# lecture14 - Applied Welfare Economics Part IIB Paper 1 Dr...

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Applied Welfare Economics Part IIB: Paper 1 Dr Toke Aidt Lecture 14 Social Cost Benefit Analysis and Distribution

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Outline Non-marketed inputs and outputs Social cost benefit analysis with distributional considerations.
Non-marketed outputs and inputs

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Non-marketed outputs and inputs The issue: The output or outcome of a project or a policy is not priced in a market. The inputs to a project is not priced in a market. Examples: The benefit of many transport projects is saving of time or a reduction in the risk of accidents. The main benefit of many medical programmes (e.g., screening) is to save lifes. An important cost of an extra run-way at Heathrow is additional noise.
How do we quantify the costs and benefits for non-marketed goods? Indirect market methods Use market information from related activities. Revealed preference. Contingent valuation Use information from surveys Stated preference.

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The statistical value of a life Many public projects and policies are designed to save lives, but use scare resources. How should the benefits of such projects or policies be valued? Indirect market methods can be used to quantity the statistical value of a life by drawing on the value implied by labour market choices.
Simple labour market studies Suppose there are two types of jobs that a person with a given qualification can hold: Safe job paying w S Risky job paying w R Annual wage differential is Δw=w R -w S >0 . Let λ be the yearly probability of a fatality in the risky job relative to that in a safe job (which we take to be zero). Competitive market will allocate workers between the two jobs so that the marginal worker is indifferent: ( 29 ) ( 1 ) ( life V w life V w R S λ - + = + λ w life V VSL = = ) (

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The key problems with this type of estimate: Cognitive biases (tendency to underestimate small risks) Self-selection into risky jobs Omitted variable bias (are risky and safe jobs really comparable?) λ w life V VSL = = ) ( ( 29 - = + = a T t r VLY t a VSL 0 1 ) ( Value of a statistical life Value of a life-year Discount factor Current age Expected number years
Hedonic pricing methods General idea : Many attributes of “assets” or “jobs” get capitalised in observable prices: Environmental quality differences get reflected in house prices. The value of a good school gets reflected in house prices. The fatality risk associated with different jobs get reflected in wages. Estimate the price for each “attribute” and use this estimate to calculate consumer’s surpluses.

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Some estimates of the value of a statistical life Based on a meta study of a large number of studies, the “best guest” estimate is: VSL = \$4 million (£2.5 million) with a range from \$2 million to \$6 million The value of a life-year (VLY) is around \$187k (£116k) per person per year (for 40 years life expectancy and a discount rate of 3.5%).
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