Benefit-Cost Analysis

Week 1-1: Introduction to BenefitCost Analysis

What is Benefit-Cost Analysis?

Benefit-cost analysis (BCA) (or cost-benefit analysis) is a
collection of methods and rules for assessing the social
costs and benefits of alternative public policies.

What is Benefit-Cost Analysis?

Benefit-cost analysis (BCA) (or cost-benefit analysis) is a
collection of methods and rules for assessing the social
costs and benefits of alternative public policies.
BCA is:
A useful way of organizing a comparison of the favorable
and unfavorable effects of proposed policies;
useful in designing regulatory strategies that achieve a
desired goal at the lowest possible cost;
useful in setting regulatory priorities;
useful in identifying important distributional
consequences of a policy;
required for all major regulatory decisions; and
one of many decision-making criteria.

What is Benefit-Cost Analysis?

Benefit-cost analysis (BCA) (or cost-benefit analysis) is a
collection of methods and rules for assessing the social
costs and benefits of alternative public policies.
BCA is:
A useful way of organizing a comparison of the favorable
and unfavorable effects of proposed policies;
useful in designing regulatory strategies that achieve a
desired goal at the lowest possible cost;
useful in setting regulatory priorities;
useful in identifying important distributional
consequences of a policy;
required for all major regulatory decisions; and
one of many decision-making criteria.

What is Benefit-Cost Analysis?

Benefit-cost analysis (BCA) (or cost-benefit analysis) is a
collection of methods and rules for assessing the social
costs and benefits of alternative public policies.
BCA is:
A useful way of organizing a comparison of the favorable
and unfavorable effects of proposed policies;
useful in designing regulatory strategies that achieve a
desired goal at the lowest possible cost;
useful in setting regulatory priorities;
useful in identifying important distributional
consequences of a policy;
required for all major regulatory decisions; and
one of many decision-making criteria.

Benefits and Costs of Federal Rules

Source:
2011 Report
to Congress
on the Costs
and Benefits
of Federal
Regulations

Benefits and Costs of Federal Rules by Office

Source:
2011 Report
to Congress
on the Costs
and Benefits
of Federal
Regulations

CBA Jumps the Shark

In its 168-page Regulatory Impact Analysis [of the Prison Rape
Elimination Act], DOJ treats the reader to a labored, distasteful, and
gratuitous essay on the economics of rape and sexual abuse9.most
awful is the Department's effort to put a monetary value on avoiding
rape and other forms of sexual abuse in prison.
Thus, it came to pass that9the DOJ found itself in the remarkable
position of asking how much money the victims of rape would be
willing to pay to avoid rape and also asking how much money these
victims would be willing to accept in exchange for being raped. In
the strange logic and twisted morality of cost-benefit analysis, the
victim not the perpetrator must be willing to pay up to avoid the
crime.
-

Lisa Heinzerling, Georgetown Law Faculty Blog

CBA Jumps the Shark

In its 168-page Regulatory Impact Analysis [of the Prison Rape
Elimination Act], DOJ treats the reader to a labored, distasteful, and
gratuitous essay on the economics of rape and sexual abuse9.most
awful is the Department's effort to put a monetary value on avoiding
rape and other forms of sexual abuse in prison.
Thus, it came to pass that9the DOJ found itself in the remarkable
position of asking how much money the victims of rape would be
willing to pay to avoid rape and also asking how much money these
victims would be willing to accept in exchange for being raped. In
the strange logic and twisted morality of cost-benefit analysis, the
victim not the perpetrator must be willing to pay up to avoid the
crime.
-

Lisa Heinzerling, Georgetown Law Faculty Blog

CBA Jumps the Shark

In its 168-page Regulatory Impact Analysis [of the Prison Rape
Elimination Act], DOJ treats the reader to a labored, distasteful, and
gratuitous essay on the economics of rape and sexual abuse9.most
awful is the Department's effort to put a monetary value on avoiding
rape and other forms of sexual abuse in prison.
Thus, it came to pass that9the DOJ found itself in the remarkable
position of asking how much money the victims of rape would be
willing to pay to avoid rape and also asking how much money these
victims would be willing to accept in exchange for being raped. In
the strange logic and twisted morality of cost-benefit analysis, the
victim not the perpetrator must be willing to pay up to avoid the
crime.
-

Lisa Heinzerling, Georgetown Law Faculty Blog

Prudential Algebra of Ben Franklin

Benjamin Franklin (1706-1790)

Lots of science, politics, writing

Joseph Priestley (1733-1804)

The History of Electricity (1767)
Isolated and characterized eight gases in
air, including oxygen (1774).

