4 624 299 387 447 338 204 276 level of significance

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Unformatted text preview: other sectors – A large project may in fact raise the labor cost for other sectors – It could also effect over all economic growth of country with its positive impact on the economy as a whole, leading to increase in demand for output of other sectors – From social point of view, government decisions must take into account these and a number of other impacts Enumeration of Cost and Benefit • Definition of project – Most of the public projects have a feed back system. For example, a highway to reduce traffic congestion may lead to increase in economic activities in that region, which cause migration to the area which in turn leads to more traffic and congestion. – Also, in many cases project A would effect project B either directly or sometimes indirectly through project C. For example, building of a highway may speed up traffic, but could lead to congestion in the feeder road, if they are left unimproved – While it is possible to see relationships mentioned above, their quantifications are not trivial and are quite difficult to estimate. • Externalities – Public investment projects should take into account the external effect of their action so far as it alters the physical production possibilities of other producers or satisfaction that consumers get from resources. It should not take into account side effects if the sole effect is via prices of products or factors. For example, a dam has its main objective of irrigation and electricity generation. But it also may provide, free of charge, possibility for people to use the area around it for picnic. The benefit to users for picnic area is the externality. But, if there is a charge for the park, only the charge should be included in estimation. – Therefore externalities is when other benefits without payment is taking place as a result of particular investment. • Secondary Benefits – Inducement to create other activities is considered to be secondary effect. These should be taken into account. For example irrigation system will lead to more grain production which in turn lead to series of other related activates down stream. There is debate as to whether we should use the secondary benefits. General consensus is that if the market price reflect benefit of secondary effect we should use that otherwise we must impute the value of secondary benefits (water is sold for irrigation to farmers then use the revenue). Valuation of Cost and Benefits • Issues relevant regarding price for the estimation of revenue. – Expected price of input and output should be used, but not change in the price due to over all price changes. Current price and cost may under estimate over all value (since it effects consumer and producer surplus) – Market prices should be used as much as possible. But what if investment is large to the extend that it changes price structure. A new power project may alter price structure of electricity and may lead to its decline. Assumption of prevailing price may over estimate revenue. – Market Imperfection may also result in distortion of price structure. In such a case price is not reflective of social benefit of the output of the project. For example government authorities which control water supplies, would have control over price of water (since there is little or no alternative for consumer). In this case price does not reflect marginal cost of water. In such a circumstance, correction should be made both to the cost and benefit of the project to reflect the actual value. • Also, divergence of social cost and private cost would emerge when there is unemployment in the economy. In such a circumstances any project would actually positively impacts the employment situation. Clearly the social benefits of reduction in unemployment should be added to over all benefits (relevant to Stimulus package being implemented at this time). • There are also intangible costs and benefits of project. The intangibles are those that are either unquantifiable (such as scenic effect of a highway) or they can be quantified but is difficult to value in a market sense (life saving impact). Choice of Discount Rate • Use of social rate of discount presents a number of difficulties. • Role of time and preference Private investor preference is toward a more quicker return (they are more short sighted) than public investment. • In particular the weighted average cost of capital used by private sector as discount rate, is not applicable in the case of public project. This is because of structure of government financing through taxes and government bonds • Government advantage in terms of having lower rate of interest than private sector. This implies that social rate of discount for the same project is lower for the government than for private sector. Constraints • Distributional Constraints – The issue of distributive effect is highly theoretical. – The argument is the following: since government is the agent of society it should take interest of all equally into account. Therefore, by...
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This note was uploaded on 07/25/2012 for the course ECON 111 taught by Professor King during the Spring '12 term at CSU Bakersfield.

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