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ZULKIFLEE BIN ABDUL SAMAD
ASSIGNMENT PROJECT COST ANALYSIS AND APPRAISAL – EMCA5103
STUDENT; NAME: MOHD. NORIZAM BIN MD. SALLEH MATRIC NO.: CGS 00534317 I/C NO: 670703-01-6045 COURSE: MASTER PROJECT MANAGEMENT
Name: Mohd. Norizam Bin Md. Salleh Matriculation No.: CGS 00534317 Assignment: EMCA5103 (Project Cost Analysis and Appraisal)
Table of Contents
Question 1 ............................................................................................................................................... 1 Answer 1; ................................................................................................................................................. 1 1.1 Introduction .................................................................................................................................... 1 1.2 Misconception on CBA .................................................................................................................. 5 1.2.1 CBA is a mechanical substitute for common sense. ............................................................. 5 1.2.2 Unethical to use CBA for making public policy decisions. .................................................... 8 1.2.3 Regards the difference between a net improvement and a confirmed panacea. ............... 11 1.3 Conclusion ................................................................................................................................... 13 Question 2 ............................................................................................................................................. 17 Answer 2; ............................................................................................................................................... 17 2.1 Introduction .................................................................................................................................. 17 2.2 Three (3) Problems That Will Affect The Using of Demand Function to Measure Indirect Benefit. ..................................................................................................................................................... 18 2.2.1 The Shape of Demand Function (Elasticity) ........................................................................ 19 2.2.2 Shifts in the Demand Function ............................................................................................ 27 2.2.3 Market Effects...................................................................................................................... 32 2.3 Conclusion ................................................................................................................................... 37 Reference (continued) ........................................................................................................................... 40
List of Figures
Figure 1: The Cost Benefit Analysis Process .......................................................................................... 2 Figure 2: National Lead Poisoning Campaign Conducted in US. ........................................................... 7 Figure 3: Penang Bridge.......................................................................................................................... 9 Figure 4: Pedestrians Are Exposes to the Pollution Emitted by Vehicles ............................................. 10 Figure 5: Has Anti Drug Campaign achieved 100% its Goals?............................................................. 12 Figure 6: Perfectly Elastic Demand Curve ............................................................................................ 20 Figure 7: Perfectly Inelastic Demand Curve .......................................................................................... 21 Figure 8: Benefit From a Subway. ......................................................................................................... 23 Figure 9: Shift in Demand ...................................................................................................................... 28 Figure 10: Income and Substitution Effects........................................................................................... 30
ii Semester September 2011
Name: Mohd. Norizam Bin Md. Salleh Matriculation No.: CGS 00534317 Assignment: EMCA5103 (Project Cost Analysis and Appraisal)
SEPTEMBER SEMESTER 2011 PROJECT COST ANALYSIS AND APRAISAL – EMCA5103 ASSIGNMENT (50%)
Question 1 Cost-Benefit Analysis (CBA) is a method of evaluating the relative merits of alternative public investment projects in order to achieve efficient allocation of resources. It helps to identify, portray and assess the factors which need to be considered in making rational economic choices. However, there are still misconceptions about CBA. Critically discuss three common misconceptions about CBA. Support your answers with appropriate illustrations and examples. (50 marks) Answer 1; 1.1 Introduction There are a lot of misconceptions on Cost Benefit Analysis (CBA) and before we go further it is good for us to understand what CBA is all about. Some author calls it CBA and some call it BCA (Benefit Cost Analysis). They are actually the same but in this assignment term CBA will be used. An understanding on CBA shall give us the answer how these misconceptions came about. According to The Free Dictionary the definition of CBA in governmental planning and budgeting is the attempt to measure the social benefits of a proposed project in monetary terms and compare them with its costs. The procedure was first proposed in 1844 by Arsene-Jules-Etienne-Juvenal Dupuit (1804–66). It was not seriously applied until the 1936 U.S. Flood Control Act, which required that the benefits of flood-control projects exceed their costs. A cost-benefit ratio is determined by dividing the projected benefits of a program by the projected costs. A wide range of variables, including non-quantitative ones such as quality of life, are often considered because the value of the benefits may be indirect or projected far into the future.
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Name: Mohd. Norizam Bin Md. Salleh Matriculation No.: CGS 00534317 Assignment: EMCA5103 (Project Cost Analysis and Appraisal)
CBA was then further formalised by Alfred Marshall, Pigou and other twentiethcentury economists, where they have diligently argued and refined the fundamental philosophy within the broader and rational analytical assemble of welfare economics. Benefit–cost analysis is one technique of analyzing proposed or previously endorsed projects to determine whether doing them is in the public interest, or to choose between two or more mutually exclusive projects. BCA assigns a monetary value to each input into and each output resulting from a project. The values of the inputs and outputs are then compared. In the most basic sense, if the value of the benefits is greater than the value of the costs, the project is deemed worthwhile and should be executed (Zerbe Jr and Bellas 2006).
Figure 1: The Cost Benefit Analysis Process
(Source: U.S. Army, 12 January 2010).
