Pub Econ Lecture 08 CBA

8/3/2019 Pub Econ Lecture 08 CBA

1/16


2/16

Suppose you are working for the Colorado state

government in the highway department.- cost-benefit analysis of road repairs


3/16

Measuring Current Costs

We need the social marginal cost.

- equal to its opportunity cost

Cost of Asphalt:1 bag asphalt costs $100

- next best use = sell to someone else

- competitive market

- opportunity cost = price

1 million bags x $100 = $100,000,000


4/16

Cost of Labor:

In a perfectly competitive market, the opportunity cost isequal to the wage.

Suppose instead an imperfect market with some

unemployment among construction workers. (due tominimum wage of $20)

Suppose the value of one hour of leisure is $10.

The opportunity cost of hiring an unemployed worker is

$10. The opportunity cost of hiring an employed worker

is $20.


5/16

Suppose we hire 500,000 previously unemployed

workers and 500,000 previously employed workers.

The opportunity cost of the labor is:

500,000 x $10 + 500,000 x $20

= $5,000,000 + $10,000,000

= $15,000,000


6/16

Even though the government is paying out $20,000,000

in cash, the opportunity cost is $15,000,000.

The cash cost of the labor cost has two parts:

- opportunity cost

- transfer of rents

Rents are payments to resource acquisition that exceed

those necessary to employ the resource.

In this case the rents are a transfer from the government

to previously unemployed workers.


7/16

Measuring Future Costs

Use the Present Discounted Value.

The PDV of a long-term stream of payments is:

PDV = payment amount

interest rate

Use 7% as the interest rate.

PDV = $10,000,000

0.07

= $143,000,000


8/16


9/16

Measuring Current Benefits

Valuing Driving Time Saved:

Various Approaches:

- wages (2009 average wage $19.29)- overstate if value of leisure < wage

(cant work overtime)

- understate if there are non-monetaryaspects of the job


10/16

- Contingent Valuation (ask individuals to valuean option that they are not currently doing)

- reveled preference (let individuals actions

reveal their value)- gas station natural experiment

Lets use $19.00 as the value of an hour of time.500,000 x $19 = $9,500,000


11/16

Valuing a life saved:

Various Approaches:

- wages

- a worker under age 50 will spend 10-20%

of all future hours working

- value of life is 5-10 times future lifetime

earnings

- Contingent Valuation

- $963,000 to $26,000,000


12/16

- revealed preference

- see how much pay to reduce odds of dying

- if airbag costs $350 and there is a 1 in

10,000 chance that it would save the life

then the value of a life is at least $3.5 million

- look at compensating differentials

- compare 2 jobs, one has 1% higher risk ofdeath in a year and pays $30,000 more

- value life at $3 million

Kip Viscusi of Harvard says: $8.7 million


13/16

- government revealed preference

- look at existing government programs

and see how much they spend to save lives


14/16

Lets use $8.7million as the value of a life.

$8,700,000 x 5 lives = $43,500,000


15/16

Discounting Future Benefits

Very tricky!

- choice of discount rate matters a lot

- how to treat future generations benefits?

Lets use 7%.

Total Benefits = $9,500,000 + $43,500,000

= $53,000,000

PDV = $53,000,000

0.07

= $757,142,857


16/16

$8.7 million / life $43.5 million

$53 million

$757 million

$499 million

The project should be undertaken.

Documents

Pub Econ Lecture 08 CBA