Chuong 1

BENEFIT ANALYSIS
USEFUL COST
For students majoring in EIA
Module assessment
methods:
Participation in the session (quantity, quality):
coefficient 0.1
Classroom test: coefficient 0.1
Group exercises: coefficient 0.1
Final exam score: coefficient 0.7

Scale: 10
Faculty Information
- TS. Hoang Thi Thu Ha
- Telephone: 0976125127
- Email: hoangthuha@neu.edu.vn
- Address: Faculty of Investment- Room 1103- A1-
National Economics University- 207 liberation- HN
Chapter 1: Overview
of cost-benefit
analysis
1 The nature and role of cost-benefit analysis
1.1 Nature
- The benefit-cost analysis (CBA) method was first developed
in the '30s in the U.S. when the federal government decided
whether to undertake a series of irrigation, hydroelectric
and water supply projects funded by the governments of the
dry central and western states.
- - Further developed by many economists

1 BThe Nature and Role of Cost-Benefit Analysis
1.1 Nature
- Francis Perkin (1994), Cost-benefit analysis is an extension of
financial analysis, conducted primarily by governments and
international organizations, to determine whether certain
projects and policies improve public welfare and
thereforeshould be implemented.
- Boardman (2001), cost-benefit analysis is a method of

evaluating policy, which quantifies in money the value of all
policy outcomes for all members of society. Net social benefit
(NSB=
B-C) is a measure of the value of the policy
1.1 Nature
- Campbel (2003), Cost-benefit analysis is a process of analyzing
the full range of results of a project, from a market
perspective, a private perspective (financial analysis), an efficiency perspective ( economic
analysis) to the perspective of stakeholder groups ( a social
perspective).
- Campbel, Brown (2003), Cost-benefit analysis is a systematic

analytical framework for the economic appraisal of proposed
private and public investment projects from a general societal
perspective
1.1 Nature
- Boardman, Vining, Greenberg, Weimer (2011), cost-benefit
analysis is a method of evaluating policy that quantifies in
money all the results that policy brings to members of society.
(The terms policy and project can be interchangeable)
1.1 Nature
 Cost-benefit analysis is an analytical technique to
decide whether to proceed with implemented projects
or whether to currently implement proposed projects.
 Cost-benefit analysis is also used to make decisions
betweentwo or more mutually exclusive projects.
1.1 Nature
Difficulties
- Determining what are the costs and what are the benefits
requires careful consideration
- Some inputs and outputs have popular and stable prices,
others have variable prices during project implementation.
- Some inputs and outputs are not exchanged in the market.
- Some benefits and costs cannot be attributed to money
1.2. Classification
CBA is conducted when the project or policy is under
review (not yet implemented)- Ex ante CBA
Ex ante CBA assists in decision-making whether to
allocate resources to the project.
CBA is conducted after the project is implemented- Ex
post CBA
Ex post CBA aims to assess whether the benefits of the
project outweigh the costs
1.2. Classification
 CBA is implemented throughout the project implementation-
In medias res CBA
Like the Ex ante analysis, this analysis has a direct effect on

whether to proceed with the project.
 Comparison between Ex ante CBA and Ex post CBA (or In

medias res CBA) within the same project or policy-
Comparative CBA
Ex ante In medias res Ex post Ex Ante/ Ex post or
Ex Ante/ In medias
res Comparison
Regulations on Help choose the best If sunk costs are low, Too Late- The Project Like analytics In
resource allocation project or make resources can be is Over medias res or ex post
for this project decisions on whether moved and vice versa
or not to implement again
the project
sentence
Provide information Poor estimation Better estimation Very goodalthough Like analytics In
about the true value increases uncertainty reduces uncertainty there are still some medias res or ex post
of a specific project of future benefits and bugs. May have to
costs wait for a long time
tow to research
Provide information Doesn't provide much GoodThe Very usefulalthough Like analytics In
about the real values contribution there are still some medias res or ex post
of similar projects increased because of bugs and need to be
the later adjusted
implementation.
Indicate errors, Not to be Not to be Not to be Get. Provide
errors in CBA's information about
forecasting, these errors and
measurement, and about the accuracy of
evaluation CBA for similar
projects
from
1.3 Roles
 Help improve decision-making
Market failure CP must intervene CBA says whether this