The Federal Navigation Act 1936 calls for cost benefit-analysis requirement. CBA was later adopted as a federal policy in 1939 by the United States and gradually all government departments are depending on CBA. It is then heavily used by the government and big corporations even until today to make economic decision and help appraise new projects. The last government instruction with regards to CBA was
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a subsequent presidential Executive Orders (12291: Reagan 1980 and 12866: Clinton 1993) have stipulated government requirements for the analysis of costs and benefits of regulatory proposals prior to their adoption. The key fundamental principle of cost-benefit analysis is the evaluation of social benefits with corresponding costs. It wills easier to the decision-makers if benefits exceed costs, as it means the project can be proceed. In the other hand shall the costs exceed benefits, the decision maker is at least need to inform of the net cost that people needs to accept shall the project is proceeded. In other words CBA is a framework or tool use to evaluate a project, pros (benefits) and cons (costs). By execution, CBA is simply adding up all the expected gains (benefits) from the project and deduct all the losses, and then selecting the alternative that might maximises the net benefits. To do so, very much the pros and cons shall be quantified if possible, even when it is not. Economists claim that further application of CBA could save billions of dollars annually. The BCA approach also forms the core of a substantial portion of normative thinking about the law associated with law and economics, usually under the rubric of wealth maximization. The methodology is widely, and repetitively, criticised on foundational grounds. The criticisms concern moral and ethical limitations and, to a much lesser extent, technical ones. A common view is thus that CBA is a flawed science that deprives citizens of the opportunity to participate in democratic processes that bear on the allocation of public resources. Economists and other practitioners actually doing CBAs generally ignore these criticisms. There are three reasons for this. One is that the critics fail to offer viable substitutes, except for rather sketchy references to political discussion. The critics do not compare the results of CBA with those of alternate approaches, so they are unable to answer the question of whether CBA is better than alternatives. Second, they fail to address the issue of whether CBA is useful and, if it is, how it might be improved. Defects found by the critics are generally uncontaminated by actual CBAs so that it is unclear whether, as a matter of fact, these defects exist. Not surprisingly then, practitioners find little to learn from the criticisms. Without determining relative usefulness, how is it possible to argue persuasively against the use of CBA? Third,
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practitioners are divided, internally and externally, about what CBA is. Critics make one set of assumptions about the nature of CBA and the practitioners another. Indeed even among the critics and the practitioners there is no uniformity of concept. The issue of the validity of these criticisms is thus unresolved, and indeed irresolvable within the existing framework, because there is no general agreement about what CBA is, or what it might be. The criticisms rest on a limited and narrow concept of CBA, but one that derives from its historical origins. The critics see CBA as a sort of mechanical algorithm that falsely claims to provide the answer to the question of what people want. Many see CBA as missing important values such as integrity and equity, as rooted also in a narrow utilitarianism, and as using private values where public values are relevant. It is said further that BCA does not make the necessary exclusions, such that it includes bad values like envy and malice. Critics see CBA as an attempt to combine incommensurables in a single metric so that the answer it provides is without meaning. Others find that it loses legitimacy as it favours the preferences of the rich and is defective or not deserving of our approbation, because it does not consider issues of income distribution or fairness. In so far as it ignores transactions costs it is seen as flawed. A few critics see the Scitovsky (1941) reversal paradox as rendering CBA useless. (The Scitovsky reversal paradox arises when analysis recommends a move from position A to position B and, having arrived at position B, to then recommend a move back to A). The responsibility for the failure to provide a clear definition for CBA lies with economists. As the inventors, users and, in general, the proponents of BCA, economists have responsibility for explaining the foundations of their methodology. This they have failed to do. What, for example, is the relation of benefits and costs to legal rights? Is ‘bad utility’ to be counted? Are moral sentiments to be counted? Is the benefit–cost analyst’s role one of providing information to a decision-making process or the answer to a public policy question? It is unnecessary to hold to the narrow concept of CBA depicted by the critics. There is a more expansive version that is fairly immune to these criticisms. Here we present two archetypal versions of CBA, representing the narrow, older mainstream version (generally referred to as Kaldor–
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Hicks, or KH) and a different, modified version that emerges from commentary and practice of recent years. The latter version is called Kaldor–Hicks–Moral or KHM. KHMis more clearly grounded in legal rights than is KH, more closely represents preferences, is more realistic about the role for CBA and is more acceptable because it obviates most of the foundational criticisms of CBA. In short, the use of KHM is more likely than KH to come closer to satisfying a Pareto superior test in that its broad use leads to gains for most members of society (Zerbe Jr and Bellas 2006).
1.2 Misconception on CBA No doubt CBA is a powerful and very informative tool available that can assist planners, engineers, and decision makers to measure project cost benefit for any project but various critics had lead to misconceptions and later direct agencies to shun or underutilise CBA. Among other are those misconceptions ten (10) that have been introduced by Bruce Hokin. They are he common misconception is that Cost Benefit Analysis is only applicable to those companies or government departments that have a vast store of funds and have specialists to call on to pump out complex recommendations, it is too complex for the layman to understand, it will take too long to learn, easier ways give the same answers, its only for accountants and managers, it takes too long to assemble all the data, it’s OK as a theory but it doesn't really work in practice, it has only limited applicability, it is too costly to implement and finally there are too few examples to learn from. This assignment shall concentrate on three misconceptions about CBA as stated by Edward Gramlich which are CBA is a mechanical substitute for common sense, it is unethical to use CBA for making public policy decisions and regards the difference between a net improvement and a panacea (Gramlich 1998).
1.2.1 CBA is a mechanical substitute for common sense. CBA is an outline for organizing thoughts, or considerations. It is a norm to encounter considerations that cannot easily quantified or gauged and where the
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results are quite imaginary. This uncertainty does not and should not be avoided or hided by CBA. The best way to deal with uncertainty is to quantify what can be quantified and to organise and categorise those unquantifiable factors and proceed as far as possible. CBA is not established on market prices alone. Benefits to society are appraised as an accumulation of individuals’ willingness to pay, where in the other hand social costs reflect opportunities gave up. As for example an individual’s willingness to pay for electricity bill, may cost him/she a couple of thousands RM a year, but the price actually paid for that electricity consumed by him/she may be far lower (perhaps just a thousand RM per year). The difference between the individual’s willingness to pay and the price they actually paid is defined as the benefit generated from the consumption of the facility. Thus benefit does not define solely on price but its net price is subjected to the willingness of the customer to pay. The net social benefit of making electricity available to the public and individuals is the present value of the difference between the sum of the residents’ net willingness to pay (their ‘consumers surplus’) and the sum of the opportunity costs of the resources used in supplying the electricity. Simply because a good or service is not marketed and is not priced, does not mean that it does not create benefits to people. As long the people keen to accept the non-marketed services or goods, there will be a benefit enjoyed. Definitely CBA is not a mechanical substitute for common sense as it is always considers in making CBA judgement. Off course to quantify and measure such benefits, common sense shall be required. Applying CBA will prevents consideration of important qualitative values such as fairness and special concern for the welfare of children. If CBA is a mechanical substitute for common sense it shall prevents consideration of important qualitative values such as fairness and special concern for the welfare of children. It is wellaccepted among CBA’s practitioners that, while many benefits and costs can be quantified, other valid considerations cannot be. That is why CBA textbooks call for intangible benefits and costs to be disclosed and considered.
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For example, suppose that a federal regulation or campaign would reduce the rate of lead poisoning among children in poor urban communities. Assume further that the quantified benefits and costs of this regulation/campaign are roughly equal. In such a case, a tie-breaking, intangible consideration arguably favours the regulation, namely the notion that the government owes a special duty to lowincome children who are less able than middle-class or wealthy adults to protect their own interests. Certainly nothing in CBA prevents analysts and regulators from giving weight to such intangible considerations (Graham 06/06/11).
Figure 2: National Lead Poisoning Campaign Conducted in US.
(Photo, Source: www.epa.gov).
Qualitative and quantitative analysis that normally use in CBA, factors out excellent ideas but these benefits is difficult to determine because it’s often based on intuition and does not offer immediate noticeable financial earnings. This however led the room for CBA misconceptions. CBA, is extremely useful as it enables us to portray an argument in terms of costs and benefits where securing a project’s approval is often very much subjected on these arguments. It is common where assumptions by CBA are not verifiable, as it is difficult to measure the intangible benefits of a new proposed project. One way to conquer this is by viewing what the cost would be
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shall the plan is implement as it shall gives ideas of the project worth including its intangible benefits.
1.2.2 Unethical to use CBA for making public policy decisions. The second major misconception, it is unethical to use CBA in making public policy decisions. The reason to his is because public policy decisions always involved important or substantial matters. For instant shall the government have intention to built bridges, with the construction of these bridges construction workers might met with accident get injured, permanent disable, and some might even lose their lives. As we all knows, construction of bridges especially crossing a straits like Penang Bridge may invite a lot of possibilities to accident to occur. Workers might fall into the sea, get struck by the cranes, hit by falling object, electricity shock and etc. In the other hand shall the same fund is spend on cancer research it might be able to save lives. Than the saving or losing lives shall become one of important criteria of the gain/losses benefit of a project. So what is our best choice? Critics are declining to turn such weighty matters to CBA thus creating this misconception. Although indeed CBA cannot be relied 100% to solve the problems but perhaps CBA might still be beneficial in some way. For instance a result from a study had found out that the bridge workers are getting higher compared to other sector and they are already aware of the risks they might faced? Even these workers themselves chose to work in the bridge construction line that offers them better wages? Is it possible to presume that risks are already included into the project cost or in the contrarily the study may point out that the risks are not included and the market cost of the project minimise the true social cost.
