of ‘sustainable development’.

4) Explain briefly any three situations under which government intervention is necessary in
public interest.

5) Briefly outline the current ‘system of national accounts’ pointing out its shortcomings from
the point of view of environmentally sustainable national accounts.

6) Discuss briefly the limitations of the ‘game theoretic approach’ to ‘common property
resource management’.

7) Present a critique of the approach to studies of ‘cost-benefit analysis’.

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M.E.C.-8
Economics of Social Sector & Environment
Disclaimer/Special Note: These are just the sample of the Answers/Solutions to some of the Questions given in the
Assignments. These Sample Answers/Solutions are prepared by Private Teacher/Tutors/Authors for the help and guidance
of the student to get an idea of how he/she can answer the Questions given the Assignments. We do not claim 100%
accuracy of these sample answers as these are based on the knowledge and capability of Private Teacher/Tutor. Sample
answers may be seen as the Guide/Help for the reference to prepare the answers of the Questions given in the assignment.
As these solutions and answers are prepared by the private Teacher/Tutor so the chances of error or mistake cannot be
denied. Any Omission or Error is highly regretted though every care has been taken while preparing these Sample Answers/
Solutions. Please consult your own Teacher/Tutor before you prepare a Particular Answer and for up-to-date and exact
information, data and solution. Student should must read and refer the official study material provided by the university.

Note: Answer all the questions. While questions in Section A carry 20 marks each (to be answered in
about 500 words each) those in Section B carry 12 marks each (to be answered in about 300 words each). In
the case of numerical questions word limits do not apply.
Section A
Q. 1. With a suitable illustration, show that when externalities are present, the price-taking profit
maximising behaviour of a producer will not necessarily lead to an efficient allocation of resources. Also,
suggest remedies in such situation.
Ans. The importance of externalities in actual resource allocation is best seen by studying cost- benefit analyses.
Such a cost-benefit analysis is Barretts and Mooneys (1982) cost benefit study of the Naas Motorway Bypass. This
study showed how the construction of the bypass resulted in significant positive externalities and a few negative
ones.
There were three main positive externalities. The first was a time savings of 10.28 minutes from reduced traffic
congestion in Naas centre at peak hours accounting for 90.5 per cent of the total benefits from the bypass, making
the social feasibility of the project was very dependent on this positive externality. The second was a reduction in
road accidents in Naas centre due to the transfer of traffic to the safer motor way, while the third was a fuel saving
accounting for 2.6 per cent of the benefits.
There were other positive externalities such as reduced lead and smoke pollution in Naas centre and especially
reduced noise pollution which constituted a serious negative externality. There were also negative externalities on
the environment associated with the construction of the motorway. The Letich committee detailed some of these
costs on non-road users such as the demolition of property, visual intrusion and the impact of farm severance. There
exist substantial problems in pricing these externalities and for this reason they were excluded from the study as no
accurate price could be put on them. This pricing problem will have affected exceeded the negative ones so yielding
a net positive externality suggesting that the real cost of the project was lower than its private cost. This would
imply that similar projects should be undertaken for congested towns on the national primary routes (Barrett, 1984),
thus leading to a more optimal resource allocation.

