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Module 7: Measuring Benefits and
Costs
- Marketed Benefits and Costs
- Non-Marketed Direct Benefits and Costs
- Non-Marketed Indirect Benefits and Costs
A properly constructed cost-benefit analysis will attempt to measure the change in
economic welfare associated with all costs and all benefits uniquely generated by a project. In
general, these will fit into one of three categories: (1) marketed (direct) benefits and costs, (2)
non-marketed direct benefits and costs, and (3) non-marketed indirect benefits and costs. For
benefits, we attempt to measure the willingness to pay by all affected consumers for the relevant
project benefits. The rationale for doing so derives from applied economic welfare analysis. This
approach argues that economic welfare derives from preference satisfaction and that preference
satisfaction is reflected by the consumer's willingness to pay.
More specifically, economists infer willingness to pay for direct benefits and costs by
observing choices made in markets or by observing other choices to spend dollars to facilitate
direct consumption of the resource. This is said to measure preferences revealed by choices, or
simply to measure revealed preferences. For non-marketed, indirect benefits and costs, stated
preference estimates derived from survey research are employed. For costs, we attempt to
measure the opportunities foregone (opportunity costs) due using the economic resources (land,
labor, materials, etc.) in the project rather than in some other use. For direct private costs, market
prices of resources are used. Non-marketed costs, tend to be treated as benefits foregone, and are
estimated exactly as are benefits. For a more detailed discussion of benefits and costs, in non-
technical terms, the reader is referred to the Resources for the Future publication "Cost-Benefit Primer."
1. Marketed Benefits and
Costs
Marketed benefits, also referred to as private benefits, are measured as the sum of
willingness to pay by consumers for the new quantity of product produced by the project being
evaluated. For example, assume that the construction of a marina produces 10,000 days of new
available dockage. The question then becomes, how to value this dockage.
In the private sector, the firm would simply measure a price times quantity dollar value,
but because public sector decision making seeks to take into account changes in welfare, rather
than changes in revenues, a somewhat different approach is taken. The accepted approach for
measuring the willingness to pay for the new dockage (and for other privately marketed goods) is
to measure the market demand curve for dockage and to calculate the incremental price that
consumers' would be willing to pay for the dockage. In general, this would not be a constant
price, but rather it would be higher for the first units and decrease thereafter until the point at
which a market-clearing (or marginal) price is reached, a price that would on average rent out all
available dock space. Thus, while all renters may pay the same market clearing price, some
might have been willing to pay a higher price than others, but were not required to do so. In fact,
each renter may have been willing to rent at a different price, but the marina may not have been
able to charge each a different price. Observing the price paid tells the analyst a lower bound for
benefits; that is, if the consumer did not receive benefits at least equal to the price paid, he or she
would not have purchased the good. Adding back an amount the consumer would have been
willing to pay adjusts the total revenue measure obtained from multiplying the total quantity
rented by the price to affect more accurately the increase in economic welfare as a result of the
marina. This concept is referred to as consumers surplus within the economics literature. It is
used to value all benefits when a demand curve can be estimated. This same approach is used for
estimating welfare for non-marketed direct and indirect benefits.
The private costs associated with the project, unlike the benefits, are typically measured at
market prices. This reflects the fact that factor inputs, like land, labor and materials tend to be much more substitutable and therefore supplied at roughly constant prices. Few
projects are by themselves large enough to cause changes in prices through project activities,
and, hence, the assumption of constant prices is reasonable.
The issue of under utilized resources is a bit more problematic, however. Local
administrators are typically enthusiastic about new jobs created economic developed, private or
public. National administrators, on the other hand, recognize that the benefits are not unique to
the project, because they would occur anywhere a project was undertaken, and would likely be
similar for quite different projects or roughly equal magnitude. The only question to a national
decision maker would be whether special weight would be given to economic development in
particular areas as a matter of policy. For those local administrators interested in exploring ways
to measure new jobs created by a project, the Department of Commerce, Office of Business and Economic Research provides
multipliers and other tools of analysis.
