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lecture12_15 - Lecture Note 12 Introduction to Social Cost...

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Lecture Note 12: Introduction to Social Cost Bene°t Analysis Part 2B: Paper 1. ° Dr. T.S. Aidt University of Cambridge Michaelmas 2010 1 Introduction Social cost bene°t analysis is perhaps the most important practical application of welfare economics. It is used by government around the world on a daily basis to make decisions of government-sponsored expenditure programmes and policies. It is used by the big international organizations, e.g., the World Bank and UN, to evaluate development aid projects, and it is even occasionally used by the big private sector consultant °rms to appraise public sector investment programmes. When done correctly, social cost bene°t analysis can make a major contribution to enhance the quality of public sector decision making. But there are many pitfalls and lots of vested special interests involved in the decision making process who are more than willing to "bend the rules" if given the chance. A °rm understanding of the principles of social cost bene°t analysis is therefore essential to be able to judge the quality and reliability of any given social cost bene°t analysis as well as to be able to conduct a proper analysis yourself. There exists many manuals for how to do this and a battery of textbooks. The so-called Green Book sets out the principles governing social cost bene°t analysis in the United Kingdom. The Little-Mirrlees manual lays out the prin- ciples of project evaluation in the context of less developed countries. This note is meant to provide a uni°ed framework suitable to illustrate the principles and some of the more signi°cant pitfalls to look out for. Combined with a more practically orientated textbook ± I recommend Boardman et al., this should hopefully provide you with a solid foundation. The remarks on the literature at the end of the note provides a rough but more detailed guide to the literature. ° Disclaimer: This note may contain mistakes. If you spot any, please bring them to my attention. 1
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So what is it all about? In one word, it is about opportunity cost: The cost related to the next-best choice available to someone who has picked among several mutually exclusive choices. Social cost bene°t analysis is a systematic way of comparing what would happen to social welfare with and without a project or policy in place. 2 Social cost bene°t analysis: e¢ ciency The following framework is useful, as a °rst pass, for thinking about social cost bene°t analysis. It is based on the assumption that individuals are identical. This allows us to isolate issues related to e¢ ciency from issues related to distri- bution, which we shall return to in the next section. More speci°cally, we make the following assumptions: 1. Many identical consumers, h = 1 ; ::; H .
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