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.
William K. Bellinger
How much to invest is a fundamental question applying equally well to socially valued public investments as to the private sector. Benefit-cost analysis is the cornerstone of the economic analysis of public policy, and is closely aligned with basic rational choice and market concepts from microeconomics. Information and other constraints often block the direct application of marginal analysis in policy decisions, but the conceptual role of marginalism can still be useful in interpreting cost-benefit analysis. While all policy analysis texts that emphasize the economic dimensions of policy cover the basics of marginal analysis, the sources of market inefficiency, and basic decision rules for policy analysis, the connections between marginal analysis and non-marginal policy decision rules are seldom emphasized. This chapter limits its discussion of marginal analysis to the concepts of optimal quantity and optimal allocation rather than the market based concepts of surplus, equilibrium and elasticity, which are discussed in later chapters. This chapter begins by reviewing marginal and non-marginal concepts and measures for policymaking, and then discusses a set of basic policy decisions that can be informed by these concepts. Student exercises are included and answered in the appendix to the chapter.
Charles Griffiths and Chris Dockins
Evaluating the benefits and costs of any action is fundamentally determined by the baseline, which determines the basis of comparison for the action. However, the topic of a baseline is often given limited attention in benefit-cost analysis (BCA) textbooks and journal articles, despite the fact that this is one of the first issues economists confront when doing applied analysis. This paper addresses the gap by discussing some of the nuances of defining and constructing a defensible baseline and illustrates these nuances with examples from the US Environmental Protection Agency (EPA). Core materials for BCA teachers include the narrative as well as links to documents, websites and regulatory impact analyses illustrating these baseline nuances.
This chapter demonstrates how to integrate distributional effects within public evaluation and benefit-cost analysis, using the Kaldor-Hicks Tableau format for distributional accounting. This format adds policy-relevant insight to the traditional efficiency evaluation.
Gelsomina Catalano and Massimo Florio
In the contest of the European Regional Policy, benefit-cost analysis (BCA) is explicitly required, amongst other elements, as a basis for decision making on the co-financing of major projects by the European Structural and Investment Funds (ESIF). How to teach the principles and applications of BCA in an intensive short course (one week) targeted to an audience of civil servants and young professionals with a range of backgrounds (economics, public administration and others) from different countries? The content of this chapter is motivated by the experience gathered by the team of the University of Milan and Centre for Industrial Studies (CSIL) in seven editions of a summer school on BCA and other training courses. The objective is to distill some lessons learned from this experience.
Massimo Florio and Chiara Pancotti
What is the benefit for society of capital-intensive investment in research and development (R & D) infrastructure? This chapter concisely presents a model for applying benefit-cost analysis (BCA) to such projects and shows its application through a quantitative case study. The content of this chapter relies on the experience gathered by the team of the University of Milan and the Centre for Industrial Studies (CSIL) in a research project on how to apply ex ante BCA for major R & D infrastructures as well as years of teaching activities for an international audience of young professionals and early career researchers. The objective is to illustrate both theoretical and empirical approaches to address the evaluation of R & D infrastructural projects which are an essential driver of scientific progress and economic growth.