E. Eide – Day 54.8 Cost-benefit analysis (CBA)

• Usually applied to evaluate a single (or a restricted number) of alternatives

• Kaldor-Hicks-criterion: A rule (or project) that produces enough benefits on the part of the winners such that losers may be compensated should be accepted

• CBA is the practical application of the Kaldor-Hicks (K.-H.) criterion.– The sum of all costs and benefits of a rule or a project is calculated– The rule or the project is accepted if the sum is positive

• CBA is (not more than):– Comprehensive analysis of consequences– (i) systematic listing of consequences of a decision– (ii)evaluation of the consequences, using money as a measuring rod as far

as possibleMD/ELE/H12 Day 4 1

4.8.1 Procedure of Cost-benefit analysis (CBA)

• Step 1. Denition/description of rule (or project)• Step 2. Listing of consequences• Step 3. Which consequences are relevant for income and welfare• Step 4. Measuring of consequences in physical terms• Step 5. Evaluation of consequenses in money terms (using market

prices and wilingness to pay) • Step 6. Calculation of present value of costs and benefits• Step 7. Use the present value criterion. (Accept if positive)• Step 8. Analyses of sensitivity (To which extent is the result

dependent on various assumptions)• Step 9. Introduce weights to various benefits and costs in order to

take distribution into account• Step 10. Describe all factor that have not been included in the

calculation

4.8.2 Questionable assumptions of CBA

(i) Money, at the margin, has the same utility for everybody

(ii) (iii) Benefits and costs are measurable in money terms• Benefits = damage costs avoided

• However, in absence of weighing costs and benefits:• Inefficiency (waste of resources) obtains

– Stupid?– Irresponsible?– Immoral?

MD/ELE/H12 Day 4 3

4.8.3 John F. Morrall III, Saving lives: A review of the record,

27 The Journal of Risk and Uncertainty, 3, 221-37 (2003).

• Study of 76 regulatory actions, not based on CBA, in the USA 1967-2001

• Morall III calculated – the costs of reducing safety risk implied by these regulations– The opportunity costs of saved statistical lives (i.e. the value of the

resources used to reduce the number o0f deaths)

• Dramatic differences in opportunity costs– $ 0.1 for regulation of childproof lighters– $ 100 000 million for the 1991 regulation of solid waste disposal

• Using a value of statistical life of $7, about 42 % of the regulations did not pass the CBA test.

4.8.4 Reasons for using the K-H criterion despite of deficiencies

• (i) Administration of compensation too costly (in particular collection of information)

• (i) In the long run for each individual the sum of costs and benefits of various rules and projects are positive

• (iii) Taxes and subsidies may improve inequality