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Figure 3: Penang Bridge.
(Photo, Source: eman.edu.pk).
In proper way it is workable to estimate the true project cost to compare them with the expected benefits and to provide in addition real data on expected loss of life in the construction phase. Shall these information being properly compiled and wisely used it can assist the making of decision whether or not to proceed with the bridge project. In the contrary shall the data were compiled but not properly used, it does not mean that it is no need to compile them. Somehow rather the society still needs to make the decision whether or not to build the bridge. One thing for sure society can never avoid all possible risk or else it will never have any bridge. Or we choose to spend the entire budget on the cancer research programme but that may not give a 100% result too. Therefore it must have some form of balance in terms of weighing this option and that is where CBA is requires. In order for CBA not to be illogical, the connection between the currency of the economic analysis and human well-being should be established (Gramlich 1998).
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Figure 4: Pedestrians Are Exposes to the Pollution Emitted by Vehicles
(Photo, Source: Graham 06/06/11).
For example, it is unethical to use CBA for making regulatory decisions about medicine, public health, safety, and environmental protection. The concept that “safety” is an absolute right, regardless what the costs like, it is indefensible on either philosophical or practical grounds. Philosophically, complete safety (zero risk) is a delusion because well-informed societies choose, on a daily basis, to assume many risks in life in trade for a diversity of benefits. For example, people habitually choose, to reduce travel time by driving faster on four-lane highways compared to lower-speed, two-lane roads.
When risks are imposed on societies without their explicit consent (e.g. when pedestrians must inhale pollution emitted by vehicles), the philosophical problem becomes more difficult. But the solution is still not necessarily to mandate zero risk. A more persuasive resolution would be to protect societies from imposed risks to whatever extent the affected citizens themselves would prefer, assuming those affected societies experienced both the benefits and costs of the regulation. Philosophically, this is a standard of hypothetical informed consent, and it forms the ethical foundation of CBA. To reject the informed preferences of societies in favour
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of absolute safety amounts to a type of authoritarianism – an ill-considered rejection of the ideals of personal freedom and consumer sovereignty at the foundation of democratic capitalism. The practical problems with a zero-risk approach are even more troublesome. If regulators go so far in the pursuit of “complete” safety that they make families poorer through higher prices for zero-risk products, they can impose more risk from the induced poverty than from the regulated activity. For example, many regulations in the energy sector have the practical effect of raising gasoline prices, which has its own adverse consequence for low-income households, including on their health. Practical considerations favour some form of benefit-cost determination over blind pursuit of zero risk (Graham 06/06/11).
1.2.3 Regards the difference between a net improvement and a confirmed panacea. The third misconception regards the difference between a net improvement and a cure. Always government programs are over advertised, i.e. – program X can cure poverty, program Y can stop illiteracy. But when program X was implemented and poverty still exists then the problem surfaced because the public will presume that program X has failed when it has not. As Franklin and Lincoln had said a policy measure is worth embracing if its benefits exceed its costs and thereby makes a net improvement even if it doesn’t solve some deep problems and issues. But if they are larger than the alternatives choices, the program is worthy of consideration. Society can ill afford to reject worthwhile programs because they do not meet a standard that is far too demanding (Gramlich 1998).
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Figure 5: Has Anti Drug Campaign achieved 100% its Goals?
(Photo, Source: www.adk.gov.my).
Another good examples is the government under the Home Ministry Department, Against Drugs National Agency are spend millions a year to fight the misused of drugs. But do they manage to cure all the drug addicts or to stop the young generation from temptation of drugs? Or whether the most important thing is the improvement (benefits) is acceptable and matches the cost? Therefore CBA can be used to assist the decision maker to determine whether or not a public project is to be implemented although their implementation will not solve 100% of the problems. For many years, there have been calls from some sector for greater reliance on the use of economic analysis in the development and evaluation of environmental regulations. Most economists would argue that economic efficiency was measured as the difference between costs and benefits were shall to be one of the key criteria for evaluating proposed regulations. As the society has limited resources to spend on regulation, such analysis can help to illuminate the trade-offs involved in making different kinds of social investments. Therefore, it would appear immature for not to conduct such analyses, while they can actually inform decisions how insufficient resources can be put to the greatest social good.
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In theory, CBA should be able to help in answering such questions of how much regulation is sufficient on certain law. Answer to this question is to regulate them until the incremental benefits from regulation are counterbalance by the incremental costs. Although it’s look straight forward, on the other hand in reality the problem is much more difficult especially for large project because of natural problems in measuring insignificant benefits and costs. Adding to it, concerning about fairness and process may also be very crucial economic and non-economic factors. Regulatory policies unavoidably involve winners and losers, even when combined benefits exceed combined costs. Since CBA was first introduced, decision makers have sent diverged indications concerning it usage in policy appraisal. Even in United Sate, The Congress has passed several ruling to protect health, safety, and the environment that effectively prevent the consideration of benefits and costs in the development of certain regulations, although other ruling are actually require the use of CBA. However on the other hand, American Presidents namely from Carter, Reagan, Bush, Clinton, and Bush Jr. are all had demanded for the processes for reviewing economic implications of major health, environmental, and safety regulations to use CBA. Seemingly the Executive Branch, who are control the designing and implementing of regulations, has comprehend the need of CBA compared to The Congress. Since then CBA has become the yardstick of choice against a new regulatory proposals. Thus the misconceptions that public policy decision makings using CBA cannot provide the complete panacea for solving the problems are not applicable.
1.3 Conclusion One such question is the comparison of the benefits and costs of proposed policies plays a truly useful role in making public policy decision, even opposing, to the development, assessment, and implementation of sound policy for the public, in term of environmental, resource, and energy realms. With an exceptionally talented group of thinkers such as scientists, lawyers, economists and etc. who are now in key environmental and energy policy positions within the government, the Department of
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Safety and Health (DOSH), the Ministry of Energy and Communication, and the Ministry of Finance, this question about the effectiveness of CBA is of particular importance. It is purely weighing the costs over the benefits which any layman could understand and figure out. The tough part is how to manage the unquantifiable nontangible values. That is the biggest challenge for CBA. CBA had proven its potential important role in helping notify regulatory decision making. Off course CBA should not be the solitary footing for such decision making. The following eight principles suggested by Professor Robert N. Stavins might be able to assist in carrying out a good and dependable CBA; First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change. But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs. Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations. Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation. Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision. Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions, and to explain why they have selected actions for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests. Factors other than aggregate economic benefits and costs may be important.
