This action might not be possible to undo. Are you sure you want to continue?
³It is best to think of the cost-benefit approach as a way costof organizing thought rather than as a substitute for it.´ ² Michael Drummond
CostCost-benefit analysis (CBA) is the implicit or explicit assessment of the benefits and costs (i.e., pros and cons, advantages and disadvantages) associated with a particular choice. Benefits and costs may be monetary (pecuniary) or nonnon-monetary (non-pecuniary, ³psychic´). (non-
For private decisions. we are often not aware of any internal process of consideration of costs and benefits. . classes or going to a movie on Saturday night.C > 0. such as taking martial arts decisions. An individual will choose an action if: Benefits (B) > Costs (C) or Net Benefits (NB) = B . but behave as though we do.
For the continuous choice of how many cigarettes to smoke. .Joan will smoke if B > C. For Joan. health consequences. C¶s are: expense. discomfort/inconvenience of ³smoking-allowed ³smokingareas´. diet control. and disapproval of others. B¶s are: taste/oral satisfaction. value of time spent. Joan will smoke the number of cigarettes which yield the greatest net benefits. relaxation. and improved work performance.
traffic circles. riverfront parks. . drunk driving laws. bridges.CBA is most commonly used for public decisions± decisions± policy proposals. e.g. programs. and projects. libraries. and anything else the government might fund. dams.. CBA can be used to rank alternative projects as well as evaluating the social value of one particular project.
reveals a cost-benefit calculus consistent with costthe observed choice. public or private. August 2002 (http:www. any decision.Even if CBA is not explicit.´ National Bureau of Economic Research Working Paper w9094. Orley and Michael Greenstone. ³Using Mandated Speed Limits to Measure the Value of a Statistical Life.org/papers/w9094) . Example: Example: Ashenfelter.nber.
Raising the maximum speed limit from 55 to 65 increased travel speed by about 2 mph (people often exceed posted speed) saving 45 million hours travel time per year. . and inducing about 360 deaths per year (125. Our decisions lead to changes in benefits and costs regardless of whether we make them explicit.000 hours of life). Our collective decision to drive faster infers that 45 million hours of travel time is worth more that 360 deaths.
Economics. Second Edition New York: Wiley and Sons. 2004. Thomas E. Playing soccer. Health Economics.Example: Example: Knee Injury: Getzen. is it worth taking 3 hours and possibly $80 to go to the ER so that a doctor can alleviate pain and check for serious damage? .e. i.. Do you go to the emergency room (ER)? CBA usually takes the form of an explicit and formal presentation of a balance sheet. you injure your knee..
2) Previously set appointment for Thursday means the proper comparison is treatment today vs. treatment Thursday (not treatment vs. (Handout. Enumerate benefits and costs.Outlining benefits and costs assists rational decisiondecisionmaking. given the information at hand. Table 3. no treatment). (Handout. . 1.1) 2. Quantify each benefit and cost as accurately as possible (usually expressed in dollars). Table 3.
$40 for crutches Value of stopping pain with certainty -the highest amount you would pay to stop the pain for 10 days. Expected value of stopping pain by going to the ER = probability that the ER visit will result in stopping the pain times the value of stopping the pain with certainty.what you are willing to pay to preserve your image. .g.. $7/hour. Value of athletic image .opportunity cost of time commonly measured by the wage.g. e.. e. e. by buying painkillers.g..Time lost .
Expected value of a benefit is: E(B) = i prob(B=bi) bi where prob(B=bi) is the probability that the benefit is worth $ bi . expected values are used. but are known with probability. .Expected Value When values of costs or benefits are not known with certainty.
then E(C)=. $100 will occur with probability 0. where the weights are the probabilities that alternative cost values will occur.6 (50)+. if $50 will occur with probability 0. and $150 will occur with probability 0. That is. $100 or more.2 (100)+.2 (150)= 80 .2.2.Knee Injury Cost of visit to ER=$50. expected value = 80 $80 is a weighted average.6.
Probability of maternal-to-fetal transmission when the mother is HIV-positive No Treatment = 25. July 10. J. et.3% Lifetime cost of treatment of an infected child from birth = $98. 132-8. al.5% With Zidovudine Treatment = 8.A.915 . 1996.´ JAMA 276: 2. ³Economic Impact of Treatment of HIV-Positive Pregnant Women and their Newborns with Zidovudine: Implications for HIV Screening.Example: Mauskopf.
