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CHAPTER 8

CHAPTER 8. COST-BENEFIT ANALYSIS. Projecting Present Dollars into the Future. R 0 = $1000 R 1 = $1000*(1+.01) = $1010 R 2 = $1010*(1+.01) = $1020.10 R 2 = $1000*(1+.01) 2 = $1020.10 R T = R 0 *(1+r) T. Projecting Future Dollars into the Present. R 0 = $1000

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CHAPTER 8

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  1. CHAPTER 8 COST-BENEFIT ANALYSIS

  2. Projecting Present Dollars into the Future R0 = $1000 R1 = $1000*(1+.01) = $1010 R2 = $1010*(1+.01) = $1020.10 R2 = $1000*(1+.01)2 = $1020.10 RT = R0*(1+r)T

  3. Projecting Future Dollars into the Present R0 = $1000 R1 = $1000*(1+.01) = $1010 R2 = $1010*(1+.01) = $1020.10 R2 = $1000*(1+.01)2 = $1020.10 RT = R0*(1+r)T Present Value R0 = RT/(1+r)T discount rate discount factor

  4. Present Value of a Stream of Money

  5. Inflation

  6. Private Sector Project Evaluation Admissible Preferable Present Value Criteria

  7. Internal Rate of Return

  8. Benefit-Cost Ratio Benefit-cost ratio = B/C

  9. Problems with the Benefit-cost Ratio

  10. Discount Rate for Government Projects • Returns in Private Sector • Social Discount Rate • Concern for Future Generations • Paternalism • Market Inefficiency • Government Discounting in Practice

  11. Price per pound of avocados Pounds of avocadosper year Valuing Public Benefits and Costs • Market Prices • Adjusted Market Prices • shadow price • Monopoly • Taxes • Unemployment • Consumer Surplus e b d Sa $2.89 c g Sa’ $1.35 Da A0 A1

  12. Inferences from Economic Behavior • The Value of Time • The Value of Life • Lost earnings • Probability of Death

  13. Valuing Intangibles • Subverting cost-benefit exercises • Reveal limits on intangibles • Cost-effectiveness analysis

  14. Games Cost-Benefit Analysts Play • The Chain-Reaction Game • The Labor Game • The Double-Counting Game

  15. Distributional Considerations • Hicks-Kaldor Criterion – a project should be undertaken if it has positive net present value, regardless of distributional consequences • Government costlessly corrects any undesirable distributional aspects • Weighted benefits

  16. Uncertainty Certainty Equivalent

  17. Are Reductions in Class Size Worth It? • Discount rate • Costs • Benefits • The Bottom Line and Evaluation

  18. Use (and Nonuse) by Government • Using Cost-Benefit Analysis • Not Using Cost-Benefit Analysis • Clean Air Act • Endangered Species Act • Food, Drug and Cosmetic Act

  19. Calculating the Certainty Equivalent Value Utility U U(E + y) U* U(E) Certainty Equivalent Expected income Income per year E E + y C I*

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