lecture13 - Applied Welfare Economics Part IIB: Paper 1 Dr...

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Applied Welfare Economics Part IIB: Paper 1 Dr Toke Aidt Lecture 13 Social Cost Benefit Analysis
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Outline Shadow prices of outputs and inputs to a project. Border prices and producer prices as shadow prices. Valuating the benefits of projects and policies where there outputs (benefits) are not traded in markets.
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Industrial Project in a LDC Government (or aid) agency is considering funding new factory that produces cloth ( x 1 ). Two inputs: labour ( l 0 ) and capital ( k ). Consumer and producer prices are q=(q k ,q 0 , q 1 ) p=(p k ,p 0 ,p 1 ) There are other competitive producers of cloth in the country. The project will increase supply of cloth by Δx 1 , the demand for labour by Δl 0 and demand for capital by Δk . How should we valuate the costs and benefits?
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Find the shadow (or accounting) price!
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The social benefit of the output There exists a pre-project market price q 1 , so can we not use that to value the extra output? Three different cases: Undistorted market with “small” project, Undistorted market with “big” project, Market distorted by sales tax. Gross social benefit = revenue from sales + change in social surplus + change in tax revenues .
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S S+project D x 1 Price Gross benefit is 0 1 p 1 x ABDE ABC x p + + 1 1 1 C A Distorted market with price effect Sales tax levied on consumers. D + tax 0 1 q B 1 1 p 1 1 q D E TAX PS CS x p + + + 1 1 1 1 t 1 1 1 0 1 2 1 1 1 ) ( t p p x x c + + Shadow price (approximately): 1 1 1 t q p - = c x 1
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Dealing with price changes in the presence of taxes ( 29 ( 29 ) ( , , , 1 1 1 2 1 1 2 1 q x t p t q m q q V + - + π The welfare effect of a small price increase is the extra tax revenue generated: 1 1 1 1 1 1 q x t m V p m V q V q V + + = ∆ π 1 1 x q V λ - = 1 1 y p = ( 29 1 1 1 1 1 1 1 1 1 q x q x t t x y q V = + - = Value of extra tax revenues 1 0 1 t p + Shadow price =
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The opportunity cost of the inputs There exists a market price of labour inputs, so why not just use that to value the inputs? Three different cases: Undistorted labour market but big project Distorted labour market: unemployment Distorted labour market: Income taxes Opportunity cost = Direct expenditure - change in social surplus - change in tax revenues .
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S D + project l 0 Price Opportunity cost is 0 0 0 0 p q = 0 l ABC l p - 0 1 0 1 0 1 0 p q = B C A Undistorted labour market with price effect Big project Shadow price PS CS l p - - 0 1 0 D ( 29 0 0 1 0 2 1 p p + D E F G
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S D + project l 0 Price Opportunity cost is 0 0 0 0 p q = 0 l ABCD l p - 0 1 0 = = 1 0 1 0 p q D C A Distorted labour market Unemployment (surplus labour) Shadow price? CS l p - 0 1 0 D Unemployed B E F ( 29 D C p p 0 0 2 1 + ( 29 G C p p 0 0 2 1 +
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S D + project l 0 Price Opportunity cost is 0 l DCBEA l p - 0 1 0 0 0 q B t 0 Distorted labour market with price effect Income tax paid by employees.
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This note was uploaded on 06/04/2011 for the course ECONOMICS paper 1 taught by Professor Aidt during the Spring '11 term at Cambridge.

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lecture13 - Applied Welfare Economics Part IIB: Paper 1 Dr...

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