Chapter 8 CostBenefit Analysis Public Finance and Public

Chapter 8 Cost-Benefit Analysis Public Finance and Public Policy Author: Jonathan Gruber Instructor: Yigang Zhang

Introduction n Theoretically, determining the efficient provision of a public good calls for equating marginal social benefit with marginal social cost. n Empirically, marginal social benefit and marginal social cost should be measured out in hard numbers, which is an easy task. n Cost-benefit analysis is to compare the costs and benefits of public goods projects to decide whether those projects should be carried out.

Introduction n In principle cost-benefit analyses are accounting exercises. n In practice cost-benefit analyses are rich economic exercises.

Cost side story n Measuring costs of public projects: n Materials (market prices) n Labor (opportunity cost) n Maintenance (present discounted value)

Cost side story n Market prices prevail when the market is competitive (or perfect). n If not, say monopoly, consider transfer of rents. n Opportunity cost is the value of that input in its next best use. n Present discounted value (PDV) derives from a dollar tomorrow is worth less than a dollar today due to the interest return.

Present discounted value n

Benefit side story n Measuring benefits of public projects: n Valuing time saved; n Valuing lives saved;

Measuring time value n Market approach: wages n Prevails under competitive labor market with freely adjusting hours. n Biased when there are non-monetary aspects of jobs. n Survey approach (Contingent Valuation): n Isolation of issues matters; (one or a list questions) n Order of issues matters; (seals and whales) n “embedding effect”; (2000, 200000 birds)

Measuring time value n Revealed Preference approach (Hedonic Pricing): n Lining for cheap Chevron gasoline; n $0. 45 per gallon saving, 10. 5 gallons purchase, 15 minutes waiting, $19 per hour value. n While $20 is the average wage in 2009. n Two apartments vary only in distances to a park. n n Cross-section regression with controls; Quasi-Experiment;

Measuring life value n Market approach: life time income n Leisure value should also be counted. n Contingent valuation n Hypothetic questions n Revealed preference n Compensating differential n Not representative n Government revealed preference n Statistics over past public projects on safety

Other issues n Long time benefits (across generations). n Cost-effectiveness analysis (comparing only costs). n Double counting errors (on purposes sometimes) n Distributional concerns n Uncertainty concerns