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Fifth, benefits and costs of proposed policies should be quantified wherever possible. But not all impacts can be quantified, let alone monetized. Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making. If an agency wishes to introduce a “margin of safety” into a decision, it should do so explicitly. Sixth, the more external review that regulatory analyses receive, the better they are likely to be. Retrospective assessments should be carried out periodically. Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs. Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health. Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population. From these eight principles, it is determine that benefit-cost analysis can play an important role in legislative and regulatory policy debates on protecting and improving the natural environment, health, and safety. Although formal cost benefit analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis. If properly done, CBA can be of great help to agencies participating in the development of environmental regulations, and it can likewise be useful in evaluating agency decision making and in shaping new laws (Stavins 2009). A lot more misconceptions on CBA might surface during its implementation, but a deep understanding on CBA fully will certainly helps to how to use CBA in project cost, analysis, making appraisal and in selecting decision process. The common objections and misconception about CBA are actually simply myths because of lack
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of understanding and stigma and perhaps the proper usage will actually helps to make better decision whether or not to proceed with it. These criticisms on CBA are also having bite to the extent that KH neglects equity and other moral values. However, they are effectively vitiated by a version of CBA that rests on rights and is inclusive of values. In this version, moral sentiments, including those of equity, fairness, and the income distribution are considered as well as the role of legal rights in determining values. Over time, the use of CBA approaching this more sophisticated version increasingly reflects ongoing work by both academics and practitioners (Zerbe and Bellas 2006). Therefore the use of CBA is highly recommended.
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Question 2 The benefits of a project could be inferred from the demand function for a good or service produced directly by the project. Demand functions could also be used to measure benefits for a project that indirectly makes some good or service cheaper – for example, a dam that supplies power more cheaply and lowers the cost of consumer goods, a road that lowers transportation costs, and so forth. But, it can get complicated to see exactly how to use demand functions in this way. Critically discuss THREE problems associated with the above issue. Support your answers with appropriate illustrations and examples. (50 marks)
Answer 2; 2.1 Introduction Demand function is defined as a behavioural relationship between quantity consumed and a person's maximum willingness to pay for incremental increases in quantity. It is usually an inverse relationship where at higher (lower) prices, less (more) quantity is consumed. Other factors which influence willingness-to-pay are income, tastes and preferences, and price of substitutes (wiki.answer.com). Indirect Costs and Benefits are more subtle monetary consequences related to a particular policy option. They are often long-term costs and benefits that result from pursuing a particular policy option. Indirect costs and benefits also can be partial costs or benefits that are affected by a specific policy but not completely determined by it. Like direct costs and benefits, indirect costs and benefits need to be expressed in U.S. dollars. For example, the indirect cost of unsafe working conditions may be an increase in insurance premiums resulting from more workers' compensation claims. An indirect benefit of a department-wide physical fitness program may be a decrease in sick days taken by staff (FESHE Course).
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A cost and benefit of a project are consist of direct, indirect and intangible cost/benefit, in this report we shall concetrate mainly on the indirect benefits as instructed. The example for indirect benefit are building a dam that supplies power more cheaply and lowers the cost of consumer goods, a road that lowers transportation costs, and so onwards. It is true that the demand functions of some public goods/services shall reflect the indirect benefits of a project as because of its existence it can either indirectly reduce the price of some public goods/services because part of the cost are now reduced because of the indirect benefit from the project and become opportunities to the entrepreneurs/people to sell their product at bigger quantity. The demand of public good/services are very much influence by the increases on prices, competition, some are seasonable, intervention by the government policy, market users and etc.
2.2 Three (3) Problems That Will Affect The Using of Demand Function to Measure Indirect Benefit. Although it is straight forward to use demand function to measure the direct benefits, it would not the same when it involve indirect benefits. There should be a clearly established demand for the public good/services. Demand should be effective, namely backed up by purchasing power and willingness to buy of the consumers. Demand alone is not enough to ensure the success of any projects and it can get complicated to see exactly how to use demand functions in this way. Among other problems that might be faced when using demand function to measure the indirect benefit are three (3) problems namely The Shape of Demand Function, Shifts in the Demand Function and Market Effects and were explaining (Gramlich 1998).
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2.2.1 The Shape of Demand Function (Elasticity) The price elasticity of demand can be applied to a variety of problems in which one wants to know the expected change in quantity demanded or revenue given a contemplated change in price. An important aspect of a product's demand curve is how much the quantity demanded changes when the price changes. The economic measure of this response is the price elasticity of demand. Price elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price. Proportionate (or percentage) changes are used so that the elasticity is a unit-less value and does not depend on the types of measures used (e.g. kilograms, pounds, etc). As an example, if a 2% increase in price resulted in a 1% decrease in quantity demanded, the price elasticity of demand would be equal to approximately 0.5. It is not exactly 0.5 because of the specific definition for elasticity uses the average of the initial and final values when calculating percentage change. When the elasticity is calculated over a certain arc or section of the demand curve, it is referred to as the arc elasticity and is defined as the magnitude (absolute value) of the following; Ed = (Q2 - Q1) (P2 + P1) (Q2 + Q1) (P2 - P1) Where; Q1 = Initial quantity Q2 = Final quantity P1 = Initial price P2 = Final price Ed = Elastic Demand The average values for quantity and price are used so that the elasticity will be the same whether calculated going from lower price to higher price or from higher price
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to lower price. For example, going from $8 to $10 is a 25% increase in price, but going from $10 to $8 is only a 20% decrease in price. This asymmetry is eliminated by using the average price as the basis for the percentage change in both cases (NetMBA.com). To better understand the price elasticity of demand, it is worthwhile to consider different ranges of values.
Elasticity > 1 In this case, the change in quantity demanded is proportionately larger than the change in price. This means that an increase in price would result in a decrease in revenue, and a decrease in price would result in an increase in revenue. In the extreme case of near infinite elasticity, the demand curve would be nearly horizontal, meaning than the quantity demanded is extremely sensitive to changes in price. The case of infinite elasticity is described as being perfectly elastic and is illustrated below:
Figure 6: Perfectly Elastic Demand Curve
From this demand curve it is easy to visualize how an extremely small change in price would result in an infinitely large shift in quantity demanded.
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Elasticity < 1 In this case, the change in quantity demanded is proportionately smaller than the change in price. An increase in price would result in an increase in revenue, and a decrease in price would result in a decrease in revenue. In the extreme case of elasticity near 0, the demand curve would be nearly vertical, and the quantity demanded would be almost independent of price. The case of zero elasticity is described as being perfectly inelastic.
Figure 7: Perfectly Inelastic Demand Curve
From this demand curve, it is easy to visualize how even a very large change in price would have no impact on quantity demanded. Elasticity = 1 This case is referred to as unitary elasticity. The change in quantity demanded is in the same proportion as the change in price. A change in price in either direction therefore would result in no change in revenue.
Applications of Price Elasticity of Demand The price elasticity of demand can be applied to a variety of problems in which one wants to know the expected change in quantity demanded or revenue given a contemplated change in price.
