Economic analysis entails a commitment to maximizing the aggregate realization of

preference satisfaction for society as a whole. This accords with the rather specialized
meaning of efficiency in economic theory. Efficiency, in the ordinary language sense of the
term, refers to the production of a desired effect with a minimum of effort, expense, or waste.
Efficiency in economic theory refers to the extent that a particular allocation of resources
maximizes overall value measured in terms of preference satisfaction. How, one might ask,
can we tell what preferences people have, in order to assess whether, and how much they
have been satisfied? The answer the theory provides is the notion of willingness to pay.
Determining just how much a social actor would be willing to pay for any particular
consumption bundle (combination of goods, commodities, or services) is, in the context of
economic analysis, tantamount to actually knowing his or her preferences. It needs to be
recognized that willingness to pay is determined in part by ability to pay, and so it will reflect
the existing distribution of income and wealth in a society.
Economic analysis typically relies upon benefit–cost, or cost–benefit analysis (CBA) as a
framework for identifying, quantifying, and comparing benefits and costs (measured in
dollars or equivalent currencies) for different policy options. An important consideration for
economic analysis is the notion of opportunity costs. These are, at their most basic, what has
to be given up, or foregone, in order to dedicate resources to a specified use. The notion of
economic scarcity is linked to opportunity costs: if resources are used for purpose A, those
very same resources cannot then be used for purpose B. Economist William Baxter (author
of People or Penguins, published in 1984) uses the example of building a dam. Such a project
would require: X hours of labor, Y tons of steel and concrete (material), and Z amount of
capital (to purchase tools, designs, plans, and technology, and to pay for labor). Those
resources, if they are spent on building the dam, cannot be used to build something else, such
as a school, a library, or a hospital. Specific resources, once allocated to use or purpose A, are
no longer available for use or purpose B. There is thus an opportunity cost, which amounts to
the value of alternatives which have to be foregone in order to achieve a particular goal, such
as building the dam.
The example of water pollution can help to illustrate the policy applications of economic
analysis. Perhaps a municipality is considering whether to invest in retrofitting its water
treatment plant to remove trace amounts of a carcinogen such as arsenic. Other potential uses
of the same funds could be investments in local community recreational facilities, or repairs
to road infrastructure. Advocates of the theory would insist that society could figure out an
optimal level of water quality, and hence an acceptable level of water pollution. Up to the
optimal level, the benefits for society as a whole of further reducing levels of pollutants
outweigh the costs of pollution prevention and treatment. But, economists will insist, beyond
the optimal level, the overall preference satisfaction for society for even greater pollution
prevention and control would be lessened, due to the opportunity costs. The money that
would be spent on the pursuit of very pure and clean water, perhaps reflecting a policy goal
of zero tolerance for pollution, is money that could be allocated to other purposes, ones that
could generate more overall preference satisfaction for society.
The notion of substitutability reflects the assumption that if someone is willing to pay a
certain amount of money for something (P), economists assume that the person is indifferent
between having P and having some other thing (Q) for which she or he would also pay the
same amount. The amount of money that a person would be willing to pay for something
reflects the amount of expected preference satisfaction from having that thing. The same
amount of satisfaction from P, it is assumed, could be obtained from spending that amount of
money on something else, such as Q.