6.

Social Cost-Benefit
Analysis
Friday, April 19, 2024 1
Contents

 Why social cost-benefit

analysis (Rationale for SCBA)

 UNIDO approach

 Little-Mirrlees approach
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 Social cost-benefit analysis

is a technique of evaluating projects

from social/economic perspectives.
 primarily used in evaluating public
sector projects

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 Why social cost-benefit analysis?

1. Market Imperfections
 market prices do not reflect social
values
2. Externalities
 are beneficial or harmful effects of
a project to the society
 benefits generated by the project and
the damages inflicted on the society
are ignored in financial analysis
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 Why social cost-benefit analysis?

3. Taxes and subsidies

 are irrelevant from social point of
view as they merely represent transfer
payments
4. Concerns for Savings
 a project may have a consumption
and saving effect, and savings are
more preferred as they lead to
investment
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 Why social cost-benefit analysis?

5.Concern for redistribution

 fair distribution of income among
different groups of the society is a
concern in SCBA
6. Merit goods
are preferences and goals not
expressed in terms of market prices.
Eg. Adult education program

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 UNIDO Approach
It involves the following steps
1. Calculate financial feasibility based on
market prices
2. Obtain net benefits measured in
economic(efficiency) prices
3. Adjust for impact on savings and
investment
4. Adjust for impact on income
distribution
5. Adjust for impact on merit and
demerit goods Friday, April 19, 2024
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 UNIDO Approach
Net benefits in terms of
economic(efficiency) prices
 economic (efficiency) prices are also called
Shadow prices.
Issues related to shadow prices
 Numeraire-unit of account in which value of
inputs and outputs are expressed
 Tradability of goods-measured using
international price

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UNIDO Approach
Net benefits in terms of
economic(efficiency) prices
Sources of shadow price

Impact of a project Source of shadow price

Consumption Consumer willingness to pay

Production Production cost

International trade Foreign exchange value

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 UNIDO Approach
Net benefits in terms of
economic(efficiency) prices…
Shadow pricing for specific goods
(a) Tradable inputs and outputs
 are goods for which increase in
consumption results in increase in import
and a decrease in export, and increase in
production leads to increase in export and
decrease in import
 shadow price is border price in local currency
translated at market exchange rate

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 UNIDO Approach
Net benefits in terms of
economic(efficiency) prices…
Shadow pricing for specific goods
(b) Non-tradable inputs and outputs
 are goods for which import price exceeds
domestic cost of production and export
prices is less than domestic cost of
production.
 shadow price is determined based on
consumers willingness to pay or cost of
production

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 UNIDO Approach
Net benefits in terms of
economic(efficiency) prices…
Shadow pricing for specific goods
(c) Externalities
 are goods that are not deliberatly created,
are beyond the control of persons
affected, and are not traded in the
market.
 value is determined indirectly

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 UNIDO Approach

Net benefits in terms of

economic(efficiency) prices…
Shadow pricing for specific goods
(d) Labor inputs
 by hiring labor a project can have impact on
the rest of the economy in the following
THREE ways
i) may take labor from other employments
ii) may induce production of new labor
iii) may involve import of workers

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 UNIDO Approach

Shadow pricing for specific goods

(d) Labor inputs
 Shadow price is as follows
If labor is taken from other employments
 rate others are willing to pay
If production of new labor is induced
 marginal product of labor in previous
employment
 value of liesure time
 additional consumption of food when working

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 UNIDO Approach

(e) Capital inputs

 investment in capital goods involves
conversion of financial resources into
physical assets and a reduction in
national savings that could have been used
for financing other projects
 shadow price therefore includes shadow
price of physical assets and the
opportunity cost of a project given up

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 UNIDO Approach
Measurement of the impact on distribution
 first, income gained or lost by individual groups
within the society is determined
 income gained or lost is the difference between
shadow price and market price
Example: Suppose that people in Gilgel Gibe area
get 10mill kwh of electricity from Gilgel Gibe II
hydroelectric power generation plant at Br 0.55
per Kwh. They were actually willing to pay Br 0.75
per kwh. The income gain is therefore calculated
as follows:
= Br 2mill (10mill kwh x (Br 0.75-Br 0.55)
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 UNIDO Approach

Saving impacts and its value

Two important questions
1. given its impact on income distribution, what would be effects of a
project on savings?
2. value of the savings to the society

IMPACT ON SAVING
equals to
where Yi change in income as a result
of the project MPSi is marginal propensity to save of
group i

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 UNIDO Approach

IMPACT ON SAVING
Example: Consider the following data
Group Gain/loss MPS
A Br 250,000 0.40
B 150,000 0.20
C -100,000 0.30
D 200,000 0.25
E -350,000 0.10

Impact on savings equals to Br 115,000

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 UNIDO Approach

Value of Saving
 is the present value of additional
consumption produced when a saving is
invested at the margin.
 additional consumption generated by
investment depends on marginal
productivity of capital and rate of
investment from additional income.

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 UNIDO Approach

Income distribution Impact

 involves weighing the net gain/loss by
each group to reflect value of income
for different groups and summing
them.
 Weights are determined as follows
w = (b/ci) ni

where wi =weight attached to income at ci level

b = base level of income that has a weight of 1
n = elasticity of the marginal utility of income

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 UNIDO Approach

Adjustment for merit and demerit goods

 merit goods have more social value than
economic value eg. Production of Oil
 demerit goods have more economic value
than social value eg. Production of
Cigarette.
 the difference between social value and
economic value is adjusted by (i) estimating
economic value (ii) calculating adjustment factor
as the difference between the ratio of SV to EV
and one (iii) multiplying economic value by the
adjustment factor(iv) add the value in (iii) to
NPV Friday, April 19, 2024
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 UNIDO Approach

Adjustment for merit and demerit

goods...
Example
Suppose the present economic value of a
project is Br 15mill and the ratio of SV to EV
is 1.30.
Adjustment factor = 0.30 (1.30-1)
Adjustment = Br 4.5 million (0.30 x Br
15million)
Adjusted Economic value = Br
19.5mill(15mill+4.5mill)
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 Little-Mirrlees Approach
Differences with UNIDO approach
 UNIDO approach measures costs and benefits
in domestic prices whereas L-M approach
measures them using international prices
 UNIDO approach measures costs and benefits
in terms of consumption whereas L-M
approach measures them in terms of
uncommitted capital
 the step-by-step analysis in the UNIDO
approach focuses on efficiency, savings and
redistribution in different stages whereas L-
M approach views them together
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 Little-Mirrlees Approach

Shadow price of traded goods

 border price because it represents the
correct social opportunity costs or
benefits of using or producing a traded
good
 if a good is exported, its FOB price
 if imported, its CIF price

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 Little-Mirrlees Approach

Shadow price of non-traded goods

 is defined in terms of marginal social
cost and marginal social benefit.
 MSC is the value in terms of
accounting prices of the resource
required to produce extra unit of the
good
 MSB is value of extra unit of the good
from social point of view
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 Little-Mirrlees Approach

Shadow wage rate

 is determined based on
i. Marginal productivity of labor
ii. cost associated with urbanization
iii. the cost of having an additional
amount committed to consumption
when consumption of a worker
increases due to employment

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End of Social Cost-
Benefit Analysis

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