Economics Dictionary of ArgumentsHome
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| Cost-benefit analysis: Cost-benefit analysis is a systematic approach to estimating the strengths and weaknesses of alternatives used to determine options that provide the best approach to achieving benefits while preserving savings. It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Economic Theories on Cost-Benefit Analysis - Dictionary of Arguments
Parisi I 359 Cost-benefit analysis/benefi-cost analysis/BCA/Economc theories: BCA evaluates policies that have benefits and costs that will normally occur both at project outset and in the future, that is, over time. Because benefits and costs are cash flows that occur over time, the analyst must take the “time value of money” into account (i.e. the idea that $100 today is not worth the same as $100 a year from now because investing the $100 earned today would yield more a year from now). To make the money value of costs and benefits commensurate over time, cash flows in each year must be discounted to their “present value.” Parisi I 360 When conducting a BCA, all monetary amounts must be in comparable units—either all in “constant dollars” or all in “nominal dollars.” Constant dollars (also called “real dollars”) take inflation into account, adjusting the value of future benefits and costs to reflect expected inflation. If constant dollars are chosen, then the inflation component must be subtracted to the discount rate. Thus, if the market interest rate is 8% and expected inflation is 5%, the real interest rate (by which future benefits and costs are discounted) would be about 8% -5%, or 3%. These considerations and others are frequently capsulated in steps for a BCA. >Kaldor-Hicks criterion/Zerbe, >Efficiency/Hicks, >Efficiency/Kaldor. Parisi I 363 Originally BCA was conceived as simply a measure to determine whether a water project, typically a dam, should be built. The Army Corps of Engineers introduced benefit–cost methods into the United States (borrowing from the French) at least as early as the Rivers and Harbor Act of 1902, and its use was explicitly mandated in the 1920 amendment to the Act (Porter, 1995(1), p. 150; Hammond, 1966(2), p. 195; Holmes, 1972(3)).Before the creation of the Corps, evaluations of public investments were almost completely ad hoc (Porter, 1995(1), p. 150). By the 1920s, the Corps required that its recommended projects have expected benefits in excess of costs. Throughout the 1930s, the numbers put forward by the Corps were generally accepted without question (Porter, 1995(1), p. 150). Congress recognized the Corps as a relatively neutral and respected arbiter in congressional fights over water projects (Porter, 1995(1), p. 153). The creation of the Corps, then, represented not only the creation of an agency to build projects, but an agency to increase congressional and public efficiency. After 1940 Corps decisions became the subject of rather bitter controversy as the Corps was challenged first by powerful electric and railroad utilities, by shipping interests, and then by rival federal agencies, especially the Bureau of Reclamation and the Department of Agriculture (Porter, 1995(1), pp. 161–175). The further development of BCA and its increasing quantification was not the product of technical elites but of disagreement, suspicion, and conflict, particularly bureaucratic conflict (Porter, 1995(1)). Rival techniques or standards for BCA became the norm, although an attempt was made to resolve differences by relying on first principles of economics. The attempt closest to reaching agreement was the “Green Book.”16 Although agreement was significantly incomplete, the grounds for decision-making were reasonably well established as rooted in economic theory. BCA was thereby transformed by conflict into a set of rationalized economic principles building on work by British economists in the late 1930s. The incorporation of economic principles into BCA “began in earnest in the mid-1950’s” (Porter, 1995(1), p. 188). Parisi I 365 VsBenefit-Costs analysis/VsBCA: There are three issues concerning the use of BCA that have been especially controversial. These are 1) what the discount rate should be, 2) the possibility of Scitovsky reversals, and 3) the role of moral sentiments in BCA. See (Polinsky, 1989)(4), Shavell (1981)(5), Kaplow and Shavell (1994)(6). >Scitovsky Paradox. 1. Porter, Theodore M. (1995). Trust In Numbers: The Pursuit Of Objectivity In Science and Public Life 187. Princeton University Press. 2. Hammond, Richard J. (1966). “Convention and Limitation in Benefit–Cost Analysis.” Natural Resources Journal 6: 195–222. 3. Holmes, B. H. (1972). A History of Federal Water Resources Programs, 1800–1960. U.S. Dept. of Agriculture, Economic Research Service. 4. Polinsky, Mitchell A. (1989). An Introduction to Law and Economics. 2nd edition. Wolters Kluwer. 5. Shavell, Steve (1981). “A Note on Efficiency vs. Distributional Equity in Legal Rulemaking: Should Distributional Equity Matter Given Optimal Income Taxation.” American Economic Review 71: 414. 6. Kaplow, Louis and Steven Shavell (1994). “Why the Legal System is Less Efficient than the Income Tax in Redistributing Income.” Journal of Legal Studies 23: 667–681. Richard O. Zerbe. “Cost-Benefit Analysis in Legal Decision-making.” In: Parisi, Francesco (ed) (2017). The Oxford Handbook of Law and Economics. Vol 1: Methodology and Concepts. NY: Oxford University._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Economic Theories Parisi I Francesco Parisi (Ed) The Oxford Handbook of Law and Economics: Volume 1: Methodology and Concepts New York 2017 |
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