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Updated:09/03/2007
Lecture Notes
ECON 622: ECONOMIC COST-BENEFIT ANALYSIS
Lecture 4
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ECONOMIC VALUATION
OF TRADABLE GOODS &
SERVICES
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Tradable Commodities Classification of a Project’s Inputs and Outputs
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
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Measuring the Economic Values of Tradable Goods: Four Cases
1. Economic value of importable good production
2. Economic cost of importable input
3. Economic cost of exportable input
4. Economic value of export production
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Importable Good
Distorted World Supply Price
Price
QQuantity per year
Domestic Supply
Domestic DemandD
S
Em * PCIF * (1+Tm) + Fm
do
so Q
Pm
Imports = Q - Q
Em = Market Exchange Rate
Tm = Rate of Import TariffFM = Domestic Freight to Market
so
do
PCIF = Price of imports at entry point to country, including international freight
and insurance charges expressed in units of foreign currency
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Project Supplies More of an Importable Good
Project reduces quantity imported. No change in domestic consumption.
Price
Quantity
S domestic
S w/ project
Qs0 Qs
1 Qd0
D domestic
S worldEm * PCIF* (1+Tm) + Fm
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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], or [(Ee/OER) - 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.
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Visayas Communal Irrigation ProjectBasic 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 480.910 million pesos (US$19.78 million).
• The project will be financed with US$15.1 million loan from the International Fund for
Agricultural Development, and remaining funding would be provided by the Philippine
government.
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Table 1: Project Supplies an Importable Good (Rice)
Financial Tradable Non-Tradable EconomicPrice
AdjustmentFor Taxes
Adjusted Value Content Content Value
(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)CIF World (US$) 314.8CIF per metric ton of rice 7659 1 7659 100% 0% 1884 0.00 9543PLUS
Transportation and Handling Charges 205 1 205 30% 70% 15.13 1.44 222Trading Margin 472 0.68 321 10% 90% 7.90 2.89 332
Wholesale Price in Manila 8336 8185 10096
LESSTransport cost, rice mill to Manila 515 1 515 30% 70% 38 3.61 557
Ex-mill price of rice 7821 9540LESS
Net milling cost 346 1 346 50% 50% 43 1.73 390Pre-milled value 7475 9150
Palay equivalent (65%) 4859 5947LESS
Grain dealer margin (4% margin) 194 0.68 132 10% 90% 3 1.19 137Transport and handling cost, farm to mill 130 1 130 30% 70% 10 0.91 141
Farmgate price of palay 4534 5670
Conversion Factor 1.25
Value of Forex
Premium
Value of SPNTO
Premium
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Measuring the Economic Values of Tradable Goods: Four Cases
1. Economic value of importable good production
2. Economic cost of importable input
3. Economic cost of exportable input
4. Economic value of export production
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Project Demands More of an Importable Good
Project requirements will be met by additional imports (world supply). Domestic consumption is not affected.
Price
Quantity
S domestic
Qs0 Qd
0 Qd1
D domestic
D w/ project
S worldEm * PCIF * (1+Tm) + Fm
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Project Purchases Importable Inputs
Input subject to Import Tariff
Financial cost is EmPw (1+t) (Q1d-Q0
d)
Economic cost is EmPw(Q1d – Q0
d) + Foreign exchange premium
World Supply
Qs0
Price
Pd Pw(1+t)
Pw
S0
Quantity
World Supply After Tariff
D0 D0+P
0 d1QQd
0
= Em
Em
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Quantity of units per year (000’s)
D0
E
0
Price / unit
G
S0
A
B
C
F
D1
S0Q
d0Q
d1Q
(cif)=P1
(P1+tariff)=P2
(P2+trade margin)=P3 (P3+freight)=P4
L M K J
H I
Economic cost of Importable Goods: With Tariff, Trade Margin and Domestic Freight
Em
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Table 2: Project Uses an Importable Good (PESTICIDES).
