Transcript PowerPoint Presentation Week 1

Lecture Notes
ECON 437/837: ECONOMIC
COST-BENEFIT ANALYSIS
Lecture Six
0
ECONOMIC VALUATION
OF TRADABLE GOODS &
SERVICES
1
Applying the Postulates to Determine Economic Evaluation
of Tradable Goods and Services
• The framework for the estimation of economic prices was
presented for the case of non-tradable goods.
• They are also applicable to the valuation of tradable goods.
• The methodology for the estimation of the economic prices of
internationally tradable goods and services when there are
distortions in their markets is also based on the three
postulates.
• These distortions may include customs duties on imported
inputs of a project or those imported items that the project
output will replace or substitute.
2
Tradable Commodities
A good or service is considered tradable when an increase in demand (or
supply) by a project does not affect the amount demanded by domestic
consumers.
• An increase in demand for an IMPORTABLE commodity results in an
increase in demand for imports.
• An increase in demand for an EXPORTABLE commodity results in a
reduction in exports.
• An increase in supply of a tradable commodity by a project will cause
either a reduction in imports or an increase in exports.
An Importable commodity includes imported goods and domestically
produced goods that are close substitutes for imported goods.
An Exportable commodity includes exported goods and close substitutes
for exported goods.
3
Tradable Commodities (cont’d)
• There are usually more internationally traded goods and
services than non-traded goods and services in economy.
• Smaller countries tend to have more traded goods and services
than large countries. Small countries cannot produce many
goods and services efficiently.
• The public sector tends to produce non-traded goods and
services but uses many traded goods and services as inputs.
• E.g., when analyzing infrastructure projects that produce
domestic services, the techniques for the economic valuation
of tradable goods are important for determining the economic
cost of inputs to the project.
4
Classification of a Project’s
Outputs and Inputs
Project
Outputs
Tradable
Importable
Inputs
Non-Tradable
Exportable
Tradable
Importable
Non-Tradable
Exportable
5
Measuring the Economic Values of
Tradable Goods: Four Cases
1. Economic cost of importable input
2. Economic value of importable good production
3. Economic value of export production
4. Economic cost of exportable input
6
Importable Good
Price
S domestic supply
Distorted World
Supply Price
Pm
Em * PCIF * (1+Tm) + Fm
D domestic demand
Imports = Q d - Q so
Q
s
o
Q
d
o
Quantity
per year
o
Em = Market Exchange Rate
Fm = Domestic Freight to Market
Tm = Rate of Import Tariff
PCIF = Price of imports at entry point to country, including international freight
and insurance charges expressed in units of foreign currency
7
Project Demands More of an Importable Good
Price
S domestic
Em * PCIF * (1+Tm) + Fm
S world
D domestic
Q s0
Q d0
Q d1
D w/project
Quantity
Project requirements will be met by additional imports (world
supply). Domestic consumption is not affected.
8
Project Purchases Importable Inputs
Input subject to Import Tariff
Price
D0+P
S0
D0
Pd = Em Pw(1+t)
World Supply
After Tariff
Em P w
0
World Supply
Qs0
Qd
0
Q1d
Quantity
Financial cost is EmPw (1+t) (Q1d - Q0d)
Economic cost is EmPw(Q1d – Q0d) + Foreign exchange premium
9
Estimating the Economic Prices of Tradable Goods
1. Adjust for commodity - specific trade distortions
• Financial prices for the commodities demanded (or supplied) by a project must be
adjusted for commodity-specific distortions and costs that drive a wedge between
their international prices and their domestic market prices.
