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Civil Systems PlanningBenefit/Cost Analysis

Chapters 4 and 5Scott MatthewsCourses: 12-706 and 73-359Lecture 5 - 9/15/2003

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Announcements

Homework 1 Due TodayWill insert 2 lectures (wed, next

Monday) Syllabus adjusted on web

Guest Lecturer next Wed

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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

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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?

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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

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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

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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

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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

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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

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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

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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’

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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

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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

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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)

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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

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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

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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

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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

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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)

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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