intervention will work
(Makes decision-making and resource allocation more efficient)
 Help the analyst understand more about the project and its
progress
2. Methodology of cost-benefit analysis
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2.1 Pros
Provide information that helps society make decisions
about effective allocation between competing objectives
Provide a solid analytical framework for data collection
Synthesis and comparison in money of different impacts
Assess multiple types of impacts (with and without market
prices)
2.2 Limitations
 Benefits and costs are not always quantifiable in monetary terms
 Alternative methods: Qualitative CBA, Cost-effectiveness
analysis (CEA)
 Seems inconsistent with other goals: effective goals
 Alternative method: implement CBA weighting according to

distribution
3 Basis of cost-benefit analysis

3.1 Welfare economic basis of cost-benefit analysis
- Every society has certain goals.
For example, a developed country pursues the goal:
 Improve economic well-being or improve people's lives
 Improving social justice
 Improving environmental quality
Benefit-cost analysis shows which options contribute the most to
economic well-being, including environmental outcomes
3. Basis of cost-benefit analysis
3.1 Welfare economic basis of cost-benefit analysis
So:
- Economic objectives are a necessary condition to guide the
evaluation of options.
- Cost-benefit analysis uses the Pareto optimization concept in

realizing this goal.
- The concept of optimal status is based on the moral basis of
self-interest.

3.1 Welfare Economic Basis of Cost-Benefit Analysis The
ethical basis is stated in the following 3 premises:
Goods, services and activities are judged on their
usefulness to humans
Usefulness to humans is judged on the basis of benefits
to individuals. These individuals are seen as the best
judges of their own welfare.
The welfare of all individuals must be taken into account

3.1 Welfare economic basis of cost benefit analysis a/
Pareto optimization
Apply personal usefulness to choosing between the
following options:
 Application 1: Plan A is better than the current state of
affairs if each individual receives more utilization from
Plan A than the current state of affairs
 Application 2: Plan A is better than the current
situation if at least one person receives more from
Plan A and no one else receives less from the current situation
Pareto optimization
Italian sociologist and economist Pareto (1909) used the 2nd
application to explain the optimal economic state
 Pareto optimization is defined as a condition in which no one
can get rich without impoverishing others
 Pareto optimization is achieved when all abilities that
increase welfare have been used up.

Pareto optimization
For example, if the benefits of education and health care
increase and reduce the benefits of
transportationinfrastructure, then that economy has reached
Pareto optimum.

Pareto optimization
Pareto optimal illustrative example
 Hypothetical scenario: Suppose A and B each receive a
monetary benefit of $25. The total welfare of 2 people
is $50. This is the status quo. The administration is
considering a project to increase their total welfare to
$100.
The question arises: Under what conditions will the
results of the project make A and B better than the
current state?

Pareto optimization
Pareto optimization
When there is a project: A and B can each receive up to $100 or 1
set of combinations along the "F" line
3 Basis of cost-benefit analysis
Pareto optimization
Any allocation of $100 that doesn't reduce benefits from the
current state of affairs is a Pareto improvement.
(2 pictures below)

For example, increase A's welfare to $75 while B still has $25
(point a) is a good thing
Example: Or increase B's benefit to $75 while A still has $25
(point B) is a good thing
The line is between the boundary and bPareto. Both A is and all B at the end of the
same points
Get more money (welfare) along

paragraph AB

Pareto optimization
Comments drawn from the example above:
 Both A and B prefer to be moved to any point on the Pareto

frontier
 These points achieve Pareto efficiency
 Society should implement this project


Pareto optimization
 It is necessary to remember the basic principle:
The basic rule for choosing is to improve Pareto practice. A

practical change that makes at least one person rich without
impoverishing anyone is a real Pareto improvement.
In other words, the selection decision is limited to abc zone

options

Pareto optimization
 Expansion scenarios (potential Pareto improvements)
Suppose this project leads to a situation outside the Pareto

limit (beyond ab).
+ Possibility 1: A will get richer while B will get poorer (e)
+ Possibility 2: B will get richer while A will get poorer (d)
 The question is: Should we scrap such a project?


