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Purpose: Estimating consumer surplus, producer surplus, and government revenue (i.e., social surplus) in primary markets (i.e., markets that are directly affected by a policy or project). ACTUAL VERSUS CONCEPTUALLY CORRECT MEASURES OF BENEFITS AND COSTS This chapter discusses how to estimate "conceptually correct" measures of benefits and costs. It begins, however, with a discussion of why these "conceptually correct" measures are frequently not used in actual CBA studies and what the implications of this are. The primary reason why conceptually correct and actual measures differ is that the easiest measures to obtain are observed prices, which may or may not be the conceptually correct measurers. Whether the observed prices are accurate measures of benefits and costs depends on the character of the market. Prices that are determined in well-functioning, competitive markets tend to be good estimates of benefits and costs, while observed prices in distorted markets tend to be poor measures. In cases where observed prices don't reflect the true (social) value of a good accurately or where prices don't exist (e.g., for public goals), a process called shadow pricing is used. Shadow pricing is when observed prices are adjusted (or values are assigned when observed prices do not exist) so that they come as close as possible to measuring the social value of the good in question. Even with shadow pricing, however, the measures of benefits and costs used in actual studies can differ from their conceptually correct counterparts for several reasons. 1. Errors can be made in CBA. Those doing the analysis may incorrectly believe they have the correct measures, when they do not. 2. It is often difficult to derive an appropriate shadow price. It may be technically infeasible or beyond the time and resources available to derive the correct price. Here, those conducting the CBA should point out the resulting biases. 3. The differences between the actual and the correct measures are small enough that the results are not affected very much. In such instances, shadow pricing may not be necessary. VALUING OUTCOMES: WILLINGNESS-TO-PAY In CBA, costs and benefits are based on the concept of willingness-to-pay (WTP). Benefits are the sum of the maximum amounts that people would be willing to pay for a policy outcome, and costs are the sum of the opportunity costs of the resources required by the policy. Benefits are first considered (measured in efficient and inefficient markets) and then costs (again measured in efficient and inefficient markets). Valuing Benefits in Efficient Markets The valuation of gross benefits in efficient markets relies on the following rule: Gross social benefits equal the net revenue plus the change in social surplus. Two situations in which the rule is applicable are examined: (1) a policy that directly affects the quantity of the good available to consumers, and (2) a policy that alters the costs of producing a good. Boardman, Greenberg, Vining, Weimer / Cost-Benefit Analysis, 3
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This note was uploaded on 01/26/2011 for the course ECON 1111 taught by Professor Fertar during the Spring '10 term at Memorial University.

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