Valuing Benefits and Costs

in Primary Market
Introduction
• In CBA, we compare between cost and benefit of a project or a
change in government policy menekankan konsep WTP
• In evaluating the benefit and cost, we emphasize the concept of
willingness to pay (WTP) and, thus, demand curves and consumer
surplus.
• We then describe the valuation of resources purchased in primary
markets as inputs for government projects, stressing the concept of
opportunity costs and, hence, the use of supply curves and producer
surplus.
Primary Market
• The main task in CBA is estimating consumer surplus, producer
surplus, and government revenue (i.e. social surplus) in primary
markets.
• Primary markets refer to markets that are directly affected by a
policy or project
• Build a subway system, the primary market is public transportation and the
market for materials used to build the sub- way.
• While secondary market refer to markets that are indirectly affected
• the market for gasoline if some commuters switch from driving to riding the
new subway
Practical vs. Conceptually Correct Measures of
Benefit and Cost
mudah didapat, tidak masuk externalities
• Practical (conveniently available) vs. conceptually correct prices
• When observed prices fail to reflect the social value of a good
accurately or observed prices do not exist, an approach called shadow
pricing is often used to measure some benefits or costs.
• Price that are determined in a well functioning and competitive
market tend to be good estimates of benefits and costs, while
observed price in distorted markets tend to be poor estimate.
• When observed prices do not reflect the true (social) value of a good
accurately or where prices do not exist (e.g. public good), a process
called shadow pricing is used.
Practical vs. Conceptually Correct Measures of
Benefit and Cost
• Even with shadow pricing, the measures of benefits and costs used in
actual studies can differ from their conceptually correct counterparts
from several reasons:
• Error can be made in CBA
• It is even difficult to derive an appropriate shadow price
• The difference between the actual and correct measures are small enough
that the results are not affected very much. In such instances, shadow pricing
may not be necessary
Valuing Outcomes: WTP
setiap tambahan unit akan
mengurangi wtp

• The valuation of policy outcomes should be based on the concept of WTP.

• Benefits are the sums of the maximum amounts people would be willing to pay to
gain outcomes that they view as desirable;
• costs are the sums of the maximum amounts that people would be willing to pay to
avoid outcomes they view as undesirable (opportunity cost).
• This discussion also focuses on gross benefits, rather than net benefits,
because it usually ignores the inputs the government must purchase to
carry out policies.
• In this section, the word "costs" refers to negative changes resulting from a
policy, not the expenses on inputs the government must purchase to carry
out the policy.
• Example: enlarging public market in a well functioning market, create a
relatively low or no rent reduction, resulting in benefits to consumers
Valuing Benefits and Costs in Primary Markets

Price

penambahan pasar
tidak menambah
harga kios
S

S + q!
• Government revenue:
P0
a b q0abq1
cons cost D

• Consumer cost = consumer

e benefit
benefit, so it can be ignored

Quantity
q0 q1

q!
Social surplus change (ignoring costs of project inputs to the government):
Project (a): Direct increase in supply of q!—gain of project revenue equal to area of rectangle q0abq1
Project (b): Supply schedule shift through cost reduction for producers—gain of trapezoid abde

FIGURE 2 Measuring Benefits in an Efficient Market with No Price Effects

bagaimana bila project oleh privat sector, gain adalah tambahn produsen surplus
trapesium abde
well-functioning market, but the increase is so small that the price of the good is unaf-
fected. If the government sells the additional units of the good at the market price,
then it may be treated like other competitors in an efficient market. Hence, as shown
in the figure, it faces a horizontal demand curve, D, for the good at the market price,
P . If the project directly adds a quantity, q!, to the market, then the supply curve as
• Example: government is deepening a harbor so it accommodates larger ships, thus
reducing the cost of transporting bulk to and from the port for the shipping companies
menurukan biaya
Valuing Benefits and Costs in Primary Markets

