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E. Eide – Day 5 4.8 Cost-benefit analysis (CBA)

E. Eide – Day 5 4.8 Cost-benefit analysis (CBA). Usually applied to evaluate a single (or a restricted number) of alternatives Kaldor -Hicks-criterion: A rule (or project) that produces enough benefits on the part of the winners such that losers may be compensated should be accepted

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E. Eide – Day 5 4.8 Cost-benefit analysis (CBA)

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  1. E. Eide – Day 54.8 Cost-benefit analysis (CBA) • Usually applied to evaluate a single (or a restricted number) of alternatives • Kaldor-Hicks-criterion: A rule (or project) that produces enough benefits on the part of the winners such that losers may be compensated should be accepted • CBA is the practical application of the Kaldor-Hicks (K.-H.) criterion. • The sum of all costs and benefits of a rule or a project is calculated • The rule or the project is accepted if the sum is positive • CBA is (not more than): • Comprehensive analysis of consequences • (i) systematic listing of consequences of a decision • (ii)evaluation of the consequences, using money as a measuring rod as far as possible MD/ELE/H12 Day 4

  2. 4.8.1 Procedure of Cost-benefit analysis (CBA) • Step 1. Denition/description of rule (or project) • Step 2. Listing of consequences • Step 3. Which consequences are relevant for income and welfare • Step 4. Measuring of consequences in physical terms • Step 5. Evaluation of consequenses in money terms (using market prices and wilingness to pay) • Step 6. Calculation of present value of costs and benefits • Step 7. Use the present value criterion. (Accept if positive) • Step 8. Analyses of sensitivity (To which extent is the result dependent on various assumptions) • Step 9. Introduce weights to various benefits and costs in order to take distribution into account • Step 10. Describe all factor that have not been included in the calculation

  3. 4.8.2 Questionable assumptions of CBA • Money, at the margin, has the same utility for everybody • (iii) Benefits and costs are measurable in money terms • Benefits = damage costs avoided • However, in absence of weighing costs and benefits: • Inefficiency (waste of resources) obtains • Stupid? • Irresponsible? • Immoral? MD/ELE/H12 Day 4

  4. 4.8.3 John F. Morrall III, Saving lives: A review of the record, 27 The Journal of Risk and Uncertainty, 3, 221-37 (2003). • Study of 76 regulatory actions, not based on CBA, in the USA 1967-2001 • Morall III calculated • the costs of reducing safety risk implied by these regulations • The opportunity costs of saved statistical lives (i.e. the value of the resources used to reduce the number o0f deaths) • Dramatic differences in opportunity costs • $ 0.1 for regulation of childproof lighters • $ 100 000 million for the 1991 regulation of solid waste disposal • Using a value of statistical life of $7, about 42 % of the regulations did not pass the CBA test.

  5. 4.8.4 Reasons for using the K-H criterion despite of deficiencies • (i) Administration of compensation too costly (in particular collection of information) • (i) In the long run for each individual the sum of costs and benefits of various rules and projects are positive • (iii) Taxes and subsidies may improve inequality

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