Cost Benefit Analysis (CBA)

Scenario 1 • You are about to buy a CD for £10 at HMV

when a friend tells you that the same CD is available online for £5. Do you:

a) Buy it online for £5b) Buy it at HMV for £10

Scenario 2• You are about to buy a laptop for £1205 while

you are in PC World. You can get the very same laptop online for £1200. Do you:

a) Buy the laptop online for £1200b) Buy the laptop in PC World for £1205

Definition of CBA• The study that compares the

costs and benefits of a given situation.• It is commonly used to assess

the desirability of a project.

Costs• What you give up when you decide to do

something• Also referred to as OPPORTUNITY COST

• Eg: Time, money, displacement, improvements on other things

Benefit• Something that satisfies your wants

• Eg: Time, saves money, improved safety, improvements in the local area

Ending World Hunger • Would you end world hunger at the cost of the

death of ten random people in the world?

Ending World Hunger • Would you end world hunger at the cost of the

death of ten random people in your country?

Ending World Hunger • Would you end world hunger at the cost of the

death of ten random people in your school?

Ending World Hunger • Would you end world hunger at the cost of the

death of ten random people in your class?

• Should the government implement a policy that is guaranteed to save 500 + lives per year?

A policy to save 500+ lives?

A policy to save 500+ lives?Costs & Benefits??

PRIVATE Costs & Benefits• The costs or benefits that are incurred by the

individual consumer or firm, directly involved in the economic transaction (1st party costs)

• e.g. Driving from A to B The 1st party cost would be the petrol, car,

time taken.

EXTERNAL Costs & Benefits• The costs or benefits that are incurred by the

3rd party, who are NOT directly involved in the economic transaction

• e.g. Driving from A to B The 3rd party cost would be congestion,

pollution caused by driving.

External Costs = Negative ExternalitiesExternal Benefits = Positive Externalities

SOCIAL Costs & Benefits• The total costs/benefits associated with an

economic transaction

Social Costs = Private Costs + External CostsSocial Benefits = Private Benefits + External Benefits

Example

What are the external costs of the proposal?

East Northamptonshire Councillors have refused to grant planning permission for a chip shop to open near two schools in Rushden, Northamptonshire.

ExampleConsider the decision to build a local bypass. What are the costs and benefits of the project?

Activity• In pairs/threes, put together a 5 minute

presentation that outlines the private & external costs and benefits associated with your given example.

Difficulties associated with CBA

Putting a value on a green open

space?

Difficulties associated with CBA

The ‘National Ecosystem Assessment’ attempts to give a standard valuation on ‘ecosystem services’ like pollination by insects, water and air purification by soils and plants, the flood alleviation provided by woods and marshes upstream of towns and cities, and the value of living close to a green space; for example the value of living near a green space is calculated as £300 in terms of savings to the NHS.

Difficulties associated with CBA

1) Finding a common unit for analysis2) Variable opinions3) Is there a right or wrong answer?4) Based on estimates, making

recommendations only guides