2. Non-Marketed Direct Benefits and
Costs
A large number of natural and environmental resources are consumed directly, but are not
purchased in markets. Examples, include fishing in a mountain stream, enjoying a panoramic
view, living in a community or neighborhood with clean (or dirty) air, or working in an
occupation that provides opportunities to enjoy increased (decreased health). We note that
environmental "dis-amenities" as well as amenities can come into play.
As it turns out, individuals who consume these amenities and dis-amenities often leave
behavioral "footprints" from which revealed preferences can be recovered using statistical
methods. For example, some individuals work in highly desirable occupations, like forest
rangers, and as a consequence receive lower wages than they would otherwise receive.
Symmetrically, workers in very undesirable occupations often received wage premia. A
statistical tool called hedonic analysis can be used to estimated these wage differentials. In
simple terms, a forecasting model is developed for various occupations, such that the impacts of
job attributes such as skills, education, as well as desirable and undesirable job features on wages
can be estimated. Hedonic models are also often used to measure the impacts of favorable or
unfavorable environmental conditions on property values. For example, the impacts of a view
could be isolated statistically, by controlling for size of house, size of lot, construction, and other
features. In other cases, a travel cost approach is used to infer willingness to pay for an
environmental amenity. For example, costs incurred by fishers can be observed and related to
stream attributes, such as beauty, isolation, average catch, average sized catch, and the like. By
isolating other affects statistically, it is possible to infer the willingness to pay for attributes of
many natural attractions, like national parks, seashores, lakes and mountains.
These approaches are referred to as revealed preference measures because they infer
willingness to pay as revealed by consumer choices. From them, demand schedules can be
estimated and consumer surplus measured.
3. Non-Marketed Indirect Benefits and
Costs
Non-marketed indirect benefits and costs arise not because of direct use of a resource, but
rather because individuals place value on the "existence" of the resources. For example, many
people have never seen the redwood forests, but have willingness to pay to see them preserved.
Likewise, people who will never encounter a baby seal outside of a zoo may have strong
feelings, backed by willingness to pay, concerning their harvest for use as furs. These values are
appropriate costs and benefits. The challenge lies in measuring these values in meaningful
scientific ways, that is, ways that can be validated and replicated.
In general, because there are no behavioral footprints from which to infer value survey based approaches are used to derive indirect values. The most commonly applied approach is
called contingent valuation analysis wherein a hypothetical, or "contingent," choice is made that
is designed to reveal an individual's willingness to pay. Typically, these analyses present
detailed scenarios to respondents that include information about the program under
consideration, what it hopes to accomplish, how it will be paid for, and over what time period
actions will take place. Various formats are then employed to obtain a contingent value that is an
estimator of actual willingness to pay. Some analysts use a family of approaches termed conjoint
analysis to seek similar information. These are termed stated preference measures because
respondents are asked to state their willingness to pay.
Stated preference measures have been criticized for a large number of reasons, some quite
esoteric and others quite practical. Some question, for example, if individuals actually have
preferences for a diverse and nearly limitless set of resources that can be estimated in this way.
Others question the sensitivity to the quality of the program being purchased. Still others
concern themselves, that respondents, sensing that their answers may affect policy, respond
strategically with very large or with zero responses. Analysts are making some headway on
overcoming these problems. A good review of these issues can be found in a book by NCEDR researchers Bjornstad
and Kahn.
These approaches have also been criticized by those who question whether or not
preference satisfaction is a useful approach to making environmental decisions. These critics
suggest that environmental decision making is essentially an ethical process that should be
removed from economic considerations. At the extreme, these observers might argue that a clean
environment is a "right" and that no expense should be spared in this pursuit. The difficulty with
such criticism is that it flies in the face of scare resources and the need to make hard decisions.
Ultimately, some mechanism must provide guidance as to priorities, proportions and overall costs of programs that must compete with other activities for funding. In addition to cost benefit
analysis approaches such as citizen juries, focus groups, decision analysis, risk analysis, and
many other approaches have been proposed to help decide these difficult issues.
A more pragmatic concern, however, is just whose preferences should count when the subnational decision maker confronts and issue. Certainly it is informative that other citizens in far
away regions value the actions of others in other regions, but they are unlikely to support these
activities financially. A good rule of thumb is that the citizens in the jurisdiction that will make
economic sacrifices for the project should be included.
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