Proyek pemerintah, ada penurunan cost,

Price
konsumer surplus tambah, karena swasta
masih di kurva S, maka produsen surplus
f
S turun, awalnya P0ae, berkurang sebesar
p0p1ac, net gain abc
S+q!
• ∆ consumer surplus: P0abP1
P0
a • Private-sector still operates in S, then the
P1 c output they sell decline to q2, creating a
b producer surplus loss P0acP1
• Net gain in surplus among private actors
bag
swast (producer and consumer) is abc
e a
yang
• The government revenue from the project
q2cbq1
diamb
d il
pemer
D
• The sum of project revenue and social
inntah

q q q
Quantity surplus is q2cabq1
2 0 1

q!

Social surplus change (ignoring costs of project inputs to the government):

Project (a): Direct increase in supply of q !—gain of triangle abc plus project revenue equal
to area of rectangle q 2cbq 1
Project (b): Supply schedule shift through cost reductions for producers—gain of trapezoid abde

FIGURE 3 Measuring Benefits in an Efficient Market

project.The equilibrium price of the good falls to P1 after the government provides the q!
units of the good. This time, because of the reduction in the price facing consumers, there
is a gain in consumer surplus corresponding to the area of trapezoid P0abP1. Because pri-
vate-sector suppliers continue to operate on the original supply curve, S, the output they
sell falls from q0 to q2, and they suffer a loss of producer surplus equal to the area of
 Valuing Benefit in Distorted Market: Monopoly
Valuing Benefits and Costs in Primary Markets

Price
• Government intervention to break
Consumer surplus
up monopoly, two things happens:
Producer surplus MC 1. DWL disappear, restore social
surplus. In CBA, this would count
a Deadweight
Pm
loss as a benefit of the government’s
AC actions.
d c
Pc 2. Since Pc<Pm, consumers would
f capture that part of the
b monopolist’s producer surplus that
AR is represented by the rectangular
area PmadPc. In CBA, this is
Quantity
viewed as a transfer.
Qm Qc D
MR

FIGURE 4 Monopoly

additional revenue it receives for each additional unit of output it sells—is less than
the selling price of that unit. For example, if a monopolist could sell four units of out-
put at a price of $10 but must reduce its price to $9 in order to sell five units, its rev-
enue would increase from $40 to $45 as a result of selling the fifth unit. Therefore, the
 m c

Natural Monopoly. So far, we have been focusing on a general form of monopoly. We

now turn to a specific type of monopoly: natural monopoly. The essential characteristic
of a natural monopoly is that it enjoys economies of scale over a wide range of output.
Usually, its fixed costs are very large relative to its variable costs; public utilities, roads,
and bridges all provide good examples. As shown in Figure 5, these large fixed costs

Valuing Benefit in Distorted Market: Natural

cause average costs to fall over a large range of output. Put another way, and as shown
in Figure 5, (long run) average costs exceed (long run) marginal costs over what we
term the relevant range of output, which is the range between the first unit of output
Monopoly
and the amount consumers would demand at a zero price, Q0 .

Price
• Gov’t can give permit and regulate the
industry if it show this kind of economies
of scale
• 4 gov’t policy options:
• Allows the monopolist to max profit
Pm a (politically unacceptable)
• Requires monopolist to set price equal to
f D
g AC (breakeven), it will increase quantity,
create additional social surplus adeb, but
Pr d still DWL dec
b e c h AC • Requires P where MC cross demand curve
Pc MC
(competitive equilibrium), DWL eliminated
P0
MR but, potential loss due AC > Pc , so the gap
Quantity
Qm Qr Qc Q0 will be subsidized
FIGURE 5 Natural Monopoly • Free access to Q0, but MC>MB, potential
loss and all will be subsidized

kebijakan yang paling baik yang memperkecil dwl,

P=mc=D, gap ac diberikan subsidi

91
 One of these curves, Di, represents how many units of the product buyers would desire
if they had full information concerning it, while the other demand curve, Du, indicates how
many units they actually desire, given their lack of full information.11 In other words,
the two demand curves represent, respectively, consumers’ WTP with and without full
information concerning the product. They indicate that if buyers had full information,
their WTP would be lower.12
Figure 6 shows that there are two effects of information asymmetry. First, by rais-
ing the price and the amount of the good purchased, information asymmetry increases
Valuing Benefit in Distorted Market:
producer surplus and reduces consumer surplus, resulting in a transfer from con-
sumers to sellers. This transfer is shown by the trapezoidal area PuacPi. Second, by in-

