Valuing Benefits and Costs

in Secondary Market

Magister Perencanaan Ekonomi dan Kebijakan Pembangunan

Fakultas Ekonomi dan Bisnis Universitas Indonesia
Introduction
• In conducting CBA for govt policy, we tend to list as many as many
effects of the policy
• To assess the effect, one must first determine which occurs in the
primary market (directly affected) and which occurs in the secondary
market (indirectly affected)
• Example: develop bus rapid transit system
• Primary market: changes in bus usage; congestion and pollution (external)
• Secondary market (called second-round, spill over, side, pecuniary, or
secondary effect): demand for auto repair, parking space, and gasoline berkurang
• The secondary effect should be ignored in conducting CBA

LIHAT BUKU
BOARDMAN
Valuing Benefit and Cost in Efficient Secondary Market
• Identify whether the policy will affect the market of the other good
as:
• Substitute good
• Complement good
• Example: develop public transportation
• Car usage (demand) will decline, car is substitute good
• Payment card demand will increase, payment card is complementary good
• If government policies affect the demand for goods in secondary
markets, then prices in these secondary markets may or may not
change as a result.
Valuing Benefit and Cost in Efficient Secondary Market
• Efficient Secondary Market without Price Changes
• Many government projects cause effects in large numbers of secondary
markets (either substitutes or complements)
• Accounting for all these effects would impose an enormous burden on
analysts.
• We should ignore impacts in undistorted secondary markets as long as
changes in social surplus in the primary market resulting from a government
project are measured and prices in the secondary markets do not change.
• Prevent double counting
 Valuing Benefits and Costs in Secondary Markets

Access price

a
PF 0 MCF 0

Valuing Benefit and Cost in Efficient Secondary Market PF 1

b
MCF 1

DF

1. Efficient Secondary Market without Price Changes q F0 q F1

Days of fishing

Valuing Benefits and Costs in Secondary Markets FIGURE 1(a) Primary Market: Market for Fishing Days

Equipment price
Access price
c
e

a harga awal
PF 0 MCF 0

b
PF 1 MCF 1

PE0 f d
DF DE 0 DE 1
Days of fishing Units of equipment
q F0 q F1 q E0 q E1

FIGURE 1(a) Primary Market: Market for Fishing Days FIGURE 1(b) Secondary Market: Market for Fishing Equipment (No Price Effect)

Equipment price

• Social surplus in the primary market: PF0abPF1becrease

c
e
counted as an additional increase in consumer surplus? It is tempting to treat the in-
in consumer surplus from efP to cdP in panel (b) as an additional increase in E0 E0

• In secondary market, market is competitive, and

done. As the consumer
discussed still
next, doing so would resulthave old (card)
in double counting. that
social benefits that should be added to P abP in panel (a), but this should not be
As long as price does
F0 F1

can be used. So the increase in demand for payment system is actually not that high
not change in the equipment market as a result of stocking the lake, the social surplus
change in the fishing market measures the entire benefit from the stocking project.
To see this, first consider fishers who already own all the fishing equipment they
need at the time the lake is stocked and, hence, presently contribute no demand to the

PE0 f d
DE 0 DE 1 121
Units of equipment
q E0 q E1
 D*

a
PF 0

Valuing Benefits and Costs in Secondary Markets

PF 1 c b

Efficient Secondary Market Effects with Price Changes1

DF 0

Valuing Benefit and Cost in Efficient Secondary Market

The situation is more complex when the supply schedule in the secondary market is up- DF
1
ward sloping.To see this, we examine the effect of stocking the lake on the demand for golf-
ing. In Figure 2a, panel (a) once again shows the demand for fishing days, while panel (b)
now shows the demand for golfing days.As before, the reduction in the price of fishing days
Days of fishing
from PF to PF as a result of stocking the lake causes an increase in social surplus equal to
2. Efficient Secondary Market with Price Changes
0 1
q F0 q F1
the area PF abPF (for the moment ignore demand schedules DF and D*).
0 1
FIGURE 2(a) Primary Market: Market for Fishing Days
1

Access price
ada social loss
Access price efg
tambahan cs ;
D* PoabP1 S

a
PF 0 e g
PG 0
f h
PG 1
DG (PF )
0 0

PF 1 c b
DG 1 (PF 1 )
DF 0
DF 1 deman
awal
Days of fishing Days of golfing
q F0 q F1 q G1 q G0

FIGURE 2(a) Primary Market: Market for Fishing Days FIGURE 2(b) Secondary Market: Market for Golfing Days (Price Effects)

• Social surplus in the primary market: PF0abPF1

Access price

• In secondary market, car demand will decline S to, creating a lower number of car purchased, to qd1 , creating
a social loss of efg
123
• A good
P G0
estimation
e
of social
g
surplus will be based on observed demand function of primary market D* (not
DF1), so it would be PF0abPF1, since triangle
P G1
f h
abc=efg
D (P ) G0 F0

DG 1 (PF 1 )

Days of golfing
q G1 q G0
Valuing Benefit and Cost in Distorted Secondary Market
• Unfortunately, use of equilibrium demand schedules in primary markets misses some of
the relevant effects that occur in distorted secondary markets—that is, in secondary
markets in which prices do not equal social marginal costs.
• Previous example: demand forBenefits
Valuing payment card
and Costs in produces
Secondary Markets externality (𝑀𝑃𝐶 ≠ 𝑀𝑆𝐶)
Equipment price
c
e