Pareto optimization
Option d? A's benefit is reduced to $10 and B's benefit is
increased to $90 (and vice versa- option e)
UA
d

Pareto optimization
 Suppose the government accepts Plan D and proceeds to
adjust
the
policy so
that B
gets $60
and A
gets $40
(point d')

Pareto optimization
 Thus, both A and B are better able with option d
 Option d is called potential Pareto improvement.
 A potential Pareto improvementif implemented can still

benefit both A and B
(Provided that the transfer process is inexpensive so that the total welfare
remains
is $100)

Pareto optimization
 A project that has gainers and losers but benefits that exceed
costs, and it is feasible for gainers to compensate the losers
that improve Pareto's potential. This improvement is also
known as the Kaldor-Hicks improvement (1939).

Pareto optimization
 Kaldor's criteria: Plan A is chosen compared to the current
situation if those who benefit from A can compensate the
loser and still get richer
 Hicks' criteria: Plan A is chosen over thecurrent situation if

those who benefit from A can bribe the disadvantaged
person to accept A and still get richer.

Pareto optimization
 In fact, there are no (or very few) projects that satisfy the
principle of improvingthe actual Pareto realism (most
projects have losers)
If only projects that meet the actual Pareto criteria are
accepted, society cannot solve many problems.
Improvement of Pareto potential as the basis for benefit-cost

analysis

Pareto optimization  Note:
Projects that impoverish at least 1 person in some way, albeit

a small amount of inadequacy, do not satisfy the principle of
Pareto improvement
Exercise 1:
 Rural communities will benefit when the project puts
unused public land into agricultural production while urban
communities will benefit from its use as recreational areas.
 Rural community utilization is approximately calculated as
annual net income (= $25 million in current condition and
$27 million in maximum condition)
 The utilization of urban communities is calculated as the net
benefit derived from recreational activities (= $1 million in
current condition and $2 million in maximum
conditionswhile maintaining $25 million in agricultural
income). Let's identify the Pareto improvement area
1.3 Basis of cost-benefit analysis
Exercise 2:
 Mining requires primary forests to be reclaimed from the
start. However, current environmental legislation requires
that timber land be restored as soon as mining is finished
and that the number of trees planted again must be at least
20% more than the trees previously felled.
 Let's say the mining operation gives a net income of $10
million, and 1,000 trees have been cut down toinitiate
mining. Logs processed from trees gave an income of $1
million and 1200 trees were replanted at a cost of $0.25
million.
 Can we say that mining has produced potential Pareto
improvements?
1.3.1 Welfare economic basis of cost-benefit analysis b/

Net social benefit and Pareto efficiency
The relationship between NSB >0 net social benefit and Pareto
efficiency:
Projects with NSB >0 can find a set of transfers that make at
least one person rich without impoverishing anyone else
1.3 Basis of analysis Cost benefits

Net social benefit and Pareto efficiency In cost-benefit
analysis:
- Willing to pay (WTP) price to assess the benefits of the
project.
- Opportunity cost (OC) to evaluate the cost of resources used
for a project

Net Social Benefit:

NSB= WTP- OC

Thus, if the net benefit is measured in WTP >0 there is
always a set of transfers that make at least one person
rich without making anyone else poorer (PE)
1.3.2 Microeconomic basis of cost benefit analysis a/

Demand curve
 The quantity demanded is the quantity of goods that buyers
are willing and able to buy
 The law of demand states that there is an inverse

relationship between price and demand
 The demand chart is a table that shows the relationship

between price and demand

Demand curve
- Demand is consumer behavior
- Diminishing marginal utility coupled with substitution
between commodities leads to a steep demand curve.

