Edited by Trine Bille, Anna Mignosa and Ruth Towse
This teaching note focuses on two common difficulties for students. The first is the failure to think in terms of marginal effects. Deciding whether something is worthwhile depends upon what other options are available. When confronted with a program that costs more than another but also has greater effects, students often don’t realize that they need to examine the marginal cost per marginal effect of the more expensive program relative to the other program. The second, related, difficulty is not realizing that, unless you have a value to place on the effects, you generally can’t say whether a project is worthwhile. Instead, students see that buying only one unit may provide a lower cost per unit than buying more units (assuming declining marginal effectiveness). Then they label that the most “cost-effective” option, and proceed to recommend that it be adopted. Several variations related to cost-effectiveness are discussed.
Susan E. Dudley
In this chapter, students learn how benefit-cost analysis (BCA) is applied to US regulation. Students gain an overview of the federal regulatory process and the important role BCA plays in making regulatory policy. The chapter reviews how markets work in order to introduce the concept “market failure,” which agencies are required to identify to justify government regulation. Students should also gain an appreciation of possible government failures as well.
Using case studies to teach benefit-cost analysis brings out aspects of the practice of BCA that cannot be effectively taught in lectures. Case studies also allow students to demonstrate what they have learned from earlier lectures. I detail my experience using Regulatory Impact Analyses (RIAs) from the federal government, analyzed and presented by students, to reinforce lessons from lectures on the quantitative aspects of BCA and to teach lessons about how understanding an analysis is more than a mechanical exercise. Among the lessons highlighted by the case studies are how one can combine two policies to obscure the net costs of one, how precision can mask inaccuracy, the use of co-benefits and confusion about baselines. Case studies can be invaluable in presenting a holistic view of benefit-cost analysis.
Richard O. Zerbe
It is sometimes said that benefit-cost analysis adds up impacts “to whomsoever they accrue”. But in practice that general guidance is more complex and it is the issue of “standing” that defines more precisely whose benefits and costs are to be counted. As in law, where to bring a suit one must have “standing” before the court; so too in benefit-cost analysis must conditions be described for what and whose benefits and costs count. Key issues involve not only whose preferences count (should “foreigners”?), but also which preferences (should criminal activity count?) and over what period of time? As with law, some answers are not clear-cut but can create useful and informative class discussion on sensitive topics.
Clive Belfield, A. Brooks Bowden and Henry M. Levin
In this chapter, we describe the ingredients method as a simple but formal way to estimate costs for the purposes of benefit-cost analysis. The ingredients method distinguishes between input quantities and prices; the product of quantities and prices yields an estimate of the total social cost of an intervention, program or policy. We begin by clarifying what is meant by “cost” and why budgetary information is unlikely to be adequate for cost analysis. We then describe the ingredients method – how to identify inputs and price out these inputs so that they reflect opportunity cost. Next, we explain why the ingredients method is preferred in terms of transparency, informational content, and ease of sensitivity testing. We conclude with an exercise that illustrates how the ingredients method is applied and why it is preferred to alternative costing methods.