Transcript Efficiency and Surplus

Efficiency, Surplus and
Doing Benefit-Cost Analysis
How can economics help determine
the optimal size of a project or extent
of a regulation?
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Motivating Group Project
2001 Actual Group Project (Advisors—
Profs. McAusland and Kendall):
A Cost-Benefit Analysis of Public Law
99-625: Sea Otter-Shellfishery
Conflicts in Santa Barbara and
Ventura Counties
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A few other examples
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What should be the CO concentration
standard in tailpipe emissions?
What is the appropriate level of GHG
emission reduction worldwide?
How large should the Channel Islands
marine reserve be?
Can we measure loss to recreationists of
the Forest Adventure Pass?
Add another lane to Hwy 101?
Close Mission Canyon to cyclists?
What habitat to buy to protect endangered
species (eg, Least Bell’s Vireo – bird)
Generic Problem
Characterize an Environmental Policy
or Action (or multiple policies or
actions)
 Estimate the Consequences of that
policy or action
 Estimate the pluses (benefits) and
minuses (costs) of that policy or action
 Reach conclusions
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CBA: main principle
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Quantify all costs and benefits in a common
measure (usually $)
Common metric need not be $
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eg, health- health analysis, with health as metric
• Benefits directly measured in terms of lives saved
• Costs indirect: costs increase deaths since
• Regs make people poorer
• lower incomes lead to higher mortality ($13 million in extra
costs results in 1 statistical death)
• Eg, Compare risks in lower and higher income countries
• Compare projects based on net effects on health.
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What others method to use?
Cost-effectiveness Analysis
 Weighted cost-benefit analysis
 Multigoal analysis
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Basic measure of value is
willingness-to-pay
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MWTP
Demand curve is marginal willingness
to pay
First units very valuable
Last units less valuable
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Quantity of water
Consumers Surplus (CS)
$
CS(q)
p
D(x)
q
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x
Calculating benefits
from MWTP
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Demand, D(x), measures MB.
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Consumers Surplus is the total benefit
to consumers minus their cost.
q
CS (q)   D( x)dx  pq
0
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Example – gross value of water
from new dam (excluding costs)
Price
New dam
Add’l
Value
...
.......
. . . . .. .
.......
Demand for water
Acre-feet of water
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What about nonmarket
goods?
Suppose there were a market:
Price
Demand for air quality
Air quality
BUT,
NO MARKET: price similar to MWTP
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Environmental goods
Demand for env goods just as real as
demand for market goods – just
harder to measure
 Demand is a measure of intensity of
preferences
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Costs are simpler
Some units are cheap to produce
 “Marginal” units are most expensive
 Costs consist of
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Fixed costs
 Marginal costs
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Marginal costs plus fixed
costs add up to total costs
Last units pricey
MC
First units cheapest
Quantity
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Producer Surplus (PS)
$
MC(x)
PS(q)
p
q
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x
How are costs calculated?
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Supply, S(x), is same thing as MC.
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Producer Surplus is the total revenue
to producers minus their cost.
q
PS ( q )  pq   S ( x ) dx
0
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Put it together
P
Total Surplus
...
.......
.............
........................
...............
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Q
Where is CS+PS
maximized?
$
Tension: Too little produced
At too high price. CS low, PS
high
CS
p
Supply, S(x)
PS
Demand, D(x)
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q1
q*
x
Suppose goods supplied in
fixed amount
Price
Supply of land
Consumer surplus
Producer surplus (goes to land owners)
Market
Price
Demand for land
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Land
Example: Add a dam
Status quo water availability
Price
PS:
Before: # and X
After:
CS: ??
##################
XXXXXXXXXXXX
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Q Water
Example: Add a dam
Supply of water increases; price falls.
What happens to PS? CS?
Price
PS:
Before: # and X
After: X and $
CS: ??
##################
XXXXXXXXXXXX $$$$$
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Q Water
If captured all costs &
benefits
Then we want to maximize CS + PS which
would occur where Supply = Demand.
 Challenge is to capture all costs and
benefits to accurately measure MC & MB.
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Costs come in different flavors:
Private, external and social
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In principle, need to
$/gal
capture all costs
and benefits.
Social costs may
exceed private
costs.
Difference is the P0
“external cost” –
the monetized cost
of the externality.
MPC
Q0
Gallons
Of Gasoline
Social vs. Private Costs
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In principle, need to
$/gal
capture all costs
and benefits.
Social costs may
exceed private
costs.
Difference is the P0
“external cost” –
the monetized cost
of the externality.
MPC
MEC
Q0
Gallons
Of Gasoline
Social vs. Private Costs
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In principle, need to
$/gal
capture all costs
and benefits.
Social costs may
exceed private
P*
costs.
Difference is the P0
“external cost” –
the monetized cost
of the externality.
MSC
MPC
MEC
Q* Q0
Gallons
Of Gasoline
First Theorem of Welfare
Economics
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In a competitive market
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Surplus is maximized at a market equilibrium
Implications
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Can rely on market if we are sure of
competitive market
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Implicit Assumptions: Distribution
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Distributional consequences ignored
Compensation Principle
Implicit Assumptions:
Income
Price
Y=$50,000 per year
Y=$30,000 per year
Restaurant meals
Demand and thus surplus depend on income distribution
Therefore: Change
in income distribution will change results of CBA
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TO USE CBA, MUST BELIEVE INCOME DISTRIBUTION IS OK
Implicit Assumptions:
Completeness
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What happens with difficult to
monetize benefits?
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Eg, clear view of Santa Cruz Islands
Difficult to monetize benes often
omitted
 Results in bias against env. benes
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Implicit Assumptions: Other
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Moral and political dimensions omitted
Should we do a cost-benefit analysis
on executing someone who has
committed a crime?
 Are there other issues when lives are
at stake?
 Are intergenerational issues
adequately treated by CBA?
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Ten Steps to doing and using
a CBA
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Decide whose benefits and costs count
Select the portfolio of alternative projects
Catalog potential physical impacts and determine how they are
measured
4. Predict quantitative physical impacts over life of project
5. Monetize all impacts
6. Discount for time to find present values
7. Sum: add up all benefits and costs
8. Perform sensitivity analysis
9. Choose alternative with largest social benefits
10. Make policy recommendation, using CBA only as part of guidance
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