• Taxes and subsidies are transfers between consumers, producers, and the
government. Therefore, they are not part of the real resources consumed or
produced by a project.
2. Value the foreign exchange at the economic (shadow) exchange rate (Ee)
• Multiply the CIF and FOB prices at the border by the economic price of foreign
exchange (Ee).
• Alternatively, add a foreign exchange premium [(Ee/Em) – 1], per unit of foreign
exchange demanded (or supplied) by a project.
3. Adjust for handling and transportation costs
• The economic costs of handling and transportation that are necessary to move
commodities to or from the point of entry must be included.
• In the case of imported commodities, these costs should be added to the CIF price.
• In the case of exported commodities, these costs should be subtracted from the FOB
price.
10
Visayas Communal Irrigation Project
Basic Facts
•
The National Irrigation Administration (Philippine National Agency) proposes to
rehabilitate 55 damaged communal irrigation systems and to build 25 new systems in
Visayas.
•
The project’s additional components include water protection and erosion control, the
strengthening of irrigation association, and the development of agricultural extension
services.
•
The goal of the project is to alleviate poverty, while improving environmental
sustainability of the region.
The life of project is 20 years.
The economic benefits arise from the increased production of rice and corn, which must
otherwise be imported.
•
•
•
•
•
The foreign exchange premium is 24.6%.
The project is expected to cost approximately 480.91 million pesos (US$19.78 million).
The project will be financed with US$15.1 million loan from the International Fund for
Agricultural Development, and remaining funding would be provided by the Philippine
government.
11
Project uses an Importable Good
(Pesticides)
(+)
Farm
Transport
Local
Market
(+)
Transport
Importer
Depot,
Manila
(+)
Transport
Port,
Manila
Tariff,
Port
Charges
12
Economic Cost of Importable Goods:
With Tariff, Trade Margin and Domestic Freight
Price / unit
S0
C
A
E
(P3+freight)=P4
(P2+trade margin)=P3
F
L
J
(P1+tariff)=P2
G
M
K
D1
Em (cif)=P1
H
B
I
D0
0
QS0
Q d0
Q1d
Quantity of units per year (000’s)
13
Table 1: Project Uses an Importable Good (Pesticides)
Financial
Price
CIF World Price per 1000 liters of pesticides
US Dollars
Local Currency
Plus: Tariff
Price at Port
CF at the Port
Plus: Handling/Transportation from Port to Manila Markets
Handling
Transportation
Plus:
Traders' Margin
Plus: Handling/Transportation from Manila Markets to Farm Gate
Handling
Transportation
Price at the Farm Gate
CF at the Project Site
Conversion
Factor for
Nontradable
Services
166.00
4,038.00
201.00
4,239.00
1.19
Value
of
FEP
993.35
Economic
Value
5,031.35
0
5,031.35
540.00
225.00
0.90
1.20
486.00
270.00
200
0.7
140.00
600.00
250.00
6,054.00
1.12
0.90
1.20
540.00
300.00
6,767.35
14
Measuring the Economic Values of
Tradable Goods: Four Cases
1. Economic cost of importable input
2. Economic value of importable good production
3. Economic value of export production
4. Economic cost of exportable input
15
Project Supplies More of an Importable Good
Price
S domestic
S w/ project
Em * PCIF* (1+Tm) + Fm
S world
D domestic
Q s0
Q s1
Q d0
Quantity
Project reduces quantity imported. No change in domestic consumption.
16
Project Supplies an Importable Good (Rice)
Rice Mill
PreExmilled milled
(paddy) (rice)
(-)
Paddy equivalent Milling
(65%)
cost
Grain dealer
margin
Farm
Transportation
& handling
(-)
Transportation
Whole
saler,
Manila
(+)
Transportation
& handling
Trading margin
Port,
Manila
Price of
rice at
the port
Farm-gate
price of paddy
17
Table 2: Project Supplies an Importable Good (Rice)
Financial
Price
CIF World Price per ton of Rice
US Dollars