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Resource allocation will not be optimal unless all costs and benefits associated with the project are calculated.
This is the major difficulty with cost-benefit analysis as we do not know how to accurately measure externalities.
Some economists such as Roth have suggested that it is impossible to price them, so much so that he ignores them
in his road pricing study. This is also echoed in the Smeed Report.
By ignoring to price externalities resource allocation will suffer as projects which would be socially profitable
when including all externalities may not be so if only private costs are calculated. This point is addressed by
Mishans horse and rabbit stew analogy (1990). He says that economists can easily ignore externalities as they are
quantitatively difficult to measure, but doing so could result in a sub optimal resource allocation as such analysis
would favour mostly commercially viable projects. There is another school of thought which says that social
expenditure cannot be justified largely on the grounds of correcting for externalities. Lees makes the point that only
5 per cent of health expenditure can be justified in terms of correcting for externalities as most medical expenditure
centres on non-contagious diseases where the benefits are quite private. Peacock and Wiseman make a similar point
saying that the positive externalities of education of the individual may be exaggerated. They suspect that the
recipient may appropriate most of the benefits in the form of higher wages and salaries.
Therefore externalities, although important in causing resource allocation to be sub-optimal, have varying
effects. One thing that is sure, however, is that they must be included in cost-benefit analysis even if they are
estimated very roughly.
The existence of externalities implies that unless special arrangements are made resource allocation may not be
Pareto optimal. One way to Pareto optimality is by modifying the pricing system to reflect the true price of the
resource. Through this process of internalisation/shadow pricing resources are allocated on the basis of their true
prices. It may not be possible to internalise all externalities (Mishan, 1990) so government intervention in the
market may be needed.
An area where externalities may be tolerated even though they affect resource allocation is where the correction
of them may have regressive social welfare distribution effects and clash with other government objectives. This
arises because the Pareto criterion takes no account of welfare distribution. The other case is where the benefit of
internalisation exceeds its cost. But society is always worse off with existence of externalities even when they are
corrected than without them. By internalising them we are doing no more that making the best of a bad job. We are
certainly not as well off as we should be if they had not appeared on the economic scene. Thus we are forced to the
theory of the second-best.
Externalities effect resource allocation by distorting the pricing mechanism, resulting in an allocation of resources
that is not optimal. Therefore the importance of externalities in resource allocation is crucial if it is to be optimal
and it is observation that gives cost- benefit analysis some of its justification as it is necessary to measure those
created by activities and to intervene to correct them.
Externalities arise when the consumption and/or the production of one or more individuals unintentionally
alters the utility and/or the production functions of one or more individuals without those persons being compensated
or forced to compensate others for that economic activity. Externalities can either be positive or negative.

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Consider our diagram of a negative externality again. Let’s pick an arbitrary value that is less than
Q1 (our optimal market equilibrium). Consider Q2.

If we were to calculate market surplus, we would find that market surplus is lower at Q 2 than at Q1 by
triangle e.
The market surplus at Q2 is equal to area a+b. [(a+b+c) – (c)].
What about social surplus? Total social benefit at Q2 is equal to a+b+c. Total social cost at Q2 is equal
to b+c.
The social surplus at Q2 is equal to area a [(a+b+c) – (b+c)].
Externalities affect resource allocation because the market fails to fully price the external effects generated by
some economic activities. This is because market prices tend to reflect the cost sellers charge buyers of a commodity,
a price based on the personal utility derived, while ignoring the costs/benefits imposed on third parties. Thus the
pricing mechanism fails to reflect the true or social costs of economic activity so private costs may diverge from
social costs. Resources will be allocated on the basis of private consumption and/or production decisions and not on
social welfare maximising ones and for this reason resources will be allocated inefficiently.
Q. 2. In case of forestry, outline how the optimal harvesting age is determined? Discuss how in this
situation, Hartman’s model yields higher rotation age than that of Faustmann’s.
Ans. Optimal forest harvesting is a problem that dates back many centuries. Modern forest-management needs
models taking into account the relatively long rotation, the multiaged structure, the age-dependent timber content of
trees, and the multiple services forests provide. Approaches to characterize the optimal management policy range
from models that represent the forest by a unique state variable that can usually be solved analytically (i.e., models
that consider forests composed by a unique even-aged stand or allow a uneven aged forest but only consider its total
biomass), to much more sophisticated linear and integer programming harvest scheduling models. In this survey,
we focus on dynamic optimization problems where the forest is represented with an age-class structure. These
models present richer dynamics than one-variable models while preserving their analytic tractability to some extent.
Forests are in a natural interaction with atmospheric carbon dioxide, the main driver behind anthropogenic
climate change. A growing tree stores carbon from the air in itself, which is later released back to the air through
fires, natural decay of the biomass, or human-induced activities. Forests involve globally both large stocks and
flows of carbon, making them an important element in the context of climate change and its mitigation.

