Unit 3 (cont.):
Economic Analysis—
Cost-Benefit Analysis 1
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Meaning of Cost-Benefit
Analysis
What is Cost-Benefit Analysis?

Meaning of Cost-Benefit Analysis
Definition:
 “… is a useful approach to assess whether
decisions or choices that affect the use of
scarce resources promote efficiency…
[The] analysis involves systematic
identification of policy consequences,
followed by valuation of social benefits
and costs and then application of the
appropriate decision criterion” (Fuguitt &
Wilcox, 1999: 35).
Meaning of Cost-Benefit
Analysis
Entails comparison of costs & benefits of a
single project or alternative projects
 NOT just about financial analysis of
revenues and expenditures but “social’’ costs
and “social” benefits
 —the gains and losses of a project as viewed
from the standpoint of society as a whole
 It is used to inform decisions

Meaning of Cost-Benefit
Analysis
Where in the Project Life
Cycle do we Need to do
Cost-Benefit Analysis
(CBA)?

Who does Cost Benefit
Analysis?

Who does Cost Benefit Analysis?
Government—its goal is to promote public
interest and increase social welfare
 Private corporations—some private
decisions have social goals in mind; or
government may demand it
 Non-profit organizations—most of them
have social goals or depend on public funds
(e.g. environmental NGOs)

Examples of Areas Where CBA
can be Applied
Water resource projects
Transportation projects
Education programs
Pollution control projects
Endangered species preservation
Etc, etc, etc

What is the main rationale
behind Cost-Benefit Analysis as
a decision-making tool?
What is it intended to achieve?

Rationale for Cost Benefit
Analysis
EFFICIENCY is at the heart of CBA
 whether benefits derived are worth the costs
 used to identify most EFFICIENT alternative
What is Efficiency?
 option that yields the most outputs for a given
amount of inputs
 used as basis for economically rational
allocation of scarce resources
Meaning of Costs and Benefits
What is Cost?
the opportunity cost of all resources to be
used for a project
Opportunity cost = the value that
would have been derived from these
resources had they been allocated to the
next best alternative foregone
Meaning of Costs and Benefits
Benefits
positive outcomes of a project
manifestations of project objectives,
plus unintended positive consequences

Meaning of Costs and Benefits
What are Disbenefits?
undesirable (negative) consequences
(disadvantages) suffered by society or
a section of society as a result of a
project, e.g. economic losses, pollution,
nuisance, etc
usually unintended outcomes
“With & Without” vs“ Before & After”
CBA deals with incremental benefits and
incremental costs
 not a before-and-after analysis: i.e. not estimation
of difference in costs and benefits b/n the time
before (baseline scenario) and the time after the
project
 Incremental benefits = (benefits with the
project) minus (benefits without the project)
 Incremental costs = (costs with the policy)
minus (costs without the project)

Basic Steps of CBA
Define alternatives to be evaluated
 Identify all expected social costs and social
benefits
 Value social benefits and costs in monetary terms
 Determine appropriate CBA decision criterion(a)
 Assess alternatives based on CBA decision
criteria chosen
 Describe consequences that can not be valued in
monetary terms
 Report results for consideration by decision
makers

Decision Criteria in Cost-Benefit
Analysis
Three common CBA-based decision
criteria:
1. Net Present Value (NPV)
2. Cost-Benefit Ratio (CBR)
3. Internal Rate of Return (IRR)
a discount rate such that NPV = 0
Desirable if IRR > actual discount rate
 WHY?
