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Civil Systems PlanningBenefit/Cost Analysis
Chapters 4 and 5Scott MatthewsCourses: 12-706 and 73-359Lecture 5 - 9/15/2003
12-706 and 73-359 2
Announcements
Homework 1 Due TodayWill insert 2 lectures (wed, next
Monday) Syllabus adjusted on web
Guest Lecturer next Wed
12-706 and 73-359 3
Externalities
Recall that external effects happen to third parties (non-consumers, producers) Cause distortions in the market
Are by-products with no marketsSince number of externalities is large,
CBA can/should be used before government intervenes to correct
12-706 and 73-359 4
Pollution (Air or Water)
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Typically supply (MC) only private, not social costs. Social costs higher for each quantity
What do these curves, Equilibrium points tell us?
12-706 and 73-359 5
What is WTP by society to avoid?
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Typically supply (MC) only private, not social costs. Social costs higher for each quantity
12-706 and 73-359 6
What is WTP by society to avoid?
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Differences in cost functions represent thealternative ‘valuations’ of the product -Thus difference between themWTP to avoid costs
12-706 and 73-359 7
Pollution (Air or Water)
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Relatively too much gets produced,At too low of a cost - how to Reduce externality effects?
DWL
12-706 and 73-359 8
Pollution (Air or Water)
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Government can charge a tax ‘t’ on Each unit, where t = distance betweenWhat are CS, PS, NSB?
t
12-706 and 73-359 9
Pollution (Air or Water)
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
CS = (loss) A+BPS=(loss) E+F
t
P# - t
A B
E F
12-706 and 73-359 10
Pollution (Air or Water)
Q
P
Q#
P#
S*: marginalPrivate costs
D
S#:marginalSocial costs
P*
Q*
Third parties: (gain) B+C+F(avoided quantity between S curves) Govt revenue: A+ETotal: gain of C
t
P# - t
B
F
CA
EC is reduced DWLof pollution eliminated by tax**
**This cannot be a perfect reduction in practice - need to consideradministrative costs of program
12-706 and 73-359 11
Distorted Market - Vouchers
Example: rodent control vouchers Give residents vouchers worth $v of cost Producers subtract $v - and gov’t pays
themLikely have spillover effects
Neighbors receive benefits since less rodents nearby means less for them too
Thus ‘social demand’ for rodent control is higher than ‘market demand’
12-706 and 73-359 12
Distortion : p0,q0 too low
Q
P
Q0
P0
S-v
DM
S
DS: represents higher WTPfor rodent control
P1
Q1
What is NSB? What are CS, PS?
SocialWTP
12-706 and 73-359 13
Social Surplus - locals
Q
P
Q0
P0
S-v
DM
S
DSP1
Q1
B
P
E
P1+vA C
Make decisions based on S-v, DmWhat about others in society, e.g. neighbors?
Because of vouchers,Residents buy Q1
12-706 and 73-359 14
Nearby Residents
Q
P
Q0
P0
S-v
DM
S
DS
P1
Q1
B
P
E
P1+vA C
Added benefits are area between demandabove consumption increaseWhat is cost voucher program?
F
G
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Voucher Market Benefits
Program cost (vouchers):A+B+C+G+E ----
Gain (CS) from target pop: B+EGain (CS) in nearby: C+G+FProducers (PS): A+C---------Net: C+F
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Notes about Public Spending
Resource allocation to one project always comes at a ‘cost’ to other projects E.g. Pittsburgh stadium projects “Use it or Lose it” There is never enough money to go around
Thus opportunity costs exist Ideally represented by areas under supply
curves Do not consider ‘sunk costs’ Three cases (we will do 2, see book for all 3)
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Opportunity Cost: Land
Q
P
D
b
Price
• Case of inelastic supply (elastic supply in book, trivial)• Government decides to buy Q acres of land, pays P per acre• Alternative is parceling of land to private homebuyers• What is total cost of project?
S Can assume quantityof land is fixed (Q)
12-706 and 73-359 18
Opportunity Cost: Land
Q
P
D
b
Price
Government pays PbQ0, but society ‘loses’ CS that theywould have had if government had not bought land. This lostCS is the ‘opportunity cost’ of other people using/buying land.• Total cost is entire area under demand up to Q (colored)
S
0
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Example: Change in Demand for Concrete Dam Project
If Q high enough, could effect market Shifts demand -> price higher for all buyers Moves from (P0,Q0) to (P1,Q1).. Then??
Q0
P0
D
a
Price
Quantity
D+q’
S
P1
Q1
12-706 and 73-359 20
Another Example: Change in Demand
Original buyers: look at D, buy Q2 Total purchases still increase by q’ What is net cost/benefit to society?
Q0
P0
D
a
Price
Quantity
D+q’
S
P1
Q1Q2
12-706 and 73-359 21
Another Example: Change in Demand
Project spends B+C+E+F+G on q’ units Project causes change in social surplus! Rule: consider expenditure and social surplus change
Q0
P0
DPrice
Quantity
D+q’S
P1
Q1Q2
E
B C FA
GG
G
12-706 and 73-359 22
Dam Example: Change in DemandDecrease in CS: A+B (negative)Increase in PS: A+B+C (positive)
Net social benefit of project is B+G+E+F
Q0
P0
DPrice
Quantity
D+q’S
P1
Q1Q2
E
B C FA
GG
G
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Final Thoughts: Change in Demand
When prices change, budgetary outlay does not equal the total social costUnless rise in prices high, C negligible
So project outlays ~ social cost usually Opp. Cost equals direct expenditures adjusted by social surplus changes
Quantity
12-706 and 73-359 24
Secondary Markets
When secondary markets affected Can and should ignore impacts as long
as primary effects measured and undistorted secondary market prices unchanged
Measuring both usually leads to double counting (since primary markets tend to show all effects)
12-706 and 73-359 25
Primary: Fishing Days
Q1
P
D
Price
Government decides to buy Q acres of land, pays P per acreWhat is total cost of project?
b
a
Q0
MC0
MC1
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