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The tree harvest problem of forest management is an archetypal investment problem; it involves time, uncertainty,
and irreversible actions with consequences in the future. The exercise of the option to cut a tree opens the option of
planting a new one or of using the land for alternative purposes. We enrich the tree harvest problem by considering
the planting decision too with no cost associated with harvesting or planting. Two tree species are available; their
growth is deterministic but their timber unit price is stochastic. In the case of a single rotation, known as the
Wicksellian tree harvest problem, the forest manager should plant one species immediately if its price is sufficiently
high relative to the price of the other species. However, if prices are close to each other, the manager should wait in
order to avoid the mistake of planting the wrong species.
Renewable resources are different from exhaustible resources in that the former is regenerated naturally and
hence stock need not always decrease whenever harvesting takes place. However, if the harvesting rate far exceeds
the natural regeneration rate then it may lead to a situation of stock going below the threshold level so that further
regeneration is not possible. In such instances, further harvesting would lead to extinction of the resources. Examples
of renewable resources are forest, marine resource, water, etc.
‘Property rights’ represents a set of characteristics that offer certain exclusive power to the owner of the resource.
‘Exclusivity’ is an important concept in defining property rights. However, there are certain natural resources
where ‘exclusivity’ is not applicable. For instance, take fishery and forestry, which are common property resources.
The owner has non-exclusive rights. He has to share the resource with others. It becomes nobody’s resource and
everybody’s resource in the end. It is also known as open access resource. The presence or absence of exclusivity
has some important implications for many economic issues. With private property rights, markets will allocate
resources efficiently. However, in the case of common property resources market mechanism does not lead to
efficient allocation and some intervention is needed. This is because no one can prevent others from using the
resource and from appropriating a share of rents from the resource.
By combining the traditional Faustmann framework with the bioeconomic framework, we show that the
Faustmann–Hartman rule arises as a special case of a bioeconomic model constrained to represent harvesting only
as clear-cutting. Furthermore, by defining nontimber benefits as a function of the ecological resource stock we are
able to evaluate the effect of timber management activities on the dynamics of the ecological resource stock. The
resulting optimal harvesting condition can be interpreted as a Faustmann–Hartman-like equation, which includes
new elements, associated with the disturbance of the ecological resource. To aid understanding this optimal solution
is simulated for an even-aged stand of maritime pine (Pinus Pinaster ) in the western part of Spain. The numerical
simulations illustrate that the optimal rotation period depends on the impact that harvesting has on the ecological
resource, the ability of the ecological resource to recover and the extent to which the carrying capacity of the system
has been affected.
The model thus includes the dynamics of an ecological resource, which is partly determined by timber harvest
activities but is not directly controllable by the forest manager. In the Faustmann framework, the specification of
nontimber benefits has been a function of the stand age. We choose an alternative specification to reflect the fact
that many nontimber benefits, including a number of provisioning and regulating ecosystem services, are not purely
dictated by the age of trees. Rather, they are a result of past and current management activities and the dynamics of
the ecological resource. The paper focuses two effects of harvesting. The first is a disturbance effect causing a
short-term impact either on a local or on a large scale. This case is compared to a habitat destruction effect, where
the ecological resource reduces to the carrying capacity of the postharvest forest.

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Section B
Q. 3. Bring out the crux of the concept of ‘sustainable development’.
Ans. In 1987, the Bruntland Commission published its report, Our Common Future, in an effort to link the
issues of economic development and environmental stability. In doing so, this report provided the oft-cited definition
of sustainable development as “development that meets the needs of the present without compromising the ability
of future generations to meet their own needs” (United Nations General Assembly, 1987, p. 43). Albeit somewhat
vague, this concept of sustainable development aims to maintain economic advancement and progress while protecting
the long-term value of the environment; it “provides a framework for the integration of environment policies and
development strategies” (United Nations General Assembly, 1987). However, long before the late 20th century,
scholars argued that there need not be a trade-off between environmental sustainability and economic development.
By utilizing economic tools, early theorists offered that policies to protect the environment could also promote
innovation and turn a profit. In 1920, Arthur Pigou noted that the presence of incidental, uncharged services act as
a barrier to achieving equilibrium in the market. In his work “The Economics of Welfare”, Pigou noted that the
divergence between marginal private costs and benefits and marginal social costs and benefits create what we now
call “externalities” (Pigou, 1920). These externalities are conceived as transaction spillovers, or costs and benefits
unaccounted for in the given price of a good or service. In order to correct the market failure, Pigou proposed a tax
on those activities that produce negative externalities at a rate equal to those external costs. By levying this charge,
called a Pigouvian tax, the market price will more accurately reflect the comprehensive costs and benefits of the
activity. From this, Michael Porter and Claas van der Linde theorized that pollution is a sign of inefficient resource
use. Therefore, win-win opportunities for the environment and economy can be captured through improvements
which reduce pollution in production processes (Porter & van der Linde, 1999). These authors argue that competitive
advantages rely on the capacity for innovation; thus, “by stimulating innovation, strict environmental regulations
can actually enhance competitiveness” (Porter & van der Linde, 1995, p. 98). As the Porter Hypothesis states,
properly designed environmental policies that make use of market incentives can encourage the introduction of new
technologies and reduce production waste. The tests of this theory have yielded mixed results, but scholars generally
agree that policy design and public support are crucial elements to the success of these incentives. Nonetheless,
market-based environmental tools are generally perceived as more “business friendly” than traditional command
and control policies.
The appreciation of our natural resource constraints is also in our best interest. Truly rational and “effective
governance requires a nation to consider and protect the environment and natural resources on which its current and
future development depend. Any other approach is self-defeating. The connections between the environment and
development thus provide a powerful rationale for environmental protection: enlightened self-interest”. This inherent
interdependence between the long-term stability of the environment and the economy is the foundation of the field
of sustainable development. Similar to Porter’s winwin hypothesis that a trade-off isn’t necessary, sustainable
development policies look to tackle the sources of environmental degradation, not just the symptoms, while still
providing opportunities and creating incentives for economic advancement
Components of a healthy environment, such as clean air and water, are considered public goods in that they are
non-rivalrous and nonexcludable. Thus, it is up to the public sector to maintain the provision of these goods and
services. More recently, nations have moved towards the implementation of these marketbased mechanisms to
internalize the complete costs of pollution and ensure long-term stability of the environment; in other words, to
ensure sustainable development.

