Valuation of indirect effects:
primary and secondary markets
ECON 4140
Notes from Boardman et al Cost-Benefit Analysis,
(4 ed) Prentice Hall
The issue
• In principle, for every primary market - the sector with the
intervention (e.g., transportation, health, recreation) there may be
one or more secondary markets that experience positive or negative
effects.
– Development of a recreational fishery in a park may stimulate
the demand for sports supplies, sales of boats, hotels, guide
services, etc.
– Using pharmacies for vaccination can stimulate collateral sales
– Transit improvements will change land values (rising close to
stations) and perhaps falling (relatively further away).
• Partial equilibrium often uses a primary/secondary market model to
trace the impact of investments
• In principle, many secondary markets exist… in practice CBA only
tracks those with the largest measureable net impact
• A computable general equilibrium model is ideal, but very costly
(data and model intensive) (see Layman article under Lecture 5)
Partial equilibrium analysis
• All primary market effects must be included
• Secondary effects can be ignored when the when the marginal
social benefit equals the marginal social cost.
• This typically occurs when secondary markets are competitive
– The purchases in the primary market will not alter supply, and therefore will not
change prices.
– If the project is small, secondary impacts will also be small, and can usually be
ignored
• Usually, a few secondary markets can be identified, analyzed
sequentially and summed as a group.
• A key challenge is to avoid double counting
– Transit improvements will lower travel time (cost) and also result in changes in
land values (count only 1)
– Vaccination reduces time lost from work (measured as the avoided time lost
multiplied by the wages) and increased produce of producers.
Special case: sometimes it is hard to value a primary effect, and we may
need to resort to measurement of the corresponding secondary effects.
Valuation in secondary markets (complements) –
efficient markets
Primary markets are directly affected by the
program/policy (hiring of labour, materials..)
Secondary markets are indirectly affected by the
policy/program.
Example: Stocking the nearby lake with fish
lowers marginal cost and number of days fishing
increases with an increase in social surplus.
Price for fishing falls to PF1 (primary market) and
this raises demand in the fishing equipment
market (DE0 to DE1)
• Under efficient secondary markets
(competition), price will not rise, and
producer surplus is not affected.
• But consumer surplus increases in the
secondary market, which we cannot
count since it has already been measured
in the primary market
• We cannot count the increase in the
primary and secondary markets…
• … as long as prices do not rise in the
secondary market.
We can ignore secondary markets when we measure all primary impacts and prices in
secondary markets do not change as a result of the program/policy/project.
Ps
Pp
Po
ΔP
S
a
b
D1
D0
0
ΔX
Xp
0
X0
Xs
Valuation in secondary markets (substitutes) – upwars
sloping secondary supply
Primary market
(Fishing)
Secondary market
(Golf)
• The increase in demand for fishing days raises
surplus by PF0abPF1 (initially)
• If fishing and golf are substitutes, the demand for
golfing will fall and green fees for golfing will fall.
• The falling price of green fees increases consumer
surplus (PG0efPG1)
• In turn, the lower green fees with reduce the demand
for fishing (DF0  DF1) \
• D* shows the observed demand and represents a
lower consumer surplus associated with the increase
in fish stocks because of the reaction in the golf
market. Consumer surplus in the primary market is
PFIacPF1.
• The argument is tricky since the two figures show a
series of interactions over time.
Therefore, D* is the curve more likely to be used
in a CBA. This curve, however, understates the
true measure of the gain in social surplus in the
primary market. But this understatement is a
close approximation of the net loss of social
surplus in secondary markets due to price
changes.
Indirect Effects
T

t 1
n
( pij  cij )( x1 jt  x0 jt ) ( pij  cij )( x1 jt  x0 jt ) / (1  i)t
j 1
The first term in the numerator (pij-xij) is the difference of price and
marginal cost in the primary market; the second term is the change in
quantity produced in the secondary market as a result of the changed
demand from the primary market. This change can be positive or
negative.
( p  c)( x1  x0 )  ( p  c)(x)
Valuation in distorted secondary markets
When market failure creates a divergence of private
and social cost, valuation impacts in secondary
markets is tricky.
EXTERNALITY
These distortions appear as a hidden extra cost
over price. In a competitive secondary market the
horizontal supply rises
The increase in the indirect demand for equipment
creates a total cost of the change in price (x) times
the change in demand (qE0 – qE1). Imagine the
equipment comprises lead sinkers that end up
contaminating the lake.
The cost of the externality (lead in the lake) should
be subtracted from the net benefits of the project.
This appears as the shaded area
Effect of taxes on substitutes
•
Beef
Chicken
•
•
•
•
•
•
•
Beef (primary) and chicken (secondary) are
substitutes. (Asymmetric substitution)
In equilibrium, assume PB and PC are the relevant
prices and demand DB0 and DC0 for beef and
chicken respectively
First , if there is an existing tax on chicken of tc →
price rises to P+tc yielding revenue of T for the
government and T+U in loss of consumer surplus
for chicken eaters. Note deadweight loss of U.
Second, if beef is now taxed by tB , price of beef
rises and the demand for chicken rises, reducing
consumer surplus by A+B
The deadweight loss in the chicken market is now
U+V
The shift in chicken demand is not an increase in
consumer surplus in the secondary market.
All the change in surplus occurs in the primary
market, while tax revenues increase in both
markets.
You need to start with a designation of primary and
secondary markets.
Boardman, A. et al Cost-benefit analysis, concepts and practice,
(4ed) Prentice Hall, p.124