Key Concepts: Measuring costs and benefits

1. Key Concepts: Measuring costs and benefits Cost-Benefit Analysis Workshop 23-25 April 2012 Marita Manley, GIZ

2. Contents • Objectives • Illustrative example • Types of costs and benefits • Costs • Benefits • Marginal vs Non-Marginal Change • Whether to measure • Recap

3. 1. Objectives Understand through examples: • Whose perspective? • Types of costs and benefits included in CBA • Why it is important to know whether changes are marginal or non-marginal • When to measure

4. 2. Illustrative Example • Soil erosion prevention program • Trains and equips farmers who occupy sloping lands, to implement a soil erosion prevention technique which is planting tree crops and grasses in lines on sloping soils to prevent soil erosion • Objective of the project is to • sustain farmer yield, • possibly increase farmer revenue, • decrease river dredging costs • increase ecosystem health of rivers and coral

5. Soil Erosion Prevention Program

6. 3. Types of Costs and Benefits • Total Costs = Explicit Costs + Implicit Costs • Total Benefits = Market Benefits + Non-Market Benefits

7. a) Costs

8. Explicit Costs • Costs of buying materials, labour, and machines to build project (accounting costs) • Purchased items needed for project • Soil erosion prevention example • Labour costs of putting together training program and costs of trainers/extension workers • Travel expenses • Material costs (planting materials/inputs e.g. fertilisers) • Purchased or rented capital (any machines/tools)

9. Implicit Costs • Opportunity costs • Value of farmers’ time • training • implementing e.g. soil erosion prevention practices • Revenue otherwise generated from land used • e.g. to plant grass and tree crops • Rental value of tools/machines already owned • Non-market costs • Lost goods and services not sold by market

10. Measuring Costs • If we assume our project does not change market prices, we can use market prices to value inputs • Examples of data we would need for our soil erosion prevention program: • Wage rates to value labour – extension workers, farmer time in training and carrying out soil erosion prevention practices • Price of inputs e.g. planting materials, fertiliser • Rental rate to value capital equipment (tools/machines) Also, data on quantities needed: • Estimates for labour time spent by extension workers and farmers on training, farmer labour time spent on soil erosion prevention practices • Quantities of inputs

11. b) BENEFITS

12. Market Benefits • Benefits that directly accrue to society (consumers and producers) of a good/service purchased in markets • Soil erosion prevention example: • More sustained (lower rate of decrease in) crop yield due to less land degradation • Increased revenue from crops/trees grown that stop soil erosion • Less time and money spent on dredging river

13. Non-Market Benefits • Non-market benefits (and costs) comefrom goods/services that aren’t purchased within a market • Soil erosion prevention example: • Preservation of ecosystem services provided by rivers and coral reefs due to less soil sedimentation and chemical leaching

14. Measuring Market Benefits • If we assume our project does not change market prices, we can use market prices to value inputs • Soil erosion prevention example: • Price of crops whose yield is sustained due to less soil erosion • Price of crops grown (e.g. tree fruits) to stop soil erosion • Other data needed: • Lower cost of dredging river • Quantities of crops grown to stop soil erosion • Increase in quantity of crops grown after soil erosion prevention program compared to without

15. Measuring Non-Market Benefits • Since these goods/services are not traded in a market, if they are large we can to use other techniques to infer the values. • Can use values measured elsewhere • Examples: • Willingness to pay • Travel Cost Models • Averting Behavior Models • Stated Preference Techniques www.sprep.org/climate_change/pacc

16. 4. Marginal vs Non-Marginal Changes • A change is marginal if it does not change price • Use price to value quantity • For example, $25/20kg bag of cabbage • The value of a change is price times the change in quantity

17. Non-Marginal Market Change IMPORTANT FOR LARGE SCALE PROJECTS: A change is non-marginal if it is big enough to change market prices. If we assume a large project will not change prices we are at risk of hugely underestimating or overestimating the net benefits of the project. • E.g. if a project has the effect of doubling cabbage production in Fiji, this may flood the Sigatoka, Suva and Nadi markets with cabbage which is likely to decrease the price, so we can no longer assume the price will continue to be 25 dollars per bag of cabbage nor a doubling of revenue for farmers. • We need a demand function for the market good – we need to know what will happen to price if we double cabbage production, we cannot assume the price will stay at 25 dollars/bag of cabbage. • Thus we need to estimate a demand function – in English, how would the price respond if we increase production

18. A demand function: as supply increases, price decreases

19. 5. When to measure • Larger projects, important projects, pilot projects and projects with attentive decision-makers should have priority in CBA efforts due to higher stakes • The cost of doing the analysis should be small relative to the cost of the project itself • Some costs and benefits aren’t worth capturing because they are either too small or too abstract (e.g. existence value of an obscure and tiny mollusc in the coral reef that may survive due to less soil erosion) • Some important aspects of the analysis may be hard or expensive to measure • For example, ecosystem services values of river and coral reef, amount of soil that is prevented from eroding • Where possible, borrow values from other studies or projects (e.g. universal soil loss equation

20. Thinking laterally • There is more than one way to skin a cat. • Because of data and resource limitations, we are often required to think of alternate ways to make measurements • E.g. the value of a new bridge • travel time (valued at average local wage) saved by working population? • value of new trade/business that it stimulates? • lower cost of vehicle repair due to not having to drive across a rocky river? • lower ongoing repair costs compared to rickety old bridge? • what was the main rationale for a new bridge?

21. When measuring is impossible? • Where it is not feasible to quantify some costs or benefits that may be important in monetary terms or this cannot be done with any precision, applying the CBA framework is still important and useful • ensures that all relevant costs and benefits are identified and properly considered as part of project appraisal/evaluation • clarifies particular areas of uncertainty and/or disagreement in project appraisal/evaluation.

22. 6. Recap Objectives were to understand through examples: • Whose perspective? • Types of costs and benefits included in CBA • Why it is important to know whether changes are marginal or non-marginal • When to measure

23. Key messages • Costs to be included in analysis can be categorised as: • Explicit • Implicit • Non-market is a type of implicit cost • Benefits to be included in analysis can be categorised as: • Market • Non-market • If a project is large relative to a domestic market, may be important to take into account non-marginal changes • Detail and accuracy of CBA should be proportional to size and importance of project. Large, important or pilot projects should usually have priority in CBA efforts. Also helps if the CBA will be paid attention by decision-makers. www.sprep.org/climate_change/pacc

24. Thank you Jonathan Bower Resource Economist, Land Resources Division Secretariat of the Pacific Community jonathanb@spc.int +679 337 0733 – ext 35425 lrdeconomics.wordpress.com Also available from ‘information and networks’ tab at www.spc.int/lrd TANGIO TUMAS/TENKYU TRU/THANK YOU/VINAKA VAKALEVU/SULANG/KO RABWA/TUBWA KOR/MALO 'AUPITO/FA'AFETAI TELE LAVA/MERCI BEAUCOUP/KIA MANUIA/KIAORA KOE/KOMOL TATA/FAKAUE LAHI/SI YU'US MA'ÅSE‘/TEKE RAOI/KALANGAN/FAKAFETAI