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For example, a state automobile registration authority considers a price hike in personalized "vanity" license plates. The current annual price is $35 per year, and the registration office is considering increasing the price to $40 per year in an effort to increase revenue. Suppose that the registration office knows that the price elasticity of demand from $35 to $40 is 1.3. Because the elasticity is greater than one over the price range of interest, we know that an increase in price actually would decrease the revenue collected by the automobile registration authority, so the price hike would be unwise (NetMBA.com). Among other factors influencing the Price Elasticity of Demand are the follows; • Availability of substitutes: the greater the number of substitute products, the greater the elasticity. • Degree of necessity or luxury: luxury products tend to have greater elasticity than necessities. Some products that initially have a low degree of necessity are habit forming and can become "necessities" to some consumers. • Proportion of income required by the item: products requiring a larger portion of the consumer's income tend to have greater elasticity. • Time period considered: elasticity tends to be greater over the long run because consumers have more time to adjust their behaviour to price changes. • Permanent or temporary price change: a one-day sale will result in a different response than a permanent price decrease of the same magnitude. • Price points: decreasing the price from $2.00 to $1.99 may result in greater increase in quantity demanded than decreasing it from $1.99 to $1.98 (NetMBA.com). • Government intervention e.g. giving/pulling incentives and subsidies to manufacturer might affect the prices (increasing/decreasing). Example; Using the natural monopoly framework, suppose that a city is considering building a subway that will lower the cost of a subway ride to $.25. Presently buses cover the same routes and charge a fare of $.50, of which $140 is the marginal cost of a bus ride and $.10 is profit. Transportation planners feel they know two points on the demand function. Presently at the $.50 fare there are100,000 riders a year, and it is estimated that if the fare were $.40, there would be 140,000 riders. Perhaps this
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last point could have come from an earlier experience when the bus company may have been forced to charge a fare of $.40. The planners also know that the annual fixed cost of the subway will be $20,000. Assume further that the planners know that if they build the subway, they should maximize net benefits by charging the fare where the marginal benefits of the last subway ride equal the marginal cost, $.25. Since they do not know ridership at this low fare, a first reasonable thing for them to do would be to project on the basis of the two demand points they do have, as shown in Figure 8. The $.10 fare reduction seems to have caused a 40,000 increase in ridership. Extending this slope as if the demand function were linear, the number of riders is projected to be 200,000 (Gramlich 1998).
Figure 8: Benefit From a Subway.
(Source: Gramlich 1998). If the demand function is linear, each $.10 reduction in the toll raises ridership 40,000. The projected number of riders at a fare of $.25 is 200,000, and the consumer surplus gain is the shaded area, (.25)(100,000) + (.5)(.25)(100,000) = $37,500. If the demand function has a constant elasticity of 1.5, the cut in toll to $.25 raises the number of riders to 300,000. The consumer surplus gain would be larger than in the linear case.
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The consumer surplus from this change is the shaded area, equal to $.25*(100,000 + 200,000)/2 = $37,500. This consumer surplus is the sum of the pure price change effect at the old quantity ($.25*100,000 = $25,000) and the expansion triangle (.5*$.25*100,000 = $12,500). Note that some of this surplus is a pure gain and some represents a transfer to consumers from the bus company, which lost $.10*100,000 = $10,000 of profits. The natural monopolies left one question unanswered. The planners know that the fare that maximizes the net benefits of the subway is that where marginal benefits equal marginal cost. But they do not know whether it is sensible to build the subway in the first place. That is why a benefit-cost analysis must be carried out. Their answer is given by comparing the net benefits with the annual fixed costs of the subway. The accord is Gain to consumers (riders) $37,500 Loss to producers (bus company) $10,000 Loss to taxpayers (fixed costs) $20,000 Net social benefits $7,500 Note that the marginal costs can be ignored in this calculation, because the toll already pays for these marginal costs. The only gain attributed to consumers was that received over and above paying the marginal cost of the subway ride. This way of doing the analysis focuses on the gains and losses of different groups consumers gain $37,500, producers lose $10,000, and tax-payers lose $20,000, making for net social benefits of $7,500. That same number can also be gotten by ignoring the gains and losses of different groups and simply focusing on real resource changes. Using this reasoning, 110,000 rides are taken more cheaply, for a saving equal to the marginal cost difference ($.15) times the number of rides taken more cheaply (100,000), for a total of $15,000. In addition, the expansion triangle, already evaluated at $12,500, gives the added benefit from the increase in number of rides. The annual cost of building the subway is $20,000. The sum is the same estimate of net benefits as before, $7,500. From an economic efficiency standpoint alone, there is not much to choose in one method over the other: probably the most
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reasonable advice is to do the analysis both ways to make sure the answer is the same. If it is not, something is wrong. This latter calculation also illustrates the nature of a transfer. Consumers are better off by $37,500 overall, $27,500 of which represents real social gain but $10,000 of which represents a transfer from the owners of the bus company. When calculating the total gain of consumers, or any other group, the gross gain of $37,500 is relevant; when calculating the net social gain, all transfers should be netted out. This example is a very simple and only used to illustrate the basic ideas of benefitcost analysis. For a real CBA, a host of complexities arise. CBA begin by examining demand and supply functions more carefully, and then go on to a more careful examination of the market equilibration process. In the above subway example we assumed that transportation planners knew two points on the demand function but had to extrapolate down to find how many riders there would be at a toll of $.25. They extrapolated along the linear demand function shown in Figure 8. Considering the Shape of the Demand Function there could obviously be many demand functions going through the two points given, and the planners should really try many different ones to see how sensitive the results are to the assumed form of the demand function. Often demand functions can be estimated with more points than two by a statistical technique known as regression analysis. In that event as well, the analyst should fit regressions of several functional forms, to see how sensitive the results are to the assumed mathematical form of the demand function. Full-blown analysis of all possibilities may takes long time to be carried out. Here we only show how the calculations would look with another common demand function. The linear function shown in Figure 8 assumes that the slope of the demand function is constant along its range; the other popular alternative is to assume that the elasticity, or percentage change in quantity caused by a percentage change in price, is constant along the demand
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function. The dashed line in Figure 8 plots a constant elasticity demand function. This constant elasticity (E) can be estimated by plugging in the formula:
( 1 ) E = (∆Q/Q) / (∆P/P)
Where Q refers to riders, P to the fare, and A represents the change. One could use either beginning or ending values for both Q and P, and the results would change accordingly. Since the choice is arbitrary, a reasonable compromise is to use the averages of the given points, 120,000 and $.45 respectively, and compute what is known as an arc elasticity: (2) E = (40,000/120,000) / (.10/.45) = 1.5
This value is then plugged in to solve for ∆Q, the change in number of riders x 2 fare of $.25
(3) 1.5 = (∆Q/(.5*(100,000 + 100,000 + ∆Q))) / (.25/.375) Adding the change ∆Q = 200,000 to the initial level, of 100,000 yields the number of riders at a toll of $.25 as 300,000, as shown in Figure 8. It is apparent from the figure that the constant elasticity form means that as the price falls and ridership increases; the percentage, and not the absolute, change in the number of riders remains the same. This forms then yield a larger consumer surplus gain than does the linear form. To compute exactly how much larger, it is necessary to use calculus: specifically, to find the area under the demand function between Q = 100,000 and Q = 300,000 by integration. The formula for this area A, analogous to the expansion triangle referred to earlier, is
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It is an increase of $4,940 in both the expansion triangle and the net social benefits of the project. The problem of estimating consumer surplus gains when one is uncertain about functional forms has not attracted much attention, because there is not much one can say about it. It is obvious from Figure 8 that this could be an important problem: here this change alone raised the net social benefits from our prototype subway significantly. But at the same time the evaluator is often in the position of observing either two points on a demand function, or only points in a narrow range, with no clue as to whether to extrapolate on a linear basis, a constant elasticity basis, or some other basis. Economic theory cannot help—there really is no guidance as to what demand functions should look like over particular price and quantity ranges. The only sensible suggestion is that the evaluator should do the calculations in a variety of ways, comparing the results to see how sensitive they are to the assumptions, a technique known as sensitivity analysis. This technique will be proposed over and over in this book to deal with various difficulties. Sometimes it does not help much, but sometimes it does. In this case, for example, we are uncertain about how great net social benefits are, but both way they are positive and the subway looks like a good deal (Gramlich 1998).
