AGEC 608 Lecture 02, p' 1

1
AGEC 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

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What 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

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Pareto Efficiency
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Operationalizing 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.
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Potential 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.
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Decision 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

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Limitations 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.

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Jurisdictional 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?

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Limitations 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
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CBA 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