COST BENEFIT ANALYSIS
The fundamental concepts
1. BENIFITS AND COSTS
2. SOCIALLY DESIRABLE CHANGES
2.1 DAP and DAA
2.2 Net benefits
2.3 DAP and surplus of the user
2.4 Compensations and improvement
3. THE FUNDAMENTAL RULE
4.TEMPORAL PREFERENCE
4.1 Discount and actual value
4.2 VAN
4.3 The fundamental rule modification
5. THE COST RAPPORT – BENEFIT
COST- BENEFITS ANALYSIS
Based on the individual behavior, there is a
tendency to act in a way to maximize the
net BENEFIT of an action, or the difference
between the profit and the applied cost
Cost- benefit analysis
tries to extend this logic
of reasoning to
the whole society.
It is profit
What satisfies a wish motivated
by individual preference.
The intensity of the individual
preference for a product
is measured by
AVAILABILITY TO PAY (DAP)
to get the product.
The intensity of the individual non –
preference is measured by the availability
to pay not to have the product or from it
AVAILABILITY TO ACCEPT (DAA )
a compensation
Therefore:
To get a BENEFIT
To bear a COST
DAP
DAA
The passage from a situation to another is socially
acceptable if the sum of the paying ability of the
interested person overcomes that of the
individuals that are harmed from it
Important:
It is remarkable
The maximum DAP
While it is remarkable
The minimum DAA
P
P
q
The DAP overcomes the real payment in presence of
a consumer SURPLUS
If really the damaged objects are
compensated from those beneficiary on the
basis of the DAP and DAA, an improvement
will be realized for all
FUNDAMENTAL RULE OF
COST – BENEFIT ANALYSIS
A change is socially desirable if the
social net benefit calculated as
addition of the individual net benefit
is positive
To keep track of the time
preferences
For many, the today’s EURO
is better than tomorrow’s EURO!
The costs are produced today and the benefits
tomorrow, a positive net benefit could not be
attractive…
Now to DISCOUNT costs and benefits
according to their temporal position.
How much does
one EURO be in 5 years?
If we invested a sum X to the annual rate X,
after 5 years it would be 1 EURO if
And therefore =
The recent value of a sum M in T
years
is therefore
Where R is the rate of annual interest
The recent value of a profit B in
the time T is therefore
While the recent value of a cost C
in the time T is
The calculation of the Net profit
must take care of the discount
relative to every period:
The recent value of a profit / cost is very
small as more as it is distant in the time!
MODIFIED FUNDAMENTAL RULE
A change is socially desirable if its net
RECENT VALUE
(VAN, or benefit –costs discounts)
is positive.
MODIFIED FUNDAMENTAL RULE
If more alternative projects have a
positive VAN, it is opportunity to
choose that with the most
elevated VAN