2.2.2 Shifts in the Demand Function Even if we know the shape of the demand function, there are also other variables that might shift it. Its impact is known as income elasticity of demand. The income elasticity of demand is the relative change in the quantity demanded of a good in response to a change in consumer income. Income Elasticity of Demand = (% change in quantity demanded) / (% change in income) Normal goods have positive income elasticity of demand because with an increase in income, the demand for these goods increases. Inferior goods have negative income elasticity. For example, if the income of a consumer increases by 50% and his
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consumption of fast-food hamburgers decreases by 10%, then his income elasticity of demand for fast-food hamburgers is - 10/50 = - 0.2. To understand how the law of supply and demand functions when there is a shift in demand, consider the case in which there is a shift in demand:
Figure 9: Shift in Demand
In this example, the positive shift in demand results in new supply-demand equilibrium point that in higher in both quantity and price. For each possible shift in the supply or demand curve, a similar graph can be constructed showing the effect on equilibrium price and quantity. Some other factors that could affect demand function are as follows;
• Consumer income - An increase in consumer income implies an increase in the ability of consumers to purchase more of all goods. Therefore, demand for most goods increase when consumer income increases. But we can also think of products, such as public transportation, whose demand may decrease with increases in income reasons because everybody afford to posses their own vehicles. This happens because consumers can afford more desirable alternatives. Such goods are known as inferior goods.
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• Prices of related goods - Changes in the prices of related goods lead to changes in demand. Related goods can be of 2 kinds - substitutes and complements. A decrease in the price of a substitute good can cause demand of the concerned good to decrease. For example, tea is a substitute for coffee. A decrease in the price of tea can cause demand for coffee to decrease. A decrease in the price of a complement good can cause demand of the concerned good to increase. For example, if the price of balls decreases, the demand for bats may increase since bats and balls are complementary goods. • Consumer preferences - Consumers have preferences for particular brands of goods. These preferences can be changed in favour of a product with the help of advertising, sales promotions etc. This will increase the demand for the product. Building brand recognition is very important for organizations and the increases demand justifies the additional expenditure. • Population - An increase in the population of consumers will increase demand for all products. The quality of the population will also affect the demand for particular products. For example, as the baby boomer generation ages and the population of elderly Americans grows, the demand for health care and related services in the United States will increase. • Seasonal factors - Seasonal factors also influence the demand for a product. Consumers purchase great deal of certain products during certain times of the year. For instance, the demand for umbrellas is higher during the monsoons and perhaps number of people going to zoo are are increases during public and schools holidays. • Expectations - If consumers' expectations about the price of a good in future changes, then the demand for the good will also change. If consumers expect prices to rise in the near future, they may demand more of a good today. The opposite is true if consumers expect prices to fall in the future. When there is a change in price, demand changes along the demand curve. However, when the other factors affecting demand changes, the demand curve shifts to the right or left.
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Even if we know the shape of the demand function, we have to worry about variables that might shift it. Referring to Figure 10, suppose the initial price of some good or service is Po and our project induces it to fall to Pi. Consumers would move along what is known as their ordinary demand function, yielding the consumer surplus of area (A + B). That is all straightforward enough, but it turns out that this is not an exact measure of the gain from the price change if there are income effects (Gramlich 1998). The reason can be seen by decomposing the price reduction into its two components, the substitution effect and the income effect. As the price falls, consumers would buy more of the good even if their initial utility were not increased, because this good competes more favorably with other goods. This is known as the substitution effect. But they also gain income and utility, because the price reduction gives them more to spend on all goods, and they might consume more of this good because of this income effect as well. Consumption increases on the ordinary demand function because of both factors. But when measuring the utility gain to consumers from the price reduction—the goal in a benefit-cost analysis—the income effect must be excluded. To measure the true utility gain from the price fall, we need to hold utility constant and measure consumer surplus by comparison with that baseline.
Figure 10: Income and Substitution Effects
(Source: Gramlich 1998). 30 Semester September 2011
Name: Mohd. Norizam Bin Md. Salleh Matriculation No.: CGS 00534317 Assignment: EMCA5103 (Project Cost Analysis and Appraisal) As the price falls from P 0 to P 1, consumers move along their Ordinary Demand Function from Q0 to Q1, Utility rises from U 0 toU1, and if that rise in utility, or income, shifts demand, we can describe demand functions at the initial utility level, U 0 , and the higher final utility level, U1. Area A is the gain in consumer welfare of this change measured at the new price level and old utility level, called the compensating variation. Area [A + B + C) is the gain in consumer welfare of this change measured at the old price level and new utility level, called the equivalent variation.
This can be done in either of two ways, both of which make economic sense: The gain can be measured by finding the value of the price change at the initial utility level and the new price level, area A in the figure. This area is called the compensating variation, the sacrifice consumers would be willing to make to keep utility unchanged evaluated at this new price level. The gain can be measured by finding the value of the price change at the final utility level and the initial price level, area (A + B + C) in the figure. This area is called the equivalent variation, the sacrifice consumers would be willing to make to keep utility at its final level evaluated at the old price level. Compared to the ordinary demand function, both measures remove income effects from the calculation. The reason for doing so is that as prices fall and real income rises, the income effect gives the change in consumption and consumer surplus from the derived change in income, indicating a form of double-counting. To measure the utility gain exactly, an experimenter might ask the consumer to pay the exact marginal valuation of the Q0 unit into a fund so that utility is held constant at U0, the exact marginal valuation of the next unit, again keeping initial utility constant, and so forth until the experimenter has collected exactly area A into the fund. Area A then measures exactly what the consumer would be willing to pay for the price change and still be at the same initial utility level, or the exact measure of consumer gain (Gramlich 1998). It may seem strange that there are two different exact measures of consumer change, but do not be alarmed. The reason is that there are two different utility levels. Once the price has fallen and the consumer is at U1, the consumer is better off and consumes more of the good. Measured at this higher utility level, the value of the
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price reduction will then be greater. This means that when the price falls, the equivalent variation at the high utility level will exceed the compensating variation at the low utility level, and vice versa when the price rises. The evaluator should first, recognize that the whole problem comes about because of income effects. If alterations in the price of some goods do not change consumer incomes much, or if income changes do not affect consumption, consumer surplus could be measured exactly from the ordinary demand curve. Beyond that, when the problem does exist, as it will for goods that loom large in consumer budgets such as housing, income effects can be removed by either procedure (Gramlich 1998).
