Lecture 11

Evaluating Trade-Offs: Benefit–Cost Analysis and Other Decision-Making Metrics

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

September 20, 2024

Benefit–Cost Analysis and Other Decision-Making Metrics

Issues in Benefit Estimation

Primary vs. Secondary Effects

  • Environmental Projects: Often produce both direct and indirect impacts.
  • Primary Effect: Direct outcomes (e.g., increased recreational use of a cleaned lake).
  • Secondary Effect: Ripple effects (e.g., more services or businesses due to increased visitors).
  • Should Secondary Effects Be Counted?
    • Yes: If they lead to new employment using previously unused resources (e.g., labor in high-unemployment areas).
    • No: If they merely shift resources without creating additional employment.
  • Key Consideration: Secondary benefits are more significant in areas with underutilized resources or high unemployment.

Issues in Benefit Estimation

Accounting Stance

  • Definition: The geographic scope where benefits and costs are measured.
  • Local vs. National Impacts:
    • A project may benefit a local region but might not be justifiable when national costs are considered.
  • Example:
    • Federal government funds a project; benefits are localized, but costs are borne nationally.
    • Project appears beneficial locally but may not be efficient from a national perspective.

Issues in Benefit Estimation

What Is the Proper Geographic Scope for the SCC?

  • Proponents of the Global Metric:
    • Climate change is a global issue; damages should be assessed globally.
    • The global metric reflects reductions in U.S.-caused damages to other countries.
    • Reducing harm to others differs morally from providing goods or services for their enjoyment.

Issues in Benefit Estimation

What Is the Proper Geographic Scope for the SCC?

  • Critics of the Global Metric:
    • Estimate should include only damages to the U.S.
    • Including global damages could impose costs on U.S. citizens for benefits abroad.
  • Proposed Solution:
    • Use both U.S.-only and global metrics in analyses for a comprehensive view.

Issues in Benefit Estimation

Aggregation

  • Challenge: Aggregating benefits and costs across different populations and regions.
  • Variation in Benefits:
    • Those closer to the project may receive more benefits than those farther away.
  • Consideration:
    • Accurate aggregation should account for these differences to reflect true impacts.

Issues in Benefit Estimation

With and Without Principle

  • Core Principle: Only include benefits that directly result from the project.
  • Avoid Overstatement:
    • Exclude benefits that would occur even without the project to prevent inflating its value.

Issues in Benefit Estimation

Tangible vs. Intangible Benefits

  • Tangible Benefits:
    • Assignable monetary value (e.g., job creation, increased revenue).
  • Intangible Benefits:
    • Harder to quantify due to measurement challenges (e.g., improved quality of life).
  • Approach:
    • Do not ignore intangible benefits.
    • Use sensitivity analysis to assess their impact on outcomes.
    • If results are sensitive to these benefits, they should be carefully considered in decision-making.

Approaches to Cost Estimation

Overview

  • Estimating Costs vs. Benefits:
    • Cost estimation is generally easier but still challenging.
    • Projecting future costs adds complexity compared to evaluating current costs.

Approaches to Cost Estimation

1. The Survey Approach

  • Method:
    • Ask those who bear the costs (e.g., polluters) to estimate and report them.
  • Advantage:
    • Leverages direct knowledge from those familiar with the costs.
  • Problem:
    • Incentives for overestimation to influence less stringent regulations.
    • Potential unreliability due to biased reporting.

Approaches to Cost Estimation

2. The Engineering Approach

  • Method:
    • Use engineering data to estimate costs for a “typical” firm.
  • Assumption:
    • Firms will choose cost-minimizing technologies.
  • Advantage:
    • Independent estimation avoids biases from regulated entities.
  • Problem:
    • May not reflect actual costs for firms with unique circumstances.
    • The “typical” firm scenario may not capture all variations.

Approaches to Cost Estimation

3. The Combined Approach

  • Method:
    • Combines survey and engineering approaches.
  • Process:
    • Survey: Collects information on technologies and specific circumstances.
    • Engineering: Applies this data to estimate actual costs.
  • Advantage:
    • Balances detailed information with independent analysis.
    • Provides a more comprehensive cost estimate.

Approaches to Cost Estimation

Challenges in Cost Quantification

  • Quantifying Non-Tangible Costs:
    • Difficult to assign monetary values to some costs (e.g., time, environmental quality).
  • Example:
    • Estimating the cost of increased travel time due to carpooling policies.
  • Approach:
    • Use opportunity cost to value time.
    • Travelers often value travel time at up to half their wage rate.

Approaches to Cost Estimation

Key Takeaways

  • Trade-offs and Accuracy:
    • Each method has advantages and limitations in accuracy and potential bias.
  • Combining Methods:
    • Mitigates individual shortcomings.
    • Requires careful consideration of specific contexts and future uncertainties.