energy and environment

energy and environment - COST BENEFIT ANALYSIS IN THE...

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COST BENEFIT ANALYSIS IN THE CONTEXT OF ENVIRONMENTAL POLICY Cost benefit analysis is a framework for evaluating the social costs and benefits of an investment project and a technique used to judge the desirability of an environmental policy. It involves defining the objectives, identifying, measuring and comparing the private costs and negative externalities of a scheme with its private benefits and positive externalities, using money as a measure of value. After evaluation, it is decided whether the project is worth undertaking, or if any other options are viable. The objective of any environmental policy is to preserve and protect the environment and maximise economic welfare from resource use. CBA 1 , in the context of environmental policy, aids to make a decision that can give highest priority to eliminating or reducing the hazards that would have blocked the society from receiving the greatest net benefits. 2 CBA has been applied in many public projects, and was first used in the planning of the M1 motorway in 1960’s. It stems from the neo-classical economics of marginal analysis and the allocation of resources. CBA is usually confined to public projects because the advantages and disadvantages are defined in terms of social gains and losses. The CBA framework is initiated by defining the objectives. An example is a possibility of undertaking a pollution control project or a proposal to construct a new plant. It then sets out the main alternatives based on ranking of the all the agencies involved depending on their desirability, and then accepts, rejects or takes no action. The alternate project is used as an opportunity cost. It then identifies the costs and benefits of the project. The ‘economic man’ is a self-interested man and only takes into account private costs and benefits. Firms and individuals tend to ignore externalities 3 , and hence make trade-offs at the margin to identify positions of equal personal satisfaction, where Marginal Private Cost = Marginal Private Benefit . The preferences are dependent on the willingness to pay, utility maximisation, and other choices which he ranks. The objective function of an individual or a firm would be to maximise private benefits. This would be objective would be maximised at MPC=MPB. However CBA also takes into account external costs and benefits to reveal the Social costs and benefits. Social Cost = Private cost + external cost (negative externality). The decision-maker wants to maximise the net social benefits. The allocation of resources that would maximise this objective of social utility is when Marginal Social Benefits= Marginal Social Costs . The diagram below shows a negative externality where the marginal social cost is greater than the marginal private cost. This can be looked in an environmental context where a firm producing one more unit of output is causing more environmental damage, which the society has to pay for. The perfect allocation efficiency only occurs in a perfect market, where market prices reflect full costs of
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This note was uploaded on 02/10/2012 for the course MGT 101 taught by Professor Staff during the Fall '10 term at Texas State.

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energy and environment - COST BENEFIT ANALYSIS IN THE...

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