Demand curve
- Consumer Surplus (CS) is one of the most basic concepts used
in CBA to assess impacts.
- CS is important because, in most cases, CS changes can be
used as an approximate measure of society's WTP value for
policy/project implementation.
- Consumer Surplus CS (Consumer Surplus) Example
Consumer units Price willing to Market Price
Consumer
pay
$/1 loaf of bread surplus $/loaf of
$/1 loaf of bread bread
1 15 3 12
2 12 3 9
3 9,8 3 6,8
4 8 3 5
5 6,7 3 3,7
6 5 3 2
7 4,2 3 1,2
8 3,6 3 0,6
9 3 3 0
Sum 40,3

Demand curve - Willing price to pay
Total price willing to pay = area below the demand curve, to the
left of point Q*
WTP

Demand curve
- Calculation of consumer surplus
CS= Difference between WTP and actual payables (Consumer
Expenditure)
CS= WTP- (PxQ)
1.3.2
Microeconomic
basis of cost benefit
analysis a/ Demand
curve
- Changes in consumer surplus

TH 1: The price of a product decreases from P 1 to P* Price
decreases demand increases from 1 to Q*
Q
1.3.2
Microeconomic
basis of cost
benefit analysis
a/ Demand curve
- Changes in
consumer surplus
The change in
consumer surplus is
trapezoidal P 1 ABP*,
where triangle ABC is
due to additional
consumption and
P1ACP* due to
cheaper price
Demand curve
TH 2: The price of a product increases by P* to P 2
Price increase  demand decreased from Q* to Q2

Demand curve
- Changes in
consumer surplus
The change in consumer

surplus (decreased,
negative) is the trapezoid
P 2ABP*, where the
triangle ABC is the
deadweight loss and
P2ACP* due to higher
prices

Demand curve
TH 3: The price of a product increases from P* to P 3

Tax interval t = 3- P*
P
Price increase demand decreased from Q* to Q3

Demand curve
Tax revenue = (P3-P*)x OQ3

ABC is the loss part
1.3 Mu De of ManurprodBe Benlimbfee
1.3.2 Mu
sclepaDe Sutrae w Mi tissne
uct ManurprodBe Benlimbfee
of efit
a/ Sugar
scle
rtpa Brid or croue fit e uct ne efit
- Naturm chan sh ResPep use
rtgecha surplus fit
e gem nge ip idu per
en
∆CS= Area prod Form Wor shrin
t enuct alk
P P AC + Area d
prodFormThreHorn
1 2
t
uct e
..CAB
∆CS= (P -P )Xq + 0,5 (Q -Q )x

2 1 1 2 1
(P -P )
2 1
1.3.2 Mu
sclepaDe Sutra
e w Mi tissne
of efit
a/ Sugar
scle
rtpa Brid or cr ue fit e uct ne efit
- Naturm chan sh o ResPep use
rtgecha surplus fit
e gem nge ip idu per
en
∆CS= Area prod Form Ladder P
t en uct al 3
P P AB= tD I'm prod Thre Horn

3 2 P2
uct e
P P B - Areasur
prod Form Thre Horn
3 1 e uct e B
P 2P 1A
P1
A D2
∆ CS= 0,5x (P -P )Xq - 0,5x (P -
3 1 2 2
P 1)Xq 1 D1
0
Q1 Q2
Demand curve Thus:
Consumers will have a surplus or net benefit when their
willingness to pay is greater than the market price.

1.3.2 Microeconomic basis of cost-benefit analysis a/
Demand curve Exercise 1
Suppose there are 2 plots of land where houses can be built
on the periphery of the city (formerly an areafor defense
facilities). Each zone has a size of 100 hectares. This land can
be sold on the market at almost zero cost for construction
land. The demand curve of the 2 construction sites is DD' as
shown below
1.3.2 Mu
sclepaDe Sutra
e w Mi tissne
of efit
a/ Sugar
scle
rtpa Brid or croue fit e uct ne efit
Car pram 1 rtge sh fit
d cticenm ip
e t en
t
- NatursurplusRe Pep use 100 ha Ord most

- eIf pricDimini
sidW $850 downw$600,
per er natuchancha surplusres
pep use
e sh. ualor ards re ge nge idu
per d al
1.3.2 Microeconomic Basis of Cost-Benefit Analysis
Exercise 2:
Choose your favorite bread for lunch and answer the
following question:
a/ Does the second bread give you more, less or the same
as the first? Similarly, does the third cake give you more,
less use, or is it the same as the second?
b/ Can you eat the fourth bread? Does this give you any
use?
1.3.2 Microeconomic Basis of Cost-Benefit Analysis
Exercise 2:
c/ Review again the breads you have for lunch. Let's say the first
cake gives you a usability of 10 units. Is it possible to find out
the utilization rate (increase or decrease) of other cakes?
(probably % of the first cake)
d/ Reconsider with the money you have inyour pocket, other
dishes for lunch and other things that you can spend on your
existing money. Determine your maximum willingness to pay
price for the 1st, 2nd, and 3rd wheels. Determination of
consumer surplus in cases. Tell me whenyou don't want to use
the extra bread?
1.3.2 Microeconomic basis of cost benefit analysis b/
Supply curve
Quantity of supply is the amount of goods that sellers are
willing and able to sell
The law of supply states that there is a covariate relationship