Local Currency
CF at the Port
Plus: Transportation/Handling Charges Port-Manila
Handling
Transportation
Traders' Margin
Wholesale Price in Manila
Less: Transportation from Rice Mill to Manila
Ex-Mill Price of Rice
Less: Milling Cost
Pre Milled Value
Paddy Equivalent (65%)
Less:
Grain Dealer's Margin (4%)
Handling/Transport from Farm to Mill:
Handling
Transportation
Price of Paddy at Farm Gate
CF at the Project Site
Conversion
Factor for
Nontradable
Services
314.80
7,659.00
1.25
Value
of
FEP
1,884.11
Economic
Value
9,543.11
50.00
100.00
472.00
8,281.00
515.00
7,766.00
345.00
7,421.00
4,823.65
0.90
1.20
0.70
192.95
0.70
135.06
50.00
80.00
4,500.70
1.24
0.90
1.20
45.00
96.00
5,600.60
1.20
1.10
45.00
120.00
330.40
10,038.51
618.00
9,420.51
379.50
9,041.01
5,876.66
18
Measuring the Economic Values of
Tradable Goods: Four Cases
1. Economic cost of importable input
2. Economic value of importable good production
3. Economic value of export production
4. Economic cost of exportable input
19
Exportable Good
Price
S
Em
* PFOB * (1-tx) - Fx
domestic supply
Distorted World
Demand Price
Pm
D
domestic demand
Exports =
Qso
-
Q do
Q
d
o
Q
s
o
Quantity
per year
Em = Market Exchange Rate
tx = Export Tax
Fx = Freight and Trading Costs to Port
PFOB= Price of exports at point of export from country in units of foreign currency
20
Project Supplies More of an Exportable Good
Price
S domestic
S w/ Project
D world
Em * PFOB * (1-tx) - Fx
D domestic
Qd 0
Qs0
Qs1
Quantity
Project increases exports. Domestic consumption remains unchanged.
21
Project Produces Exportable Goods subject to
Export Tax (No domestic transportation costs)
Price
S0
S0+P
Em P w
World Demand
ww
Pd=EPmd P
= P(1-t)
(1-t)
World Demand
After Export Tax
D0
0
Quantity
Q d0
Q s0
Q1s
Financial benefit is EmPw (1-t) (Q1s-Q0s)
Economic benefit is EmPw(Q1s – Q0s) + Foreign exchange premium
Economic values of exportable goods are based on the FOB values
of demand for exports
22
IRRI Supply an Exportable Good
(Seeds)
(-)
IRRI Gate
Port
Port charges
Transportation
23
Table 3: IRRI Supply an Exportable Good (Seeds)
Financial
Price
Price per ton of Seeds
US Dollars
Local Currency
Conversion
Factor for
Nontradable
Services
410.00
9,975.00
Plus: Export Subsidy (10% of Price)
Price at the Port
CF at the Port
998.00
10,973.00
1.13
Less: Handling/Transportation Charges from IRRI to Port
Handling
Transportation
Price at IRRI Gate
CF at the Project Site
120.00
50.00
10,803.00
1.14
Value of
FEP
Economic
Value
2,454.00
12,429.00
12,429.00
0.90
1.20
108.00
60.00
12,261.00
24
Measuring the Economic Values of
Tradable Goods: Four Cases
1. Economic cost of importable input
2. Economic value of importable good production
3. Economic value of export production
4. Economic cost of exportable input
25
Project Demands More of an Exportable Good
Price
S domestic
Em * PFOB * (1-tx) - Fx
D world
D
D w/ Project
domestic
Qd0
Qd 1
Qs0
Quantity
Project requirements will reduce quantity exported.
Consumption of previous consumers remains unchanged.
26
Project Uses an Exportable Good
(seeds)
Local
Market
(+)
Transportation
Farm
(+)
Transportation
Dealer’s
margin
IRRI
Exporter
(-)
Port Handling
Transportation
Port,
Manila
27
Table 4: Project Uses an Exportable Good (Seeds)
Financial
Price
Price per ton of Seeds
US Dollars
Local Currency
Plus: Export Subsidy (10% of Price)
Price at the Port
CF at the Port
410.00
9,975.00
998.00
10,973.00
1.13
Less: Handling/Transportation Charges from IRRI to Port
Handling
Transportation
Plus: Dealers' Margin
Plus: Transportation Cost from IRRI to Farm
Price at Farm Gate
CF at the Project Site
120.00
50.00
370.00
635.00
11,808.00
1.12
Conversion
Factor for
Nontradable
Services
Value
of
FEP
Economic
Value
2,454.00
12,429.00
12,429.00
0.90
1.20
0.70
1.20
108.00
60.00