Information Assymmetry
creasing the amount of the good sold relative to the full information case, information
asymmetry results in a deadweight loss, which is shown as the triangular area abc.

Price • Govt intervention: provide missing

information
S • It will transfer the surplus from
Transfer to seller producer to consumer
a
• But, obtaining and disseminating
Pu information is costly

Pi
• Govt must be sure that the benefits of
harga c
Du
intervention is higher than the cost
informed
consumer Deadweight loss (depend on the type of goods: search
b
goods, experience goods, and post-
Di
experience goods)

Quantity
Qi Qu
experience good, pernah kita alami
FIGURE 6 Information Asymmetry konsumsinya, ada pihak ketiga yang
meninformasikan experiencenya
post experience..baru bisa menilai setelah
menikmati barang
careful CBA should first be conducted before the government intervenes Theto standard
correct technique for reducing deadweight loss resulting from nega
any specific externality. 15 ternalities is to impose taxes.16 For example, the suppliers of the good repres
We first examine a negative externality (i.e., one that imposesFigure 7 could
social costs) andbe required to pay a tax, t, on each unit they sell, with the tax s
then a positive externality (i.e., one that produces benefits). Figure 7toillustrates a mar- between marginal social costs and marginal social benefits (s
the difference
ket in which the production process results in a negative externality, such as air or
the figure as the vertical distance at Q* between the two supply curves). As pro
water pollution. The supply curve, S*, reflects only the private marginal costs incurred
costs would
by the suppliers of the good, while the second supply curve, S#, incorporates now include the tax, the supply curve of sellers, S*, would shift up
the costs

Valuing Benefit in Distorted Market:

#. Consequently, the price paid by consumers would increase from P* to P#,
that the negative externality imposes on third parties, as well as theS private marginal
* #
costs incurred by suppliers. The vertical distance between these twoprice curves, measuredby producers would fall from P to P - t, and output produced a
received
would
thosefall from Q* to Q#. Note that pollution associated with the good woul
Externality
over the quantity of the good purchased, can be viewed as the amount subjected
to the negative externality would be willing to pay to avoid it. In other words,but
duced, it repre-
not completely eliminated, because the good would continue to
sents the costs imposed by the externality on third parties. The length of this distance
duced, although in smaller amounts.17
Figure 7 implies that the benefits and costs of the government’s tax policy
Price
tributed unequally among different groups in the economy. These are displaye
• The problem
following social accounting ledger. of “missing market”
S # (marginal social cost)

Benefits Costs
P# S * (marginal private cost) Consumers of good A!B
C t
Producers of good E!F
A B
P*
Third parties B!C!F
F Government revenue A!E
E
P# – t Social benefit C
D

Because the policy causes consumers to pay a higher price for less of th
they lose surplus equal to areas A and B. Similarly, because the tax causes prod
Quantity
Q# Q* sell less of the good but increases their production costs, they lose producer
FIGURE 7 Negative Externality problem: konsumsi equal
lebih to areas E and F. On the other hand, because of the reduction in produ
the good and, hence, in pollution, third parties receive benefits from the policy
besar. dengan adanya
tax maka ada benefit
areas B, C, and F. Finally, the government receives tax revenues equal to area
yang diterima p3, yaitu
bcf E. Because areas A, B, E, and F represent transfers from one group to anoth
area C can be counted as a gain to society as a whole from the tax policy. This a
responds to the deadweight loss eliminated by the tax policy. To compute the n
benefit of the tax, the cost of administering it would have to be subtracted from
duction in deadweight loss.
95
 dA

