Title: AGEC 608 Lecture 02, p' 1
1AGEC 608 Lecture 2
- Objective Review conceptual foundations
of CBA - Readings
- Boardman, Chapter 2
- Kankakee, Sections I and II (pp. 1-21)
- Homework Chapter 1, problem 1 Chapter 2,
problem 2 Chapter 2, problem 4 due Feb. 27
2What is Efficiency?
- Allocative efficiency
- - are resources deployed in their highest
and best use? - Pareto efficiency asks - could winners
compensate losers? - Any allocation is Pareto efficient if no
alternative allocation can make at least one
person better off without making anyone else
worse off (see Figure 2.1). - Transfers are required!
- CBA is a method for measuring allocative
efficiency
3Pareto Efficiency
4Operationalizing efficiency
If Net Benefits are positive, then the test of
Pareto Efficiency is satisfied Willingness to
Pay (WTP) is the payment one would have to make
or receive so as to be indifferent between the
status quo and the policy with payments. Sum of
WTP Net Benefits of a policy Opportunity cost
dollar value of the best alternative use of a
resource.
5Potential Pareto Efficiency
Also called Kaldor-Hicks criterion Key It is
impractical to implement only Pareto efficient
policies. So adopt policies with positive net
benefits. Redistribution is not necessary, only
that society as a whole is better off in
aggregate.
6Decision rule in practice
- Adopt all policies with positive net benefits
- Benefit Cost Ratio (BCR) Benefits/Costs
- Assess both BCR and Net Benefits, choose policies
with largest net benefits - If policies interact, choose combination that
maximizes net benefits
7Limitations on WTP
- The theoretical rule for creating a social
ranking of alternatives is not fully
satisfactory - Scitovsky reversals (A ? B ? A) can occur
- WTP depends on distribution of wealth(WTP ?
ability to pay) - Measure of NB depends on ones definition of
standing.
8Jurisdictional Standing
- Jurisdictional boundaries
- What are the boundaries of the project?
- Are there important spillovers?
- Jurisdictional membership
- Whose utility should be counted?
- Is anthropocentrism OK?
- 3. Exclusion of unacceptable preferences
- How are social values included?
- 4. The future generations problem
- How do we measure WTP of future generations?
9Limitations of CBA
Monetization may not be possible Two
alternatives 1. Conduct a qualitative CBA 2.
Perform cost-effectiveness analysis (a
good option if the benefit can be quantified
but not monetized) Goals other than efficiency
may matter Two alternatives 1. Multi-goal
analysis 2. Distributionally weighted CBA
10CBA and the Political Process
Two major criticisms of the use of CBA for pubic
policy making 1. Monetization may be possible
but not desirable Example valuing human
life 2. Reliance on a single value of efficiency
may be inconsistent with democratic values