Partial equilibrium B/C - A

Partial equilibrium B/C - A (Cost Benefit Analysis DEC 51304) R. Jongeneel Zerbe & Dively Ch.7-8

Lecture Plan • Partial equilibrium analysis • CS and PS revisited • Examples- monopolist with constant costs- taxation- technical progress- external effects • Multiple market - equilibrium analysis • Multiple price changes + Footnote on welfare economic analysis and applied CBA

Partial equilibrium analysis • Assumption only one one market is affected • Examine effects in this market only • Partial equilibrium (PE) analysis • PE  MME  GE (general equilibrium)

CS and PS revisited • Demand curve  approx WTP • CS: excess of WTP over what is actually paid • Supply curve  opportunity costs of output provision • PS: excess of payments over opportunity costs (quasi-rents) • External effects give rise to CS and PS changes • Transfers: neither benefit nor cost

CS and PS revisited Fundamental equation of welfare change W = CS + PS + GR + EE CS: consumer surplus PS: producer surplus GR: government revenue EE: external effects

price DWL-triangle A P1 B C P0 MC E demand MR Q0 Q1 butter Examples: Monopolist W = CS + PS = A - (A+B+C) + (B-0) = -(B+C) + B = -C

price A P1 S+t t B C P0 S(=MC) Q1 Q0 quantity Examples: Taxation W = CS + PS + GR = -(B+C) + 0 + B = -C excess burden of taxation

price S1=S0+t t A S0 PD B C D P0 F E PS G D Q0 Q1 quantity Examples: Taxation W = CS + PS + GR = -(B+C+D) - (E+F) + (B+C+E) = -(D+F) = DWLcons + DWLprod

Example: taxation & welfare loss Bishop’s rule : absolute values of elasticities t: percentage tax (e.g. 0.25) Lessons ….?

Some Lessons • Distortionary taxation is not P-Eff. • DWL is quadratic function of t (broad tax base-argument) • DWL increase the more elastic are demand and supply (Ramsey) • The relative inelastic-side of the market pays the main burden

price S0 A S1 P0 B C D P1 E F D Q0 Q1 wheat Examples: Technical progress W = CS + PS = (B+C+D) + (F-B+E) = C+D+F

A LRS+t P1 B C P0+ D LRS+D (=soc. cost) G t D E F P0 LRS=MC D Q1 Q0 Q1 Examples: External effects + tax W = CS + PS + GR + EE = -(B+C+D+E+F)+ 0 + (B+D) + (E+F+G) = -C+G

Multiple Market Equilibrium (MME) analysis • MME analysis takes into account relevant related markets • Harberger’s ruleAdd to the standard PE-analysis the change in GR’s in the related distorted markets • In non-distorted related markets marginal costs and marginal benefits of changes in production and consumption will just offset each other.

Multiple price changes • Multiple price changes require sequential welfare measurement W = CS + PS + GR + EE

CBA in Individual consumer economy & Small project A footnote on welfare economic (surplus) analysis and applied cost benefit analysis

CBA in Individual consumer economy & Small project • Single individual • Single price change / income kept constant • No 2nd market price effects • First-best economy (no other distortions) • Marshallian CS good approximation • PS good approximation

CBA in Individual consumer economy & Small project Tax/levy a P1.0 d e P2.0 b P1.1 c q1.0 q1.1 q2.0 q2.1

CBA in Individual consumer economy & Small project • Change in CS : P10 a b P11 • Income constant : change in spending is zero! • q10 c b q11 – P10 a c P11 – q21 d e q 20 = 0 • Change in welfare (dU) • dU = P10 a b P11 = P10 a c P11 + abc • dU = q10 a b q11 + q21 d e q 20

CBA in Individual consumer economy & Small project a P1.0 d e P2.0 b P1.1 c -- + q1.0 q1.1 q2.0 q2.1

CBA in Individual consumer economy & Small project • Change in welfare: dW continued • . • Small project: price changes small • . Total benefits-method => income effect-method

Partial equilibrium B/C - A