between price and quantity of supply
Supply curve
When prices rise, producers can increase production because:
- For opsthat use more than one expensive input
- Allows greater use of expensive inputs
- Encourage the transfer of input resources from the production

of other goods.
Supply curve
 Supply is the behavior of producers
 Supply curve is an important tool for measuring costs. It
measures the marginalcost to produce the added unit of goods
The upward sloping supply curve
reflects diminishing marginal
returns on input usage

1.3.2 Mu
scle paDe Sutra
e w Mi tissne
uct ManuprodBe Benlimbfee
of efit
b/ Sugar
scle
rtpaBow or cr ue fit re uct ne efit
Area prod sh o Bow b metre me Sum
mrtunderSugar fit lim fee Source forc
(Total uct
enm Cost)
variable ip get useei pu Proasexpo go level
b
Pro amouneth .
t en g urrt o
Lim fee this also b lim fee m asst ofduc eve wea su hea duc
entet at
t e e ut
b e b us em tion
ry k e d tion r
cle ble
Supply curve
- Opportunity cost:
+ Other costs of investors
+ Cost to society is the money earned in other best uses, because
this money is what society has given up to make project
investment.
Note: No benefit is received without cost because all actions have

an opportunity cost
1.3.2 Mu
sclepaDe Sutrae w Mi tissne
of efit
b/ Sugar
scle
rtpa Bow or cr ue fit e uct ne efit
- SurplusmRertPro Expo o
sh(Producer surplus) fit
en
Tilted Skew mduc
sid middl ip aut sell Row (= PxQ ) an lim fee Pro Expob
rtjoint
tual
ention um d b duc rt ei
surplusRe Proe Expo(PS )
ed
t rt n tion g
sid duc
e
ual tion
- Producer surplus
Example
So single poop c s n Marginal fee Price Thereis asurplus ofpennies
XuT genera Schools
$/drive $/drive $/drive Tdriveo ng ng
100Thin T 1 1,0 3 2,0 200
100thin two 2 1,5 3 1,5 150
100pcs 3 2,0 3 1,0 100
100quarters 4 3,0 3 0 0
Tdriveng 450
Supply curve
- Producer surplus
When the market price is higher than the marginal cost, the
producer receives a net benefit (surplus)

Supply curve
- NSB Net Social Benefit
 NSB= WTP – OC
 Graphically illustrated: benefits are measured by the relevant
area below the demand curve and costs are measured by the
relevant area below the supply curve.

1.3.2 Mu
scle paDe Sutrae w Mi tissne
of efit
b/ Sugar
sclertpaBow or croue fit e uct ne efit
- Ben Benmco rt ass PureshNSB fit
efit efiten
mmem ip
tmenble
Sum Be Benun co ass= OCEQ
t
efit m
Sum lim feeem
ne co emass= OBEQ
fit
b m ble
un em
Be com Ben Ben co Pure=
m ble ass
ca pareefit efit
e m em
BCE un
us m ble
e
e un
e
Supply curve
These net benefits include: a PCE consumer surplus, and a BPE
producer surplus.
 Net social benefit = Consumer surplus + production surplus
 Or: BCE= PCE+ BPE

Supply curve
 In perfectly competitive markets, balanced markets maximize

net social benefits- consumers maximize utilization and
producers maximize profitsoptimize Pareto
 The Pareto optimization can be achieved when the price

consumers pay for a good = the marginal cost of society to
produce that good
 Any cause that causes output to deviate from equilibrium will
cause losses (reduction in social surplus).