PE + x Marginal social cost

0

x exeternalitas cost di pasar

secondary, bila besar maka
PE 0 Marginal private cost diperhitunglan sebagai
f d
DE 0 DE 1 pengurang dari benefit di
Units of equipment
qE 0 qE 1 primary cost
FIGURE 3 Distorted Secondary Market: Market for Fishing Equipment (No Price
Effect)

For purposes of our illustration, let us assume that chicken is currently subject to a
tax of tC cents per pound, but beef is not presently taxed. In this situation, the existing
demand schedules for beef and chicken are represented by DB and DC , respectively. As
0 0
panel (b) of Figure 4 indicates, the tax on chicken provides the government with revenue
equal to area T but reduces consumer surplus by areas T ! U.Thus, the tax on chicken re-
sults in deadweight loss equal to the triangular area U.

Price Price
 pound on beef. As indicated in panel (a), if the new tax is adopted, the governmen
collect revenue represented by area A, but consumers of beef will lose surplus equ
PE + x Marginal social cost
0
the areas A ! B. Consequently, imposition of the new tax will result in deadweigh
x in the beef market equal to area B.
The increase in the market price of beef shifts the demand schedule for chick
Marginal private cost
PE 0
f d substitute, from DC to DC . For reasons discussed previously, this shift does not r
DE 0 DE 1 0 1
sent a Units change in consumer surplus. Indeed, the deadweight loss in the marke
of equipment
qE 0 qE 1
chicken remains the same, although it does shift from area U to areas M ! N. How
FIGURE 3 Distorted Secondary Market: Market for Fishing Equipment the shift causes
(No Pricean increase in the sale of chickens, as consumers substitute chicke
Valuing Benefit and Cost in Distorted Secondary Market
Effect) beef, resulting in an increase in tax revenues collected by the government.
For purposes of our illustration, let us assume that chicken increase,
is currently which
subject toisarepresented in panel (b) by area U ! V, is a benefit from th
tax of tC cents per pound, but beef is not presently taxed. In this imposed
situation, on beef that could conceivably more than offset the deadweight loss o
the existing
• The effect of tax on substitute good
demand schedules for beef and chicken are represented by DB and
0
D
ring Cin0
, respectively.
the beef As
panel (b) of Figure 4 indicates, the tax on chicken provides the government with revenue
market. The various effects of the tax on beef are summarized i
following social accounting ledger:
• Initial condition is tax on chicken, followed by tax on beef
equal to area T but reduces consumer surplus by areas T ! U.Thus, the tax on chicken re-
sults in deadweight loss equal to the triangular area U.

Price Price
Benefits Costs
Consumers — A!B
Government revenue A!U!V —
Social benefit and costs U!V B
PB + tB
A
B PC + tC Notice that while all of the change in consumer surplus takes place in the primary
PB
T
V Notice that while all the consumer
ket,Mincreases in tax revenues occur in both markets.
PC
U
The important lesson surplus changes
from this occurs
illustration in primary
is that, unlike situations in which
markets,markets,
are Nno distortions in secondary increases in taxand
benefits revenues
costs of a policy interve
cannot be fullyDC 1
measured by observing
occurs in bothonly the effects that occur in primary ma
markets
DB 0
Effects that occur in distorted secondary markets should, in principle, be valued
DC 0
rately. A method for doing this is described in Exhibit 1. Yet, in practice and as
Pounds cated in the exhibit,
Pounds it is usually
awalnyavery
ada difficult to do sapi
dwl di u,ketika so. Estimation
di beri problems us
FIGURE 4(a) Market for Beef FIGURE 4(b) Market
preclude accurate measurement
for Chicken of welfare
pajak maka changes
dwl juga that occur in secondary ma
pada b.government
Estimating own-price effects (how quantity demanded
revenue adalah A. kenaikan changes as the price o
sapi maka
good changes) is often difficult; estimating cross-price effectsdwl
permintaan ayam akan naik.sehingga (how the quantit
m dan n. maka
manded of good Y changes as the price of good Z changes) is more difficul
Consequently, we are rarely very confident of predictions of demand shifts in
ondary markets. Moreover, when secondary markets are distorted, it is also diffic
measure the size of the distortions. (Recall the x-cent loss of wildlife from the sa
Valuing Benefit and Cost in Distorted Secondary Market
• The important lesson from this illustration is that, the situations in distorted secondary
markets warrant a close look at the benefits and costs of a policy intervention in
secondary market because it affects benefit and cost significantly in primary markets.
• Yet, in practice and indicated in some study (using CGE), it is usually very difficult to do.
• Estimation problems usually preclude accurate measurement of welfare changes that
occur in secondary markets
• estimating own price elasticity, cross price elasticity àless confident in predicting demand
change in secondary market
• It is very difficult to measure the size of distortion, when secondary market is distorted

• However, it is very important when the effect is considered to be significant!

• Fortunately, price changes in most secondary markets are most likely to be very small à
will not create significant bias in CBA estimation
Conclusions
• Costs and benefits that occur in undistorted secondary markets are typically very
difficult to value, but generally should not be added to costs and benefits that are
measured in primary markets. Doing so will usually result in double counting.
• The rules that appear in Table 1 cannot be used without first determining the
type of market in which the various potential impacts of a project or program
occur—primary, secondary, or factor market—and then determining whether the
market is efficient or inefficient. In practice, this is sometimes difficult.