Financial Adjustment TradableNon-Tradable EconomicPrice For Taxes
Adjusted Value Content Content Value
(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)
CIF World (US$) 166
CIF per 1000 liters of pesticides 4038 1 4038 100% 993.35 5031PLUS
Tariff 201 0 0 0% 0.00 0Port charges, handling and transportation to Manila
155 1 155 30% 70% 11.44 1.09 168
Importer Price, Manila 4394 5199
PLUSTransport cost, Manila to local market 515 1 515 30% 70% 38.01 3.61 557Dealer's margin 201 0.68 137 10% 90% 3.36 1.23 141
Price at local market 5110 5897
PLUSLocal transport cost 120 1 120 30% 70% 8.86 0.84 130
Price at farm gate 5230 6026
Conversion Factor 1.15
Value of Forex
Premium
Value of SPNTO
Premium
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Measuring the Economic Values of Tradable Goods: Four Cases
1. Economic value of importable good production
2. Economic cost of importable input
3. Economic cost of exportable input
4. Economic value of export production
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Exportable Good
Quantity per year
Distorted World Demand Price
Price
Q
Domestic Supply
Domestic DemandD
S
Em * PFOB * (1-tx) - Fx
do
soQ
Pm
Exports = Q - Q
Em = Market Exchange Rate
tx = Export Tax
Fx = Freight and Trading Costs to Port
do
so
PFOB= Price of exports at point of export from country in units of foreign currency
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Project Demands More of an Exportable Good
Project requirements will reduce quantity exported. Consumption of previous consumers remains unchanged.
Price
Quantity
S domestic
Qd0 Qd
1 Qs0
D w/ ProjectD domestic
D worldEm * PFOB * (1-tx) - Fx
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Table 3: Project Uses an Exportable Good (Seeds)
LESS
Financial Tradable Non-Tradable EconomicPrice Content Content Value
(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)FOB per ton of PADDY SEED (pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882
Port Handling and Transportation 155 1 155 30.00% 70.00% 11.44 1.09 168From IRRI to port of Manila
IRRI Exporter Price 6171 7715PLUS 0.00 0.00
Transport Cost, IRRI to local market 515 1 515 30.00% 70.00% 38.01 3.61 557Dealer's margin 235 0.68 160 10.00% 90.00% 3.93 1.44 165
Price at Local Market 6921 8436PLUS
Local transport cost fromMarket to farm (Project site) 120 1 120 30.00% 70.00% 8.86 0.84 130
Price at Farm Gate 7041 8566
Conversion Factor 1.22
AdjustmentFor Taxes
Adjusted Value
Value of Forex
Premium
Value of SPNTO
Premium
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Measuring the Economic Values of Tradable Goods: Four Cases
1. Economic value of importable good production
2. Economic cost of importable input
3. Economic cost of exportable input
4. Economic value of export production
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Project Supplies More of an Exportable Good
Project increases exports. Domestic consumption remains unchanged.
Price
Quantity
S domestic
S w/ Project
Qd0 Qs
0 Qs1
D domestic
D world Em * PFOB * (1-tx) - Fx
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Project Produces Exportable Goods subject toExport Tax (No domestic transportation costs)
Pd = Pw(1-t)
Pw World Demand
Price
Quantity
S0+P
D0
World Demand After Export Tax
S0
0 d0Q s
0Q s1Q
Financial benefit is EmPw (1-t) (Q1s-Q0
s)
Economic benefit is EmPw(Q1s – Q0
s) + Foreign exchange premium
Em
Pd=EmPw(1-t)
Economic values of exportable goods are based on the FOB values of demand for exports
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Table 4: IRRI Supply an Exportable Good (Seeds)
Financial Tradable Non-TradableEconomic
Price Content Content Value
(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)
FOB Port (US$) 260FOB Port (Pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882
LESSPort Charges and transportation 155 1 155 30.00% 70.00% 11.44 1.09 168from IRRI to Port
IRRI Gate Price 6171 7715
Conversion Factor (EV/PV) 1.25
AdjustmentFor Taxes
Adjusted Value
Value of Forex
Premium
Value of SPNTO
Premium
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SUMMARY
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 Cost of Imported Input = CIF (adj. For Economic Exchange Rate) + Economic Cost of Freight from Port to
Project
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
Economic Value of Exportable Production = FOB (adj. For Economic Exchange Rate) - Economic Cost of Local Freight from
Project to Port