Supply curve
Attention: The role of market prices
- Market price is the variable that consumers use to adjust
purchases, producers adjust supplies.
- In balanced competitive markets: the benefit of an additional
unit of good is measured in WTP and equal to the price of
that good. The cost of a unit is measured in OC and by its
price in the same condition
 Price can be a measure of the benefit/cost of the incremental
unit
1.3.2 Microeconomic basis of cost-benefit analysis
Exercise 3
Let's say all of your classes are students with scholarships
that only meet the basic expenditure. Each of you has the
opportunity to work about 5 hours / week. The job is to
load goods into stalls at a supermarket near the market.
You have a minimum of 20 hours of study per week and of
course you have to spend one of the minimum time doing
homework, eating, sleeping, relaxing. How many people in
your class can work for the following salary:
1.3.2 Microeconomic Basis of Cost-Benefit Analysis Exercise 3
Wages $/hour/person Total income$/5 Number of people offering to
hours/person work
1 5
5 25
10 50
15 75
20 100
25 125
1.3.2 Microeconomic basis of cost-benefit analysis
Exercise 3
- Show quantity with wages on graphs to represent supply
curves.
- Does the supply of labor increase when market prices
rise?
- If it increases, why? If not, why?
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BENEFIT ANALYSIS

For students majoring in EIA

Final exam score: coefficient 0.7

- - Further developed by many economists

- Boardman (2001), cost-benefit analysis is a method of

- Campbel, Brown (2003), Cost-benefit analysis is a systematic

Like the Ex ante analysis, this analysis has a direct effect on

 Comparison between Ex ante CBA and Ex post CBA (or In

Market failure CP must intervene CBA says whether this

(Makes decision-making and resource allocation more efficient)

about effective allocation between competing objectives

Provide a solid analytical framework for data collection

Synthesis and comparison in money of different impacts

Assess multiple types of impacts (with and without market

 Seems inconsistent with other goals: effective goals

 Alternative method: implement CBA weighting according to

3 Basis of cost-benefit analysis

- Cost-benefit analysis uses the Pareto optimization concept in

3. Basis of cost-benefit analysis

ethical basis is stated in the following 3 premises:

Goods, services and activities are judged on their

to individuals. These individuals are seen as the best

judges of their own welfare.

The welfare of all individuals must be taken into account

3. Basis of cost-benefit analysis

3. Basis of cost-benefit analysis

3. Basis of cost-benefit analysis

3. Basis of cost-benefit analysis

Pareto optimal illustrative example

Get more money (welfare) along

3.1 Welfare economic basis of cost benefit analysis a/

 Both A and B prefer to be moved to any point on the Pareto

 These points achieve Pareto efficiency

 Society should implement this project

3.1 Welfare economic basis of cost benefit analysis a/

The basic rule for choosing is to improve Pareto practice. A

In other words, the selection decision is limited to abc zone

3.1 Welfare economic basis of cost benefit analysis a/

Suppose this project leads to a situation outside the Pareto

+ Possibility 1: A will get richer while B will get poorer (e)

+ Possibility 2: B will get richer while A will get poorer (d)

 The question is: Should we scrap such a project?

3.1 Welfare economic basis of cost benefit analysis a/

3.1 Welfare economic basis of cost benefit analysis a/

3.1 Welfare economic basis of cost benefit analysis a/

 Option d is called potential Pareto improvement.

 A potential Pareto improvementif implemented can still

3.1 Welfare economic basis of cost benefit analysis a/

3.1 Welfare economic basis of cost benefit analysis a/

 Hicks' criteria: Plan A is chosen over thecurrent situation if

3.1 Welfare economic basis of cost benefit analysis a/

Improvement of Pareto potential as the basis for benefit-cost

3.1 Welfare economic basis of cost benefit analysis a/

Projects that impoverish at least 1 person in some way, albeit

1.3.1 Welfare economic basis of cost-benefit analysis b/

1.3.1 Welfare economic basis of cost-benefit analysis b/

1.3.1 Welfare economic basis of cost-benefit analysis b/

Net Social Benefit:

1.3.1 Welfare economic basis of cost-benefit analysis b/

Thus, if the net benefit is measured in WTP >0 there is

always a set of transfers that make at least one person

rich without making anyone else poorer (PE)

1.3.2 Microeconomic basis of cost benefit analysis a/