P*
dB

MB,D
Quantity
q1 q2 Q*

Valuing Benefit in Distorted Market:

FIGURE 9a Rivalrous Good (e.g., hamburger)

Public Goods
MB • Non excludable and non rivalry à
Price jointness in supply mengecilkan WTP, tidak
dB • ”free rider” problem bersedia
WTP<MC
membayar, sehingga

P*
• Tend to be underprovided
• The importance of obtaining WTP
pb makanya kebijakan maka bagaimana memperoleh
WTP
dA

p
a

Quantity
Q* Q# Q
FIGURE 9b Nonrivalrous Good (e.g., streetlight)

99
Valuing Benefit in Distorted Market:
Consumption under Addiction
• Economic models of addictive goods assume that the amount
demanded at any time depends on the amount of previous
consumption.
• Rational addiction occurs when consumers fully take account of the
future effects of their current consumption.
• The presence of negative intrapersonal externalities brings into
question the appropriateness of using changes in consumer surplus
measured under market demand curves as the basis for assessing the
benefits of alternative policies.

kita menggunakan D/S biasa tidak mencerminkan pasar adiksi

actually make consumers better off—it avoids the pain of abstinence but does not pro-
vide as much happiness as would alternative consumption in a nonaddicted state. The
stated desire and costly efforts made by many adult smokers to quit smoking suggests
that they perceive benefits from ending their addiction. In other words, they wish they
had not been addicted by their younger selves.
A plausible approach to measuring consumer surplus in the presence of undesir-
able addiction involves assessing consumer surplus using unaddicted demand curves.21
Figure 10 illustrates the approach taking as an example addicted, or so-called problem,

Valuing Benefit in Distorted Market:

gamblers. It shows two demand curves: DA, the demand curve for gambling in the
presence of the addiction, and DR, the demand curve for the same group of addicted
gamblers if they were instead like the majority of recreational gamblers who enjoy

Consumption under Addiction

gambling but do not have a strong compulsion to gamble that leads them to regret

Price

adiksi DA misal pemerintah menetapkan harga P maka

ada 2 keseimbangan, maka untuk orang yang
adiksi ada di q2.
benefit dilihat dsri konsumer suprlus, maka
konsumer surplus PcAP padahal ada tambahan
pengeluaran konsumer adiksi Qm Qa bc.
sehingga dalam membuat BCA, konsumer
suprlus harus dikurangi dampak adiksi yang
rasional lebih banyak

PC DR

P a b S

c
Quantity
QR QA

FIGURE 10 Consumer Surplus in the Presence

of Gambling Addiction
Valuing Inputs: Opportunity Cost
• Public policies usually require resources (i.e., inputs) that could be used to produce other goods
or services instead.
• Once resources are devoted to these purposes, they obviously are no longer available to produce
other goods and services. opurtinit cost dihituung area dibawah suplly, prosuden surplus
• Almost all public policies incur opportunity costs.
• These opportunity costs are represented by areas under supply curves.
• As a practical matter, the most obvious and natural way to measure the value of the resources
used by a project is simply as the direct budgetary outlay needed to purchase them.
• But the use of budgetary outlay depends on three alternative market situation: 1) when the
market for a resource is efficient (i.e., there are no market failures) and purchases of the resource
for the project will have a negligible effect on the price of the resource; (2) when the market for
the resource is efficient, but purchases for the project will have a noticeable effect on prices; and
(3) when the market for the resource is inefficient (i.e., there is a market failure).
 Opportunity Cost in Efficiency Market with
Negligible Price Effects
Valuing Benefits and Costs in Primary Markets

Price
D D + q′
• Example: buy pencil for govt
official training package
• Perfectly elastic supply curve
• it is often reasonable to
a b
presume that expenditures
P0 S
required for project inputs
equal their social costs
Quantity
q0 q1
q′
biaya yang dikeluarkan
FIGURE 11 Opportunity Costs with No Price Effects

equal their social costs. This is the case when the quantity of the resource purchased
makes only a small addition to the total demand for the resource, and where, in addi-
tion, there is no reason to suspect the existence of significant market failures.