259.00
762.00
13,282.00
28
Summary
Economic Cost of Imported Input =
CIF (adj. for economic exchange rate) + Economic Cost of Freight from Port to
Project
Economic Value of Importable Good Production =
CIF (adj. for economic exchange rate) + Economic Cost of Local Freight from Port
to Market - Economic Cost of Local Freight from Project to Market
Economic Value of Exportable Production =
FOB (adj. for economic exchange rate) - Economic Cost of Local Freight from
Project to Port
Economic Cost of Exportable Input =
FOB (adj. for economic exchange rate) + Economic Cost of Local Freight from
Export Producer to Project - Economic Cost of Local Freight from Export
Producer to Port
29
Additional Examples on
Calculation of Tradable Goods
30
Example 1: The Import of Pneumatic Tires
(with an import duty)
Financial
Price
CIF World Price
US Dollars
Local Currency @39 pesos per US Dollar
Plus:
Tariff @30%
VAT @10%
Price at the Port
CF at the Port
Plus: Handling/Transportation from Port to Project Site
Handling
Transportation with Subsidy
Price at the Project Site
CF at the Project Site
Conversion
Factor for
Nontradable
Services
40.00
1,560.00
234.00
468.00
202.80
2,230.80
0.804
18.00
9.00
2,257.80
0.807
Value
of
FEP
(15%)
Economic
Value
1,794.00
1,794.00
0.90
1.25
16.20
11.25
1,821.45
31
Example 2: The Export of Shoes
(with an export subsidy)
Financial
Price
FOB World Price of Shoe
US Dollars
Local Currency @39 pesos per US Dollar
Plus: Export Subsidy (10% of Price)
Price at the Port
CF at the Port
200.00
7,800.00
780.00
8,580.00
1.045
Less: Handling/Transportation Charges from Port to Project
Site
Handling
Transportation with Subsidy
Price at Project Site
CF at the Project Site
67.20
80.00
8,432.80
1.042
Conversion
Factor for
Nontradable
Services
Value
of
FEP
(15%)
1,170.00
Economic
Value
8,970.00
8,970.00
0.90
1.25
64.48
120.00
8,785.52
32
Example 3: The Export of Garments
(with an export tax)
Financial
Price
FOB World Price of Garments
US Dollars
Local Currency @39 pesos per US Dollar
Less: Export Tax (5% of Price)
Price at the Port
CF at the Port
800.00
31,200.00
1,560.00
29,640.00
1.211
Conversion
Factor for
Nontradable
Services
Value
of
FEP
(15%)
Economic
Value
4,680.00
35,880.00
35,880.00
33
MEASUREMENT OF
ECONOMIC PRICES OF
NON-TRADABLE GOODS
34
Non-Tradable Commodities
• A good or service is considered non-tradable
when its domestic price is determined by local
demand and supply.
• An increase in demand (or supply) by a project
could affect the amounts demanded by
domestic consumers (or produced by other
suppliers).
35
Defining a Price of Non-Traded Good or Service
• Goods and services whose domestic production satisfies all the domestic
demand for these items and whose domestic prices are not affected by their
world prices are referred to as non-traded goods.
Price
S domestic supply
Em * PCIF * (1+Tm) + Fm
Distorted World
Supply Price
Domestic price Pm
Em * PFOB* (1-tx) - Fx
Distorted World
Demand Price
D domestic demand
Quantity
per year
36
Steps to Estimate the Economic Value of a
Non-Tradable Good or Service
1)
Adjust for distortions in the market for the item (whether
input to, or output of, the project).
2)
Adjustment for distortions in market where demand is
being diverted towards or away from (wd).
3)
Correct for distortions in the markets for the inputs used to
produce the item. Correction is applied to the proportion of
the item produced by other suppliers in the market (ws).
4)
Correct for the foreign exchange premium and the shadow
price of non-traded outlays (SPNTO) on tradable and nontradable components of the non-tradable good or service.
37
General Formula for the Estimation of the Economic
Prices of Non-Tradable Goods and Services
P W P W P
e
x
s
x
s
x
d
x
W P d
d
x
m
x
d
x
*
n
z