Prudential Algebra of Ben Franklin

London, September 19, 1772

Dear Sir,
In the affair of so much importance to you, wherein you
ask my advice, I cannot, for want of sufficient premises,
advise you what to determine, but if you please I will tell
you how.
When those difficult cases occur, they are difficult, chiefly
because while we have them under consideration, all the
reasons pro and con are not present to the mind at the
same time: but sometimes one set present themselves,
and at other times another, the first being out of sight.
Hence the various purposes or inclinations that
alternatively prevail, and the uncertainty that perplexes us.

Prudential Algebra of Ben Franklin

London, September 19, 1772

To get over this, my way is to divide half a sheet of paper by a line into
two columns; writing over the one Pro, and over the other Con.

Then, during the three or four days consideration, I put down under the
different heads short hints of the different motives, that at different
times occur to me, for or against the measure.

Prudential Algebra of Ben Franklin

London, September 19, 1772

When I have thus got them all together in one view, I

endeavor to estimate their respective weights; and
where I find two, one on each side, that seem equal, I
strike them both out.
If I find a reason pro equal to some two reasons con, I
strike out the three. If I judge some two reasons con,
equal to three reasons pro, I strike out the five; and thus
proceeding I find at length where the balance lies; and if,
after a day or two of further consideration, nothing new
that is of importance occurs on either side, I come to a
determination accordingly.

Prudential Algreba of Ben Franklin

London, September 19, 1772

And, though the weight of reasons cannot be taken with

the precision of algebraic quantities, yet when each is
thus considered, separately and comparatively, and the
whole lies before me, I think I can judge better, and am
less liable to make a rash step, and in fact I have found
great advantage from this kind of equation, in what may
be called moral or prudential algebra.

Franklins Method
Not unusual. . .
How did he get the motives and weights?

Franklins Method
But what
about when
you have
lots of
people?

Vilfredo Pareto (1848 1923)

Pareto primarily
studied national
income distribution.
He developed a
criteria for defining an
improvement in
aggregate welfare.

Pareto Efficiency

Gainers and Losers

1936 Flood
Control Act: 9if
the benefits to
whomever they
accrue are in
excess of the
estimated costs
[to whomever
pays them]

EPA Non-Road Diesel Rule

BENEFITS
Reductions in:
Premature Deaths
$39,000
Chronic Bronchitis
$ 1,600
Improved Visibility
$ 1,200
Others
$ 1,200
Total Benefits
$43,000
COSTS
Engine Costs
Equipment Costs
Operating Costs
Total Costs

$ 921
$ 132
$ 332
$ 1,385

NET BENEFITS

$41,615

Is there an Alternative to Pareto?

Farewell Pareto efficiency criterion?
How does this work when some people are paying costs and
others are benefitting? Clearly some people are worse off.

British Economists debated this in the 1930s

Interpersonal comparisons of utility are unscientific (Robbins)
But it can be made irrelevant (Hicks)
When a policy leads to an increase in income)the economists
case for the policy is quite unaffected by the question of the
comparability of individual satisfaction, since in all cases it is
possible to make everybody better off than before, or at any rate to
make some people better off without making anybody worse off.
Whether compensation should actually be done is a political
question on which the economist ) could hardly pronounce
opinion.

Kaldor agreed and a new test was born.

The story as told here is adapted from Ethical Benefit Cost Analysis as Art and Science: Ten Rules for Benefit-Cost Analysis by Richard Zerbe

Potential Pareto
Potential Pareto Criterion (aka Kaldor-Hicks)
If the gainers could compensate the losers and still have some
left over (Kaldor), or the loser could not compensate the gainers
to forego the action (Hicks), then well call it efficient.
This means there are positive net benefits, or the benefits outweigh
the costs.

Note that the compensation doesnt actually have to take place

its hypothetical, and need only be possible in principle

This criteria allows us to sum benefits and costs across

different individuals and arrive at an efficiency conclusion

Pareto Efficiency

Alternative: BCA as a free market test

BCA is sometimes characterized as a free
market test
If this policy could be packaged up and sold, would it
be bought at the price it requires (I.e., at its cost)
If no: the costs of producing these benefits are higher
than their value to individuals
Like a restaurant that goes out of business

If yes: the costs of producing these benefits are less

than the value to individuals
It would sell!

What does BCA do?

BCA is an exercise to assess efficiency
Public goods or publicly provided goods
Regulations and other policies

The distributional effects (equity, or who gets how much)

is a separate consideration
Equity is subjective
Economists dont have a normative way to determine what is a
better distribution
For efficiency we are guided by Pareto efficiency to tell us what
ought to be

Better and ought to be: Normative

BCA & Economic Efficiency

The most economically efficient policy is the one that maximizes net
benefits
(Net Benefits = Benefits Costs).

BCA & Economic Efficiency

The most economically efficient policy is the one that maximizes net
benefits
(Net Benefits = Benefits Costs).
This is not:
Maximum Benefit/Cost
ratio
Most Cost-Effective Point
Benefits equal to Costs
Maximized Benefits
Minimized Costs