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Q. 4. Explain briefly any three situations under which government intervention is necessary in public
interest.
Ans. One of the main issues in economics is the extent to which the government should intervene in the economy.
Free market economists argue that government intervention should be strictly limited as government intervention
tends to cause an inefficient allocation of resources. However, others argue there is a strong case for government
intervention in different fields, such as externalities, public goods and monopoly power.
Government intervention advocates defend the use of different economic policies in order to compensate the
flaws of the economic system that give way to large economic imbalances. They believe the Law of Demand and
Supply is not sufficient in order to ensure economic equilibriums and government intervention should be used to
assure a correct functioning of the economy. Examples of these economic doctrines include Keynesianism and its
branches such as New Keynesian Economics, which relay heavily in fiscal and monetary policies, and Monetarism
which have more confidence in monetary policies as they believe fiscal policies will have a negative effect in the
long run. On the other hand, there are other economic schools that believe that governments should not have an
active role in the economy, and therefore should limit its intervention, as they believe it will have a negative impact
in the economy. They believe that the economy should be left to run in a laissez-faire way and it will find its optimal
equilibrium. Advocates of none or limited intervention include liberalism, the Austrian school and New Classical
Macroeconomics.
As in most imperfect competition markets and especially in monopolistic ones, a firm may practice an abusive
behaviour, which will translate into a loss of welfare. In such cases, government intervention will be praised both by
consumers and those firms that seek for lower prices and a profitable share of the market. Regulations such as price
setting, taxation or subsidies may be used in order to restore and maximise the initial efficiency of natural monopolies.
Nevertheless, the government must be cautious when setting and applying regulations, as an incorrect
comprehension of the market structure may bring a higher cost to social welfare instead of the expected benefits. In
order to achieve an optimal regulation level, governments should analyse and determine if natural monopolies can
be sustained whenever they ensure a lower total cost. If this is the case, the government will have to guarantee that
the firm does not make excessive revenues, and that fair prices are maintained. If, on the contrary, the total costs of
the industry would diminish if new firms entered the market, the government should regulate their entrance.
Essentially, what governments should do is to correctly balance the conflict between the industry’s efficiency and
its profitability.
Indeed, though government intervention in the marketplace is often justified, it does not always achieve its
“first-best” textbook ideal. There is an elegant efficiency in the market price system, allowing resources to flow
naturally to their highest-valued uses as signaled by suppliers and demanders; but still there is a role for government
where markets fail to price goods and services to reflect social values. Where government intervention can help
“correct” prices, whether through regulations or fiscal (tax and spending) policies, government will improve economic
and social outcomes. This is not a blanket endorsement of government intervention, however, as public policies are
often imperfect “fixes” that can worsen, rather than improve, outcomes. A worthy government role does not mean
we should hand over full control of markets to government. The free market may still be superior to government in
getting most of the prices and flows of resources right.
Q. 5. Briefly outline the current ‘system of national accounts’ pointing out its shortcomings from the
point of view of environmentally sustainable national accounts.
Ans. The present system of national accounts (SNA) views the relationship between the environment and the
economy from economic perspective only. It groups the national income accounts into three categories, viz., current