s
T
m
NT
s m
d m
 Wx ∑a xi  ( Pi d i )  ∑a xj W j Pj (d j  k j )  W j Pj d * 
 i 1

j 1
m
m
x
x


+TxP xFEP  NTxP xNTP
This formula can be used to estimate the economic price of a non-tradable
good, that is either an input used by a project or an output produced by it.
38
Step One: Adjusting for Distortions in the Market for
Good or Service
P  W P W P
e
x
s s
x x
d
x
d
x
39
Step One: Adjusting for Distortions in the Market for Good or Service
Economic Costs for Project Input
(Input production subsidized and a sales tax is levied on input)
S0
Pz
P1d=P1m (1+tz)
P1s=P1m/(1-kz)
P0d=P0m (1+tz)
P0s=P0m/(1-kz)
P1m
P0
B
C
S0+subsidy
M
L
G
R
N
J
U
H
D0
E
m
Dn+P
Dn
A
Q1 d
0
Q1 s
Q0
Financial Cost is P1m (Q1d-Q1s)
P  W P W P
e
Example
s
s
d
Q2 d
Economic Cost is
m
d
P
where, P 
1 k
s
Qz
Value of postponed Value of
consumption
additional
resources
Q1dMGQ0 + Q0RLQ1s
P  P (1  t )
d
1
m
1
s
s
Wxs = 0.25, Wxd = 0.75, P0 m = 90, t = 0.15, k = 0.4
P1s = 90/(1-0.4)=150, P1d = 90 (1+0.15) = 103, Pe = 0.25(150)+0.75(103) = 114
40
Step Two: Adjustment for distortions in
markets where diverted demand moves
W P d
d
x
m
x
*
41
Step Two: Adjustment for distortions in markets
where diverted demand moves
d
m
• Amount of diverted demand per unit is Wx Px
• Because of increased demand by our project, they will shift their
consumption to other goods and services. If these goods and services are
taxed at an average rate of d*, the additional taxes will reduce the economic
cost of good X.
• These additional taxes are denoted as W d P m d* and offset initial cost.
x
x
• The economic cost of the non-traded good X now becomes:
Pxe = Wxs Pxs + Wxd Pxd  Wxd Pxm d *
• We should note that the larger is the value of d*, the lower will be the
economic cost of a non-traded input used by a project, or the lower will be
economic benefit generated by the non-traded output of a project.
42
Step Three: Adjustment for Distortions (Tariffs, Excise Taxes and Subsidies)
in the Markets of the Inputs Used in the Production of a Non-Tradable Good
Economic Benefits of Project Output (No distortions on output but
input market distorted)
Price
S0
A
S0 + Project
C
P0m
G
P1m
F
E
B
D
D0
Q s Q0
1
d
Q1
QT
Quantity
Value of
Resources
Saved
Value of distortions
on inputs (taxes) no
resource value
Value of
Increased
Consumption
Economic Value
= WxsPs+WxdPd
If distortions on markets of input
then
Pd = Pm but Ps < Pm
43
Step Three: Adjustment for Distortions (Tariffs, Excise Taxes and
Subsidies) in the Markets of the Inputs Used in the Production of a
Non-Tradable Good
n
z


s
T
m
NT
s m
d m
 Wx ∑a xi  ( Pi d i )  ∑a xj W j Pj (d j  k j )  W j Pj d * 
 i 1

