F.  Cost-Benefit Analysis

• Attempt to monetize all costs and benefits of a proposed action to determine the net benefit

Ex. - Higher ozone standard saves 5,000 lives but costs $16 billion

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1.  Steps

a.  List all the costs and benefits of a proposed action

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b.  For costs and benefits measured in monetary units, obtain reliable estimates

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c.  For costs and benefits not ordinarily measured in monetary units, such as human health or ecosystem impacts, use nonmarket valuation techniques to obtain estimates

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d.  If actual nonmarket values cannot be estimated due to budgetary or other constraints, consider transferred values or expert opinions

• Benefit transfer - use similar studies to estimate benefits and/or costs

• Less costly and less time consuming

Ex. - Arsenic in drinking water (2001) - chronic bronchitis used as a proxy for nonfatal bladder cancer

Ex. - Oil spill off Rhode Island (1996) - use impact of an oil spill off New York

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e.  Add up all the costs and all the benefits, preferably under a range of plausible assumptions or scenarios

• Sensitivity analysis - examine impact if assumptions made change

- Most common is to change discount rate

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f.  Compare total costs to total benefits to obtain a recommendation

(1) Net benefits

• Total benefits minus total costs

• Understake project / program if net benefits > 0

• Use when budget is unlimited

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(2)  Benefit-cost ratio

• Total benefits / total costs

• Consider project / program if benefit-cost ratio > 1

• Choose project / program with highest benefit-cost ratio if budget is limited

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2.  Present value and the discount rate

• Money in the current period is worth more than in the future

- Inflation

- Returns from investment

- Uncertainty about the future

- Impatience

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a.  Present value

• Current value of future benefits and costs

• Discounting - benefits and costs in the future should be assigned less weight than benefits and costs in the current period

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• Present value is affected by the discount rate

- Higher discount rate => less weight on future

- Lower discount rate => more weight on future

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b.  Determining the discount rate

(1)  Use return on low-risk investments like government bonds

• Represents opportunity cost of spending money now

• Can vary over time

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(2)  Social discount rate

• Also known as social rate of time preference (SRTP)

• Pure rate of time preference - preference to obtain benefits now as opposed to the future

• People will be richer in the future, monetary impact is not as great

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• Office of Management and Budget (OMB) uses a discount rate of 7 percent for federal projects

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3.  Valuing human life

• Most controversial topic

• Value of a statistical life (VSL) - willingness to pay of society to avoid one death

- Based on changes in the risk of death

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a.  Contingent valuation

• Use survey to determine willingness to pay

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b.  Wage-risk analysis

• Determine wage premium necessary to attract people to higher risk jobs

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c.  Issues

(1)  VSL lower in developing countries

(2) People who take risky jobs are not representative of general population

• More accepting of risk

• Men more likely

(3)  May not be appropriate to use same VSL for different policies

Ex. - Cancer from pollution vs. nuclear accident

(4)  Ethical considerations

• Human life inherently priceless, shouldn't put numerical value on it

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4.  Risk and uncertainty

• Risk - variability or randomness that can be quantified

• Uncertainty - outcomes are unknown or can't be quantified

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a.  Expected value

• Weighted average of potential values

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b.  Risk aversion

• Prefer certainty instead of risky outcomes

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• Precautionary principle - avoid low-probability but catastrophic events

• Safe minimum standard - set standard to avoid possible catastrophic consequences

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5.  Example

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6.  Alternative approaches

a.  Cost effectiveness analysis

• Determine least-cost way to achieve a policy goal

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b.  Positional analysis

• Combines economic valuation with other considerations - equity, individual rights, social priorities

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