Definition

Cost Analysis refers to the measure of the cost – output relationship, i.e. the economists are
concerned with determining the cost incurred in hiring the inputs and how well these can be
re-arranged to increase the productivity (output) of the firm.

In other words, the cost analysis is concerned with determining money value of inputs
(labour, raw material), called as the overall cost of production which helps in deciding the
optimum level of production.

CBA vs CEA

Cost-benefit analysis and cost-effectiveness analysis are two approaches that sound the
same, operate similarly, have similar goals, and are often referred to interchangeably.
Despite what these two techniques have in common, they are indeed two distinct
techniques that ask different questions and have different approaches to evaluating the
efficiency of a program.

At the most fundamental level, cost-benefit analysis and cost-effectiveness analysis are
centred on two different questions. While cost-benefit analysis asks whether the economic
benefits outweigh the economic costs of a given policy, cost-effectiveness analysis is
focused on the question of how much it costs to get a certain amount of output from a
policy. Formulas to calculate the two are listed below.

Cost-benefit = Benefits - Costs (AKA “net benefits”)

OR

Cost-benefit = Benefits / Costs (AKA “benefit ratio”)

Cost-effectiveness = Costs / Outcome

Example

Let’s put this into practice. Say an analyst is conducting a policy analysis on a proposal to
expand a school district’s preschool education program by opening free slots for children
from low-income families. What would this analysis look like if it focused on cost-benefit
outcomes versus cost-effectiveness outcomes?

A cost-benefit analysis would attempt to collate all the benefits of the program such as
future labour market earnings benefits for participants, improved health benefits,
reductions in crime, and reduction in future social spending, and compare that to program
costs and other costs of the program, for instance the potential for increased public-sector
spending on higher education. The analyst would then convert all these benefits to dollar
figures and then estimate the dollar value of benefits compared to costs as a ratio or
difference depending on client needs.

A cost-effectiveness analysis, on the other hand, would focus on a given outcome and see
how much spending is needed to bring about that outcome. For instance, if the preschool
program was focused on trying to increase high school graduation rates, an analyst could
estimate how much would need to be spent on the program, given what we know about
how preschool participation impacts high school graduation rates, in order to cause one
new person to graduate who would not otherwise. This cost could then be measured
against other interventions to improve high school graduation rates to assess how cost-
effective opening preschool slots is for improving graduation rates compared to other
options the school district may have.

Looking at this example, you can start to see some of the advantages and disadvantages of
using one technique versus the other. Cost-benefit analysis is usually considered a more
comprehensive analytical technique since the process of monetization (converting all costs
and benefits to dollars figures) converts all costs and benefits into a common currency,
namely economic benefit.