2.2.3 Market Effects Companies or organizations have to know who are their customers to their goods or services and inquire how the whole market mechanism in order to measure benefits. Project managers have to decide how much of output to sell and what price to charge for each unit of the product/service. These are important in order to maximise the production and maximizing profits. For example a developer who wants to built expensive houses for niece market should understand the regulation and the capacity of the buyers, suitability it location and etc. before they make up their decision otherwise the project will fail because of no demand. Profit = Price*Quantity - Costs. For the quantity produced and the costs incurred during the production, the higher the price is charged the more the profits will be. Nevertheless, the maximum limit of any prices can be increased are very much depend on the market strength benefited by the organisation. If a company or organisation is the sole manufacturer of a good/service then they have a full control over the demand and can charge a higher prices. In the other hand the presence of several manufactures that produces similar products might restricts the company selling their product too expensive due to the fear of losing customers. Shall there are several manufacturers selling a similar
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product then the market is to be competitive while monopoly is a market with only a single producer of any product or service. Some examples of competitive market are automobile and computer industries where monopoly markets are electricity producer and water supply. The following are some brief scenarios how the market effect will influences pricing and output decisions; Perfect competitions normally have these characteristics; • Many players - There are a large number of companies in the market. As the result each organisation produces a very small portion of the industry output. However this means that a single organisation cannot affect the market prices. • Identical products - All the organisations in market produce and sell a similar product. The consumers cannot tell the product different between produced by one company and another. • Free entry and exit – Anybody are free to enter the market and it also goes to whom that are want to leave. Therefore new company might reduce price but increase their supply in order to gain the market with less profit margins but in bigger volume. Producers who cannot sustain shall leave. • Perfect information - All companies are fully aware about the prices and costs of their rival. Buyers have full information about prices and other relevant factors. For some product no organisation can influence the market price by increasing their supplies because of its relative small size in the market. Then the price is determined by the forces of total demand and total supply. Each organization takes the equilibrium price as given. The only variable that is under the control of an organization is its level of productivity. An organization decided on a higher output level will maximise profits. Monopoly is a market where there is only one player of particular product/service. Being the sole supplier, the monopoly organisation has the power to control prices and output to maximise its profit. Monopoly means the absence of competition among organizations.
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In order for monopoly to happen the following conditions should be present; Single producer of the product/service. There must be no close substitutes for the product so that there is no competition. Strong barriers to the entry of new organizations into the industry. For simplicity assume away the previous issues—let say demand functions are known to be linear and income effects are known to be absent. Even then, the exact measure of project benefits depends on two characteristics of the consumer market, whether costs are constant or increasing, and whether there are market imperfections. The various cases are illustrated in Figures 11 and 12. Figure 11 shows the situation when there are no market imperfections—the demand function for the good measures the value of the good, and the supply function measures the true marginal social cost of producing the good. Things are pretty straightforward if the marginal cost of supplying the good is constant, as shown in the left panel of Figure 11. Our project makes something cheaper—energy, transportation, or whatever; this lowers the supply function and generates the familiar shaded trapezoid in project benefits. Now say the supply function is sloped upward, because it costs more at the margin to expand output. The project shifts the supply function falls S to S', the market price falls from P0 to P1, and output rises from Q0 to Q1 Gains and losses from this change are as follows;
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Figure 11: Value of Output, No Distortions
(Source: Gramlich 1998)
A project lowers the cost of providing a good or service, shifting down the supply function. (a)If there are constant costs in the supplying industry, the supply function is shifted down and the shaded trapezoid represents project benefits. (b)If costs are increasing, project benefits are given by the shaded area. Consumers gain the consumer surplus trapezoid P0ABP1. Producers had a surplus of P0AE before the change and get P1BF after the change. Netting out the common triangle P1CE, producers gain trapezoid ECBF and lose trapezoid P0ACP1 The sum of the gain to consumers and producers from the change is the shaded trapezoid EABF, approximately the same as for the constant cost case but very slightly smaller.
In Figure 12 market distortions was added. There could be lots of ways in which a market is distorted, and here we show only one. Suppose the good in question generates benefits to outsiders, called external benefits. These external benefits can be added to consumer demand to yield the higher social demand function D'. The difference between D' and D at any quantity represents the external benefits from the good. In both panels of the Figure, market output rises from Q0 to Q1. All the external benefits up to Q0 are not at issue—they were realized before the change and they still are. But new external benefits equal to the shaded parallelogram ABCE are realized on the expanded output, and these new benefits must be counted in to get
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the social benefits from the project. That gives the shaded areas shown, the sum of benefits inside the market and new benefits outside the market.
Figure 12: Value of Output, Distortions
(Source: Gramlich 1998)
A project lowers the cost of providing a good or service in the presence of some market externality. a) If there are constant costs the trapezoid P0ECP1 gives the gain to consumers of the good or service and the parallelogram ABCE the external benefits of the change in output. The net gain is the shaded area. b) If costs are increasing, project benefits are the sum of the net gains in the market and the external benefits, the shaded area.
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2.3 Conclusion Definitely there will be indirect benefit that resulting because of the existent of a new project. The increase/decrease prices of some public good or services will be some of them. Although the demand function can be used to measure or calculate the indirect cost/benefit but there are three (3) problem that need to be cater namely The Shape of Demand Function, Shifts in the Demand Function and Market Effects and were explaining (Gramlich 1998). The Shape of Demand Function is crucial to demand curve because the quantity demanded changes when the price changes. This elasticity behaviour are very much affected by the availability of substitutes: the greater the number of substitute products, the greater the elasticity, degree of necessity or luxury: luxury products tend to have greater elasticity than necessities, proportion of income required by the item: products requiring a larger portion of the consumer's income tend to have greater elasticity, time period considered: elasticity tends to be greater over the long run because consumers have more time to adjust their behaviour to price changes, permanent or temporary price change: a one-day sale will result in a different response than a permanent price decrease of the same magnitude, price points: decreasing the price from $2.00 to $1.99 may result in greater increase in quantity demanded than decreasing it from $1.99 to $1.98, Government intervention e.g. giving/pulling incentives and subsidies to manufacturer might affect the prices (increasing/decreasing) and others. On top of that, the demand curve that requires iteration or regression analysis (solution using calculus) should be used compared to linear demand line solved using extrapolation statistical method. The analysis should be carried out regression that fit several functional forms in order to see how sensitive the result are to the assumed mathematical form of the demand function.