210 = $17.210 Expected benefits of treatment = Expected costs averted by treatment = 25.013 .045 Expected Net Benefits = 17.1.083 98.013 Cost of Zidovudine treatment = $1.Expected value of cost of a lifetime pediatric HIV infection = probability of transmission lifetime treatment costs No Treatment = .255 98.968 per HIV-positive pregnant woman .915 = $25.8.223 .915 = $ 8.045 = $15.223 With Treatment = .
it benefits society to treat the mother with Zidovudine. .g.If medical expenses are paid privately. Medicaid±OHP). If the child will be on public assistance for medical care (e. the woman will opt for the treatment..
Theory of Cost-Benefit Analysis CostPublic Policy Objective: Choose the level of output of a good or service to maximize net social benefits (NSB) NSB = TSB ± TSC where TSB = total social benefits TSC = total social costs .
Marginal Social Benefit (MSB) = additional social benefits from one more unit of output Marginal Social Cost (MSC) = additional social costs of producing one more unit of output MSB = d TSB/d Q MSC = d TSC/d Q Q = quantity of a publicly provided good or service NSB are max when MSB = MSC Social Decision Rule: Choose Q for which MSB = MSC Rule: .
Economic agents and society as a whole will maximize the present value of expected net benefits. benefits and costs must be included in the analysis. as well as present.Present Value Future. . But costs and benefits that accrue in the future are worth less than costs and benefits today.
e. costs for a dam built today may be spent primarily during the initial period of the project.g.. we calculate the present value of net benefits: PV(NB) = t NB/(1+r)t .Costs and benefits may occur over different periods of time. To account for all costs and benefits in the same units across time periods. but benefits will accrue over the lifetime of the dam.
$104 tomorrow is worth $100 today.04 is $100. .Present Value Worksheet $100 invested today at an annual interest rate (r) of 4% will be worth $104 in 1 year. PV = F/(1 + r). That is. Present value (PV) of $104 next year when r=. where F is a fixed sum of money to be received next year.
. the higher the social value of consumption today relative to consumption tomorrow.Discount Rate What value of r should be used? r = rate of discount of future consumption or rate of time preference The higher the social discount rate.
Conventional to use 3-5% or the T-Bill interest rate 3Tsince it represents the cost of borrowing at virtually no risk. and benefits. Researchers often conduct a sensitivity analysis to see how sensitive the results are to changes in assumptions about the discount rate. costs. . Results can be sensitive to the discount rate chosen.
Value of life Does society view life as infinitely valuable? .
employment of firefighters. traffic signs. etc.Many public programs and projects involve the prevention of loss of life: dams. maintaining roads. provision of health care. How do economists value a life saved (death averted) in the cost-benefit calculus? .
Human Capital Approach Value of life = present value of lifetime earnings (= lifetime productivity in competition) (benefit side) or productivity losses from early death (cost side) represents productivity gains from extending life for society as a whole.1. represents a loss in national output due to mortality .
000 .g. e. court awards the family of a man who dies at 35 in a car accident the amount of his expected PV of lifetime earnings = $650..Method often used in court cases.
time away from the job is valued at 0. students.) social value.. homemakers. retirees) are valued at 0! (Even for the employed. discrimination. . e. Implies that people with higher wages have higher Does not account for labor market imperfections.g.g..Problems with human capital approach: People who are not working for pay (e.
.2. Willingness-to-pay (WTP) Approach Value of life is estimated from the amounts that people are WTP to reduce the probability of dying.
smoke detectors. Recall net benefits are maximized when marginal benefit (MB) = marginal cost (MC). Benefit of 1 more safety device (MB) = (change in probability of dying) (value of life) Cost of 1 more safety device = MC Assuming people are maximizing NB. radon gas detectors) which reduces the probability of death by 1 in 10. seat belts. MB = MC MC = (change in probability of dying) (value of life) Value of life = MC/(change in probability of dying) = 100 (1/10.000 is $100.. and people are WTP the $100.g.000) Value of life = $1 million .Suppose the cost of a safety device (e.
value will be understated life Disadvantages. .Advantages. value) Measures total value of life (not just labor market Includes foregone earnings and nonmarket value of Estimates vary widely Price may be less than true WTP.