Time and Discounting in Private and Public Decision Making
Edited by David J. Pannell and Steven G.M. Schilizzi
Chapter 2: Investigating Net Benefits from Alternative Uses of Resources
Bill Malcolm SUMMARY In this chapter, the method of benefit–cost analysis (or discounted cash flow analysis) and its major complications are briefly explained. When people face a choice about using resources in one way instead of another, they need some means of deciding which choice is most likely to meet their goals. One method used to inform this choice is to compare the benefits and the costs that are expected to result from using resources in particular ways. The resource use that promises the greatest net benefits is the best choice. This method of analyzing choices, benefit–cost analysis, has some peculiarities and complications of economic ways of thinking that need to be understood well by analysts and decision makers. For example, the effects of time on the value of benefits and costs in the future; discount rates, time preferences and opportunity costs; the value of benefits and costs that do not have ready market prices; the risk and uncertainty associated with the estimates of the components of the analysis and the outcomes; the boundaries of the project; initial and subsequent rounds of benefits and costs arising from an investment; the often well-hidden but ever-present possibility of inadvertently counting effects twice (or more); the distinction between real and nominal terms; technical foundations of project analyses; productivity gains; taxation; economic versus financial analysis; and getting the perspective right. Once these complications of benefit–cost analysis or discounted cash flow analysis are understood, the information that is generated is helpful when...
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