j 1


44
Step Three: Adjustment for Distortions (Tariffs, Excise taxes and Subsidies)
in the Markets of the Inputs Used in the Production of a Non-Tradable Good
(Cont’d)
•
WsPs might overstate or understate opportunity costs if there are taxes or subsidies on the
inputs.
Tradable Inputs
•
•
•
Suppose, in the production of good x, the market of one of its tradable inputs (i) is
distorted by an excise tax.
These taxes are not economic costs.
Need to adjust by  [W s aT ( Pmd )]
x
aTxi
xi
i
i
=
input-output coefficient showing the quantity of (distorted) input i
used in the production of one unit of x
m
P i = market price per unit of input i
di =
effective rate of tariff, excise tax or sales tax on input i
This correction is equivalent to substituting the economic values of the inputs (excluding
the adjustment for the FEP) for their financial values. The expression for this adjustment is
written in a more general form in terms of distortions di, as
 [Wxs aTxi (Pi mdi )] , di has a positive value if it represents an excise tax, sales tax, import
tariff or a negative value if the distortion is a subsidy.
45
Step Three: Adjustment for Distortions in the Markets of the Inputs Used in
the Production of a Non-Tradable Good (Cont’d)
Non-Traded Inputs
•
The fundamental objective is to remove any distortions associated with the non-traded
inputs j used to produce a non-traded good X.
•
Case I: Tax (dj) on non-traded inputs
In the case where there is just a tax on the purchase of input j, the financial cost of the
input will be Pjm(1+dj) and the economic cost [WjsPjm + WjdPjm(1 + dj - d*)] where dj is the
rate of tax on input j and d* is the average rate of indirect taxes on traded and non-traded
goods. In this case, Ps = Pm.
We wish to subtract the financial costs of input j from the supply price of X and then add
back j’s economic cost. The adjustment to the supply price of X for the distortions input j
is expressed as:


Wxs axjNT Pjm (1 d j )  [W js Pjm  W jd Pjm (1  d j  d*)]
Simplifying this expression, we have to do adjustment for this tax, dj, on j. Hence, the
value of the distortion cause by the tax adjustment is:

W P

 W xs a NT
W js Pjm  W js Pjm d j  W jd Pjm  W jd Pjm d j  W js Pjm  W jd Pjm  W jd Pjm d j  W jd Pjm d *
xj
 W xs a NT
xj
s
m
j
j

d j  W jd Pjm d *
46
Step Three: Adjustment for Distortions in the Markets of the Inputs Used in
the Production of a Non-Tradable Good (Cont’d)
• Case II: Subsidy (kj) and Tax (dj) on non-traded inputs
Suppose instead there is a tax on input of j and also a subsidy on
production of j. Hence, Ps = Pm (1 + kj) and Pd = Pm (1 + dj). The
adjustment will be:


Wxs a NT
Pjm (1 d j )  [W js Pjm (1 k j )  W jd Pjm (1  d j  d*)]
xj
Hence, the value of the distortion created by the tax and subsidy on nontraded input is:


s m
d m
Wxs a NT
xj W j Pj (d j  k j )  W j Pj d *
47
Step Three: Adjustment for Distortions in the Markets of the Inputs Used in
the Production of a Non-Tradable Good (Cont’d)
•
The distortion of tax and subsidy on non-traded input is:

Wxs  axjNT Wjs  Pjm (d j  k j )  Wjd  Pjm  d *

when, dj, a tax on non-tradable input, and d* are both positive that will
reduce the economic cost of the final non-traded good X but kj is a subsidy
on non-tradable supply of input j which is negative and will, thus, increase
the economic cost of the final non-traded good X.
• The expression summing up the distortions in the markets for traded inputs i
(=1 through n), and non-traded inputs j (= 1 to z) is as follows:
n
z


s
T
m
NT
s m
d m
 Wx ∑axi  ( Pi di )  ∑axj W j Pj (d j  k j )  W j Pj d * 
 i 1

j 1


48
Step Four: Adjust for Foreign Exchange Premium
on Tradable Components
• There will be a need to adjust the proportion of the tradable components (T)
of the non-tradable good by the foreign exchange premium (FEP). This is
expressed as follows:
– Value of foreign exchange premium (FEP), (FEP = Ee/Em - 1), on the
tradable good components of the non-tradable input
= [T  Pxm  FEP)]
where:
T = proportion of tradable good component of the non-tradable input (x) used
by the project expressed as a proportion of the financial market price Pxm
Pxm = market price per unit of output x
Ee = economic exchange rate
Em = market exchange rate
49
Step Four: Adjust for Shadow Price of Non-Tradable Outlays
(SPNTO)
• There will be a need to adjust the proportion of the non-tradable
components (NT) of the non-tradable good by the premium of non-tradable
outlays (NTP). [NTP = SPNTO – 1].
• This is expressed as follows:
Value of the NTP adjustment for the non-tradable component of the nontradable input
= [NT  Pxm  NTP]
where:
NT = proportion of non-tradable good component of the non-tradable
input (x) used by the project expressed as a proportion of the
financial market price Pxm
Pxm = market price per unit of output x
NTP = the premium on non-tradable outlays
50
General Formula for the Estimation of the Economic
Prices of Non-Tradable Goods and Services
P W P W P
e
x
s
x
s
x
d
x
d
x
 Wxd Pxm d *
n
z


