E. Eide – Day 5
4.8 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 possible
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4.8.1 Procedure of Cost-benefit analysis (CBA)
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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?
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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