The problems associated with Shifts in the Demand Function are other variables that might shift the demand function e.g. the consumer income that are also known as income elasticity of demand. An increase in consumer income implies an increase
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in the ability of consumers to purchase more of all goods or services. Therefore, demand for most goods increase when consumer income increases but for inferior products, such as public transportation and cheap meal the demand may decrease with the increases in income. This happens because consumers can afford more desirable alternatives. Some of the prices of related goods lead to changes in demand, related goods can be of 2 kind; substitutes or complements, consumer preferences; consumers have preferences for particular brands of goods, an increase in the population of consumers; will increase demand for all products, the quality of the population; will also affect the demand for particular products, seasonal factors; also influence the demand for a product, if consumers' expectations about the price of a good in future changes; then the demand for the good will also change and if consumers expect prices to rise in the near future; they may demand more of a good today. The problems associated with Market Effects are that the companies or organizations have to know who are their customers to their goods or services and inquire how the whole market mechanism in order to measure benefits. These are important in order understand the market in order to maximise the production and maximizing profits. Therefore the company or organisation must know whether their businesses are either perfect competitions or monopoly. This will very much contribute to the productions, profit and market force. If all these associated problems are solved then only the indirect benefits calculated using the demand function are accurate enough and can used in the CBA.
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1) (ed), Cat Sharpe. (1998). How to conduct a cost-benefit analysis. [Books24x7 version] Available from http://common.books24x7.com/toc.aspx?bookid=6588. 2) Armstrong, Michael. (2006). Handbook of management edition. [Books24x7 version] from http://common.books24x7.com/toc.aspx?bookid=18795. techniques, revised third Available
3) Boardman, A.E., Greenberg, D.H., Vining, A.R. and Weimer, D.L. (2006). Cost Benefit Analysis: Concepts and Practice. Englewood Cliffs, NJ: Prentice Hall. 4) Brent, R. J. (2006), Applied cost-benefit analysis, Edward Elgar Publishing Limited, Cheltenham, UK. 5) Bruce Hokin, Cost Benefit Analysis - 10 Most Common Myths Debunked, Article Snatch, LLC Extracted on 06/09/2011 from website; http://www.articlesnatch.com/Article/Cost-BenefitAnalysis---10-Most-Common-Myths-Debunked/144209. 6) Buchanan, James M. (1999). The Demand and Supply of Public Goods. Library of Economics and Liberty. Retrieved December 6, 2011 from the World Wide Web: http://www.econlib.org/library/Buchanan/buchCv5c10.html. 7) Burgess, David F. and Zerbe, Richard O. (2011) "Calculating the Social Opportunity Cost Discount Rate," Journal of Benefit-Cost Analysis: Vol. 2: Iss. 3, Article 8. DOI: 10.2202/21522812.1106. Available at: http://www.bepress.com/jbca/vol2/iss3/8. 8) CBA Step 2: Identify Assumptions, Costs, and Benefits. FESHE Course: Analytical Approaches to Public Fire Protection. Extracted on 06/09/2011 from website; http://etudesproject.org/nonfpdata/cog/FS362/DOC0082.htm. 9) Defination for “Cost Benefit Analysis”. The Free Dictionary, Extracted on 15/11/2011 from website; http://encyclopedia2.thefreedictionary.com/cost-benefit+analysis. 10) Defination for “Demand Function”. wiki.nswer.com http://wiki.answers.com/Q/What_is_demand_function. Retrieved from
11) Economic Analysis Primer Benefit-Cost Analysis. United States Department of Transportation - Federal Highway Administration Extracted on 15/11/2011 from website; https://www.fhwa.dot.gov/infrastructure/asstmgmt/primer05.cfm. 12) Graham, John, D., (06/06/11), The Myths of Benefit Cost Analysis, University of Pennsylvania Law School · 3400 Chestnut Street · Philadelphia, PA 19104Extracted on 15/11/2011 from website; http://www.law.upenn.edu/blogs/regblog/2011/06/the-myths-of-benefit-costanalysis.html. 13) Gramlich, E. M. (1998). A guide to benefit-cost analysis (2 Press, Inc.
ed.). Long Grove. Waveland
14) Greenlees, J. S., & Mc Clelland, R. B. (2008). Addressing misconceptions about the consumer price index. Monthly Labor Review, 131(8), 3-19. Retrieved from http://search.proquest.com/docview/235706699?accountid=48462. 15) Husdal, J. (2007) Cost-Benefit Analysis – an essay about valuation problems. Unpublished working paper. Molde University College, Molde, Norway. Extracted from; http://www.husdal.com/2007/01/05/cost-benefit-analysis-an-essay-about-valuationproblems/ 39 Semester September 2011
16) Kathleen Kingsbury (Tuesday, May 20, 2008), The Value of a Human Life: $129,000, Time Health, Extracted on 06/09/2011 from on 06/11/2011 website; http://www.time.com/time/health/article/0,8599,1808049,00.html#ixzz0kbG0gZE. 17) Kerzner, H. (2009). Project management: a systems approach to planning, scheduling, and controlling (10th ed.). Hoboken, N.J.: John Wiley & Sons. 18) Lientz, B. P., & Rea, K. P. (2003). International project management. Amsterdam; Boston: Academic Press. 19) NetMBA – Economic. Internet Center for Management and Business Administration, Inc. Extracted on 01/12/2011 from website; http://www.netmba.com/econ/. 20) Oosterhaven J., and Elhorst J., P., Indirect Economic Benefits of Transport Infrastructure Investments. Extracted on 06/09/2011 from website; http://www.regroningen.nl/oosterhaven/doc/BIVEC%2703%20ZZL%20indirect.pdfhttp://www.r egroningen.nl/oosterhaven/doc/BIVEC%2703%20ZZL%20indirect.pdf. 21) Project Management Institute. (2008). A guide to the project management body of knowledge (PMBOK guide) (4th ed.). Newtown Square, Pa.: Project Management Institute, Inc. 22) Stavins, R, N. (July 8, 2009), Is Benefit-Cost Analysis Helpful for Environmental Regulation?, , Belfer Center for Science and International Affairs, Harvard University. Extracted on 06/09/2011 from website; http://www.robertstavinsblog.org/2009/07/08/is-benefit-costanalysis-helpful-for-environmental-regulation/. 23) Szekeres, Szabolcs (2011) "Comment on Burgess and Zerbe's “Appropriate Discounting for Benefit-Cost Analysis”," Journal of Benefit-Cost Analysis: Vol. 2: Iss. 3, Article 7. DOI: 10.2202/2152-2812.1093. Available at: http://www.bepress.com/jbca/vol2/iss3/7. 24) Tang, S. L. (2003). Economic feasibility of projects: managerial and engineering practice (3 ed.). Sha Tin, N.T., Hong Kong: Chinese University Press.
25) U.S. Army (12 January 2010), Cost Benefit Analysis Guide (Ver 1.0). Office of the Deputy Assistant Secretary of the Army (Cost and Economics) 26) Zerbe Jr R, O,. and Bellas A, S, (2006), A Primer for Benefit–Cost Analysis, Edward Elgar Publishing Limited, Cheltenham, UK.
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