s
T
m
NT
s m
d m
 Wx ∑a xi  ( Pi d i )  ∑a xj W j Pj (d j  k j )  W j Pj d * 
 i 1

j 1


m
+NT
*
P
+T * P * FEP
x * NTP
m
x
This formula can be used to estimate the economic price of a non-tradable good,
that is either an input used by a project or an output produced by it.
51
Economic Value of Increase in Quantity Demanded of an Input in the
Case of the Infinite Supply Elasticity
Price
- Example of Electricity Supply by Thermal Generation
Project demand (Q1 – Q0) of a non-tradable
Step 1
Ws = 1 and Wd = 0
If no direct subsidy then Ps = Pm
Ps=Pm
D0+P
D0
ΣiaxioPimdi
-
Q0
Q1
Step 2
With an infinite supply elasticity of electricity,
Wd = 0. There is no diverted demand from
other goods and services.
Quantity
Step 3
Need to adjust for input distortions. If supply of output is infinite elastic then supply of inputs must also be
infinite elastic (tradable good inputs). Estimation of value of input distortion = ΣiaixoPimdi where aixo is the inputoutput coefficient of the input, i, used to produce a unit of x, while Pim is the price of a specific input i, and di is
the tax wedge associated with the use of input i in the production of x.
Step 4
Need to adjust for foreign exchange premium (FEP) and premium on non-tradable outlays (NTP) on tradable
and non-tradable goods and services, respectively. Total costs of production made up with tradable inputs
proportion (Tx) and non-tradable inputs proportion (NTx). In the case of thermal electricity supply we would
expect Tx to be close to 1 and NTx to be quite small, where Tx + NTx = 1. Estimation of adjustments for
premiums = Pxm Tx FEP + Pxm NTx NTP
To summarize, the economic value of a unit of good x being demanded (or produced) by our project is equal to:
Pxm - ΣiaixoPidi + Pxm Tx FEP + Pxm NTx NTP
or,
Pxm [1 + (Tx  FEP) + (NTx  NTP)] - ΣiaixoPi di
Illustrative Example: Estimating the Economic Cost of a
Non-tradable Input
•
Assume that the market for clay bricks is competitive, the market price is
subject to a 14% excise tax and brick producers receive a 15% subsidy (k) on
their production cost.
•
Without the project, the quantity demanded and supplied in the market is 7
million bricks per month at a market price (Pmz) of R0.2 per brick.
•
Now introduce a project that requires 300,000 bricks per month.
•
Two of the inputs used in the production of bricks have distortions in their
markets: (1) Clay, a non-tradable good, has a 14% excise tax levied on its
market price (Pmclay) of R7 per ton, (2) Furnace oil, an importable good, has a
subsidy (koil) of 20% on its CIF price of US $240 per ton.
•
The input-output coefficient for furnace oil (Azoil) is 0.180 tons of oil per 1000
bricks and that of clay (Azclay) is 3.5 tons of clay per 1000 bricks.
53
Illustrative Example: Estimating the Economic
Cost of a Non-tradable Input (cont’d)
• The tradable, T, (proportion of the market price) and non-tradable, NT,
(proportion of the market price) good components of bricks are estimated
at 0.60 and 0.40, respectively, of the market price of bricks.
• The market exchange rate (Em) is R9.85 per US dollar, the economic
exchange rate (Ee) is R10.44 per dollar, NTP is 1%, and the weighted
average rate of indirect taxes on traded and non-tradable goods and
services (d*) is 9%.
54
Prices, Relative Supply and Demand Weights, and Tradable