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accounts, asset accounts and balance sheets. Current accounts deal with the production or income and the use of
income while asset accounts cover changes in assets and liabilities and changes in net worth. On the other hand, the
balance sheets present stock of assets and liabilities, and net worth.
The most familiar of the three accounts is the current accounts (or the supply and use accounts). In the supply
and use accounts income is computed in three different ways: 1) the sum of value added (revenue minus intermediate
consumption) across all industries (i.e., the production account); 2) the sum of final consumption and savings
(disposable income) (i.e., the use of income account), and the sum of employee compensation and operating surplus
(i.e., the distribution of income account).
The gross capital formation consists of a) gross fixed capital formation, and b)changes in inventories in produced
assets such as buildings. roads. machinery and stocks of commodities. The gross fixed capital formation may also
include additions to the produced assets such as improvement of land, cost of transferring land and other non-
produced assets between owners. The value of capital formation is added to the value of non-produced assets. but
separately ‘depreciated’ as other changes in volume. Thus, the elements of the column related to non-produced
economic assets, do not figure in the calculation of NDP, as all the changes in non-produced natural assets between
opening and closing stocks are explained in the SNA as holding gains or losses and other changes in the volume of
assets. Hence, the elements under other changes in volume are the most relevant items to be reclassified for analysis
in the natural resources accounting.
The present system of national accounts reflects the Keynesian macro-economic model and like the Keynesian
system it largely ignores the productive role of natural resources. The major aggregates of Keynesian analysis. viz.,
consumption, savings, investment. and government expenditures are carefully defined and measured. As Keynes
and his contemporaries were preoccupied with the Great Depression and the business cycles, scarcity of natural
resources was never given any importance. In fact, natural resource scarcity played little role in the 19th century
neo-classical economics, from which the traditional Keynesian and most contemporary economic theories are derived.
The conventional/traditional system of national accounting implies that the environmental assets like air, and
water may be degraded due to economic activity, resulting in a reduction in social welfare. However the corresponding
adjustment is not made in the accounts. This gives a false impression of increase in income while natural wealth is
reducing. Further, ignoring the contribution of non-market value of environmental goods and natural resource
depletion would result in misrepresenting the current well-being and would distort the economy’s production and
substitution possibilities. Thus the current measures of national income are inadequate as indicators of social welfare.
Moreover, these provide misleading information about whether an economy is using its resources in a sustainable
manner. Thus the policy-makers are not rightly informed on the important link between economic growth and the
environment. Henc e environmental accounting can be use fill in removing the current biases
Q. 6. Discuss briefly the limitations of the ‘game theoretic approach’ to ‘common property resource
management’.
Ans. This approach shows that cooperation may emerge even within the framework of the prisoner’s dilemma
(PD) game, where there is repeated interaction over time between different actors. This is examined in the light of
recent developments of non-cooperative game theory. Game theorists have found conditions under which the mutual
defection outcome would cease to be a unique possible equilibrium even within the basic framework of the PD
game. In other words, they have set about demonstrating the possibility of cooperation without giving up the payoff
structure characteristic of the PD.

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The reason why cooperation may be consistent with self-interested behaviour is that the repetition of the game
opens the door to the possibility of conditional cooperation and punishment. More precisely, to show that cooperation
is possible, the assumption must be made that the game is repeated infinitely or that informations incomplete - there
is some uncertainty about the others’ strategies or about the length of the game (the game horizon is finite or
indefinite).
Common property is the property on which well-defined collective claims by an exclusive group are established,
the use of the resource is subtractive, having the characteristic of a public good such as indivisibility. The common
property resource has two distinct features. First, it has the nature of a public good, which is the physical and
intrinsic character of the resource. Second, it should have an association with a community or user group in a
specific way, namely with collective claims.
Further, CPR, in principle, has three basic characteristics. First, a well-defined group or community has to have
exclusive rights on the use of the resource. Second, there is the non-excludability condition that no member of that
community can be excluded from the use of the resource. However, no single individual in the group has any
exclusive property rights on those resources either. Nor does any outsider member have any rights. Third, the use of
the resource is subtractive in the sense that use of it by any user would reduce access and the welfare of other
members in the group.
A common property resource is potentially subject to congestion, depletion or degradation when its use is
pushed beyond the limit of sustainable yield. Hardin (1968) called the problem of CPR as the ‘tragedy of the
commons’. He brought out the problem by illustrating it through the metaphor of shepherds and the size of their
herds. It is in the self-interest of individual shepherds that they increase the size of their herds, as it will generate
more profits. Eventually the overall sheep population will exceed the pasture’s (the common’s) regeneration capacity.
As a result, the pasture area will shrink and degenerate. While Hardin explained the problem through a lucid
example, it holds true for all natural resources which do not have well-defined property rights.
The tragedy of the commons can be represented by the formal framework of the ‘prisoner’s dilemma’ (PD)
game. This game has a peculiar characteristic, which makes it an excellent representation of an important class of
social phenomena. It brings out that the problem of social aggregation is not so simple. There are situations when
everyone may suffer loss even if every individual acts rationally.
Q. 7. Present a critique of the approach to studies of ‘cost-benefit analysis’.
Ans. Cost”benefit analysis (CBA) is an economic technique applied to public decision”making that attempts to
quantify and compare the advantages (benefits) and disadvantages (costs) associated with a particular project or
policy for society as a whole. The appeal of CBA is that by monetising the benefits of the policy, it is possible to
compare and/or aggregate many different categories of benefits with one another, and with the costs of the policy.
When the social benefits outweigh the costs, the policy should be implemented.
When a number of alternative policies or programs are being examined, CBA would recommend choosing the
one with the largest net benefits, where net benefits are defined as the benefits minus the costs. The estimation of
costs and benefits also allows one to determine the socially optimal size of the program or project, i.e., the one that
maximises net benefits.
Concerns with respect to the application of CBA include its partially subjective nature, its lack of concern for
the distribution of the achieved benefits, its treatment of intergenerational equity, and the difficulty of accurately
estimating all social costs and benefits, which might make the actual conduct of a fully comprehensive CBA a very
costly business.

