Abstract
This chapter constitutes a survey of economic measurement and social cost-benefit analysis. Economic analysis employs many of the same criteria as financial analysis to determine whether a project or activity is worth undertaking – net present value (NPV), the benefit-benefit ratio (B/C) and internal rate of return (IRR). The main difference relates to what is counted. Economists measure net benefits as surpluses, namely, consumer surplus, producer surplus (or quasi-rent), and differential and scarcity rents. These measures are described in detail, as are techniques (e.g., hedonic pricing, contingent valuation) for measuring non-market or environmental costs and benefits that accrue to citizens and need to be included in a social evaluation of a policy or project. As discussed in this chapter, environmental costs and benefits can be significant and their measurement controversial, and sometimes incorrectly applied. Since costs are incurred and benefits accrue at different times, an aggregation of costs and benefits requires that they be discounted to the present period (or compounded to a common future time) using a discount rate. The controversy as to which discount rate (or rates) is most appropriate to use is examined. Finally, the precautionary principle for addressing extreme events and the possibility of irreversibility is discussed; indeed, a precautionary approach is evident in some cost-benefit analyses of anthropogenic global warming through assumptions of an extremely low discount rate, a high probability of catastrophic future damages, and very low costs of immediate mitigation (as discussed further in Chap. 7).
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- 1.
Of course, the supply/marginal cost function is much flatter before the project is built than afterwards. Once the project is built, the construction cost is ignored in the determination of quasi-rent, as bygones are bygones.
- 2.
Consumer surplus is not the theoretically correct measure in the case of non-market environmental amenities; rather, the correct measures are compensating and equivalent surplus (variation). A clear discussion is found in van Kooten and Folmer (2004, pp.13–25).
- 3.
For marginal agricultural land that provides wildlife habitat benefits and visual amenities, OV and TNUV (total non-use value) are measured using a contingent valuation device (see next section), while QOV can be determined using stochastic dynamic programming, for example, as demonstrated by Bulte et al. (2002) for the case of forest protection in Costa Rica.
- 4.
This is the difference between the area under MC (total costs) and that under MB (total benefits) between gE and g*. It is the net social cost (negative benefit) of providing g* of the environmental amenity.
- 5.
The term environmental amenity is used in a generic sense to refer to any good or service that is unpriced or priced well below its marginal cost of provision, whether that is wildlife habitat, water/air quality, wilderness areas, recreation sites, visual landscapes, risk of exposure to radiation, et cetera. All of these have value because individuals would be willing to pay something to have more of it or require compensation to put up with it. Of course, this presumes that the individual has some property right over the externality.
- 6.
A function U(x 1, x 2, …, x n) is strongly separable if U(x 1, x 2, …, x n) = U 1(x 1) + U 2(x 2) + … + U n(x n). In this case, the marginal utility of x i unaffected by changes in x j, so ∂2 U/∂x j∂xj = 0. This does not imply, however, that the price of x j has no affect on x i; that is, ∂x i/∂p j ≠ 0.
- 7.
In court cases, CVM can be used to estimate compensatory damages, but not the punitive damages that the court might assess.
- 8.
We could just as well examine the case where the ‘original’ level of the environmental amenity in Figure 6.7 is E 1, and then ask what the associated measures would be. In this case, WTP would be a negative value (indicating that compensation is required), while WTA is positive (indicating the respondent would need to pay). By switching the subscripts in the figure, we then find that WTA < CS < WTP.
- 9.
Information about the Colorado State University benefit transfer project and a toolkit can be found at: http://dare.colostate.edu/tools/benefittransfer.aspx (viewed February 12, 2011). Another effort to collect information for the purposes of benefit transfer is underway at Central Queensland University in Australia under the guidance of John Rolfe and Jill Windle; see ‘benefit transfer’ at http://resourceeconomics.cqu.edu.au/ (viewed February 12, 2011).
- 10.
I am indebted to Brian Scarfe for suggesting this approach.
- 11.
Note that β here is defined differently than its earlier use in Eqs. (6.6) and (6.7).
- 12.
For example, under the social CBA criterion, a project is desirable only if the benefit-cost ratio is greater than 1.0. Monte Carlo cost-benefit analysis might generate 10,000 benefit-cost ratios, of which some proportion are less than 1.0.
- 13.
Statement adopted by 31 individuals at the Wingspread Conference, Racine, Wisconsin, 23-25 January 1998 (http://www.gdrc.org/u-gov/precaution-3.html as viewed February 25, 2010).
- 14.
This is not to suggest that Nordhaus and others ignore technological changes. Integrated assessment models of climate change do include parameters for technical progress, but these translate into rate of change as a function of time or income. They do not attempt to address technologies that change a society’s very structure or the utility functions of individuals. The reason is simple: No one can predict what changes lie in the future, even the near future.
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van Kooten, G.C. (2013). How Economists Measure Wellbeing: Social Cost-Benefit Analysis. In: Climate Change, Climate Science and Economics. Springer, Dordrecht. https://doi.org/10.1007/978-94-007-4988-7_6
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