and Non-Tradable Components for Brick Production
Price Estimation
Pmz = R0.2
Psz = Pmz / (1 - zk) = 0.2 / (0.85) = R0.2353
Pdz = Pmz  (1 + excise tax) = 0.2 (1.14) = R0.2280
• Assigning a weight of 0.67 to the supply side (Wsz) and a weight of 0.33
to the demand side (Wdz) and seems plausible.
• Pe = 0.33 * 0.2280 + 0.67 * 0.2353
55
Adjustment for distortions in markets for bricks and where
the diverted demand moves :
•
On the demand side, the tax on good tz, that other demanders will not be
paying because they are now buying other goods is partially offset by the
taxes they will now pay d*.
•
Hence, the opportunity cost of the forgone consumption of others is equal to,
Pzm [1 + (tz – d*)]
where tz is equal to excise tax, 14%.
d* is the weighted average rate of indirect
taxes on traded and non-tradable goods
and services, 9%.
The net adjustment is:
- Pzm d*
= - 0.2 x 0.09
= - 0.0180 R/brick
56
Estimating the value of the distortion per ton of
furnace oil (Tradable component)
Pimdi
= CIF Price  Em  (-k)
= 240  9.85  (-0.2)
= -R 472.80 per ton
aoilkPimdi (the value of the distortion per brick)
= aoilz* (-472.8/1,000)
= - 0.18 *0.4728
= - 0.085 R/brick
57
Estimating the value of the distortion per ton of Clay
Pmclay * aclayz [Wsclay(dclay – kclay) + Wdclay d*]
= 7 * 0.0035 [0.67 * (0.14 – 0) + 0.33*0.09]
= 0.0245 (0.0938 + 0.0297)
= 0.0245 (0.1235)
= 0.0030 R/brick
58
Estimating the Economic Price of Brick
P ze
= Wzs Pzm/(1-kz) + Wzd Pzm [1 + (tz – d*)]
- Wzs{ΣiaizoPmi di + Σjajzo[WjsPmj(dj – kj) + WjdPmj d*]}
+ Pzm  Tz  FEP + Pzm  NTz  NTP
= 0.67 (0.2353) + 0.33 (0.2280 – 0.0180)
- 0.67 (-0.085 + 0.0030) + 0.2 (0.60)(0.06) +0.2 (0.40)(0.01)
= 0.2270 + 0.0549 + 0.0072 + 0.0008
= 0.2899 R/brick
59
Conversion Factor for Bricks
• To estimate the commodity specific conversion factor for
bricks used by a project (CSCFdz), we divide the economic
price by the financial demand price.
• Recall that the demand price is inclusive of the excise tax.
CSCFdz = Pez / Pdz
= 0.2899/ 0.228
= 1.2715
60
SPECIAL NOTE:
Adjustment for VAT in the Markets of the Inputs Used in the Production of a
Non-Tradable Good
Final Good X Subject to VAT or Zero Rated
•
If final good X is subject to VAT or Zero Rated, then VAT paid on purchase of inputs can
be taken as a credit against tax owed on sale of output or refunded if zero rated when
final product is exported.
•
The line item in the financial analysis reporting the net VAT payments to the government
(or refunds of input taxed received from the government on exports) will have a
conversion factor of zero.
•
In calculation of conversion factors the financial price of the items include the VAT in
the financial values.
Final Good X Exempt from VAT
•
If the final good X is exempt from the VAT, the value added tax paid on the inputs will
have to be taken into account in deriving the economic value of output because no credit
is possible against the tax on the sales of final good, because there is no tax liability.
•
The rate of VAT on the price of input i would have to be estimated tvi. The amount of
adjustment to WxsPxs is - Wxs(ATxiPim tiv) for the economic analysis.
•
This is the identical treatment to the case of any excise tax, sales tax or import tariff on
an input. When these taxes are not used as a credit to offset any indirect taxes owed on
the sales of final good or service.
61