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The application of CBA in an IA poses a number of questions. First, CBA measures costs and benefits on the
basis of (subjective) individual preferences given objective resource constraints and technological possibilities.
Whether or not a project or policy that maximises (subjective) individual preferences is preferable is an open
question – and should probably be answered on a case”by”case basis.
Second, CBA is often criticised for its apparent insensitivity to issues of intra” and intergenerational equity.
With respect to the issue of intra”generational equity, CBA is insensitive as to the distribution of cost and benefits
over different individuals, as long the ‘winners’ could, in principle, compensate the ‘losers’ (but CBA does not
require that this compensation actually takes place). With respect to intergenerational equity, the correct practice of
CBA to discount future costs and benefits to their present values has been criticised on the grounds that it would
thus neglect the welfare of future generations. While the critique on discounting in CBA has sometimes been less
than rational, it is true that the choice of a particular discount rate (or discount function) will strongly influence the
net present value of long”term sustainability policies such as climate change policies. In academics as well as in
policy, some consensus seems to be emerging to discount potentially irreversible environmental damages in the
very long term (> 100 years) at the lowest possible rates.
Third, in CBA uncertainty and risk are treated in a classical fashion. If certain future effects are uncertain, the
correct procedure is to assess the (discounted) expected utility of the effects. In this approach, the probability and
the size of the effects play a role, but also the rate of risk aversion of the relevant population. In CBA, future low
probability – high impact events are more important for current policy making, the higher the probability of occurrence,
the higher their potential damage, the lower the discount rate, and the higher the rate of risk aversion.
Fourth, certain costs and benefits that are in the social and environmental domains of sustainable development
may be difficult to quantify and to value in monetary terms. There are observers who object in principle (or on
moral grounds) to the notion that every ‘value’ can be traded for a price. But putting these moral objections aside,
in the practice of CBA advanced ‘valuation’ tools have been developed that are capable of inferring individuals’
preferences over both market and non”market (e.g. environmental) goods which are introduced in the valuation
methods section.
The main criticisms of cost-benefit analysis (CBA) that have emerged over the years. It is noted in passing that
views on what type of technique CBA really is, or should be, have differed and continue to differ depending on the
set of value judgements used. We emphasise that the more recent suggested extensions to or modifications of CBA
have sought to make the technique more comprehensive (i.e. to include distributional, environmental quality and
other objectives as well as economic efficiency) at the inevitable cost of a loss of precision. The underlying principles
of CBA are examined and the problems of multiple objective planning highlighted. Valuation problems are analysed,
in particular with regard to amenity and environmental effects. Finally, the issues of uncertainty, irreversibility and
intergenerational equity are raised briefly to indicate the complexity of the decision-making task when large-scale
technologically advanced projects have to be appraised. In conclusion it is argued that CBA presented in a
disaggregated format, as a comprehensive method for the ordering of information and a testing procedure for a
range of valuations can perform a useful role in the decision-making process. The term ‘policy analysis’ is probably
a better one for this broader view of the use of CBA. Ultimately we seem to be searching for a synthesis of the
participatory and the traditional (technocratic) style of decision-making though we have a long and difficult course
to chart before we even approach such a goal.

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