Week 1-1 Introduction to Benefit-Cost Analysis .pdf - Week...

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Week 1-1 Introduction to Benefit-Cost Analysis Our first topic will be a brief introduction to benefit-cost analysis. We begin with a definition of benefit-cost analysis. According to the New Palgrave Dictionary of Economics, benefit-cost analysis, or cost-benefit analysis as it often called, is a collection of methods and rules for assessing the social costs and benefits of alternative public policies. In other words it is the way in which we assess the good things the “benefits” and the bad things the “costs” of some policy or action that we would like to undertake. While benefit-cost analysis can be applied to any number of situations, as mundane as the decision of whether to have oatmeal or a Crispy Cream Donut for breakfast, it is most often used to measure the impact of public policy programs. This common use is reflected in the definition here. In a more general context, we can simply say that benefit-cost analysis is the method of assessing the costs and benefits of any action. However, we will generally draw from public policy examples in this class, particularly from benefit-cost analyses done for the Federal Government, so the definition from the New Palgrave is appropriate. Benefit-cost analysis is used both formally and informally in many disciplines, but it is the workhorse of economists. It is also not without its critics. Some people feel that benefit-cost analysis has too large of a role in federal policy making. In response, a number of well known economists, including Nobel laureate Ken Arrow, put together a statement of reasons why one should embrace the use of benefit-cost analysis in policy making. Summarizing from their 1996 article, the author’s say that benefit cost analysis is A useful way of organizing a comparison of the favorable and unfavorable effects of proposed policies. In other words, benefit-analysis demands an accounting of all the good things and bad things that might come from a policy and, as such, formally organizes a comparison of these things. Benefit-cost analysis is also useful in designing regulatory strategies that achieve a desired goal at the lowest possible cost. In many cases, a desired outcome can be achieved in a number of possible ways. Explicitly measuring the costs of achieving a goal allows a decision maker to choose the method that is the least burdensome on society. Benefit-cost analysis is also useful in setting regulatory priorities. As we shall see, benefit-cost analysis measuresthe net gain to society from an action. A comparison of the net gain for alternative policies allows the decision maker to set priorities where the greatest net gain to society can be had. Benefit-cost analysis is also useful in identifying important distributional consequences of a policy. One aspect of a good economic analysis is formally looking at which groups gain and which groups lose from a particular policy. While economists may not always choose to weigh in on whether a gain to one group is worth the

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