Perfectly Inelastic Supply Curves. In contrast to pencils, let us now examine a gov-
ernment purchase of a parcel of land for a park. We assume that, unlike the pencils, the
 Opportunity Cost in Efficiency Market with
Negligible Price Effects
Valuing Benefits and Costs in Primary Markets

Price • Example: govt purchases

a
S land for public park
• Land is limited (perfectly
dibeli swasta
inelastic supply)
P b • Beside expenses for land,
the opportunity cost should
harga yang
dibayarkan=oportyunit D
include CS, should it bought
y cost
by private sector
Acres of
0 A land

FIGURE 12 Opportunity Costs with Inelastic Supply Curve

ukursnnys yasng tepat selain menghitung cost
pemerintah, tetapi juga consumer suprlus
Measuring Opportunity Costs in Efficient Markets
with Noticeable Price Effects
It is possible that even when a resource required by a project is purchased in an essen-
tially efficient market, such a large quantity is required that its price is bid up. This
could occur, for example, if the construction of a very large dam requires massive
 Quantity
q2 q0 q1

q′
FIGURE 13 Opportunity Costs with Price Effects

increase than the original buyers lose—a gain represented by areas A ! B ! C. Par
Opportunity Cost in Efficiency Market with the gain in producer surplus, the area represented by A!B, merely offsets the los
consumer surplus and, hence, is a transfer from buyers to sellers. However, area C r

Noticeable Price Effects resents a gain in producer surplus that partially offsets the social cost resulting fr
increased government expenditure on the resource.24 To measure the social cost of
Valuing Benefits and Costs in Primary Markets project’s purchase of the resource, this net gain in producer surplus must be subtrac

Price • Example: markets for input

from the project’s total budgetary outlay on the resource, areas B ! C ! G ! E !
Thus, the net social cost of the project’s purchase of q" units of the resource is rep
(brick) in building dams
sented by areas B ! G ! E ! F. The effects of the purchase are summarized in the
lowing social accounting ledger.25
D
D + q′
Benefits Costs
Original buyers sebelum proyek A!B
S Sellers A!B!C
Project expenditures B!C!G!E!F
P1
Net social cost B!G!E!F
A B C F
P0
E
G
The basic point is that when prices change the budgetary outlay does not equal
G
G social cost. In the example shown in Figure 13, they differ by area C. As an examinat
of the figure suggests, however, unless the rise in prices is quite substantial, this a
Quantity
q2 q0 q1 will be small relative to total budgetary cost. This suggests that in many instances b
getary outlay will provide a good approximation of true social cost.
q′
If the price of an input does go up substantially, however, then the budgetary c
FIGURE 13 Opportunity Costs with Price Effects
must be adjusted for CBA purposes. If the demand and supply curves are linear

increase than the original buyers lose—a gain represented by areas A ! B ! C. Part of
the gain in producer surplus, the area represented by A!B, merely offsets the loss in
consumer surplus and, hence, is a transfer from buyers to sellers. However, area C rep-
resents a gain in producer surplus that partially offsets the social cost resulting from
24
Conclusion
• The benefits and costs associated with government programs and projects
are appropriately determined by valuing the resulting changes in net
government revenue flows, producer surplus, and consumer surplus.
• Even when the relevant demand and supply curves are known, great care
must be exercised in order to measure the changes appropriately,
especially when the relevant markets are distorted.
• Two types of relevant markets were considered: the market in which the
policy inter- vention takes place and factor markets where the government
purchases the inputs required by the program or project.
• These markets, primary markets, are the ones that are directly affected by
a particular policy.
LIHAT BUKU HAL 131