Lecture Notes for Economics 435: Economics of Resources

Prepared by Gunnar Knapp, Professor of Economics

January 30, 2001

ECONOMICIMPACTANDECONOMICVALUEANALYSIS
CostBenefitAnalysisandEconomicImpactAnalysis
Twotechniquesusedintheevaluationofpublicresourcepoliciesandprojectsarecostbenefit
analysisandeconomicimpactanalysis.Itisimportanttounderstandthedifferencesbetween
thesetwotypesofanalysis.
Cost benefitanalysis(orbenefitcostanalysis)involvestheuseofvariouseconomictechniques
tocalculatethecostsandbenefitsofaparticularprojectorpolicy,andhowthesecostsand
benefitsaffectdifferentgroups.Byaddinguptotalcostsandbenefitswecancalculatethenet
valueofaprojectorpolicy.Bycomparingcostsandbenefitsofdifferentprojectsorpolicies,we
canfigureoutwhichprojectsorpoliciesarerelativelymoreefficient,andhowthecostsand
benefitsfallupondifferentgroups.
Theexplicitorimplicitpolicygoalincostbenefitanalysisisefficiency:projectsorpolicies
shouldonlybeundertakenifthebenefitsexceedthecosts.However,costbenefitanalysis,if
welldone,shouldalsoconsiderthedistributionalimplicationsofprojectsorpolicies:who
enjoysthebenefitsandwhopaysthecosts.
Economicimpactanalysisinvolvestheuseofvariouseconomictechniquestocalculatehowa
particularprojectoractivityaffectstheeconomyofaparticularregion.Mostcommonly,
economicimpactanalysisusesmeasuresofeconomicimpactsuchasemploymentandincome.
Economistsoftendistinguishbetweenthedirecteconomicimpactsofaprojectoractivity(for
example,employmentorincomegenerateddirectlyintheexploitationofaresource)andthe
indirecteconomicimpactsresultingfromadditionalactivitycreatedbytheproject(suchasthe
incomeearnedinrestaurantsorbarbershopsasworkersinresourceindustriesspendtheir
income).
Largeeconomicimpactsareoftenconsideredgoodforregionsinneedofjobsandincome.
Notethatlargeeconomicimpactsdonotnecessarilyimplythataprojectisefficient.Themorea
projectcosts,themorejobsandincomeitislikelytogenerate.Itisperfectlypossiblefora
projecttogeneratelotsofemploymentandincomeandatthesametimehavethecostsexceed
thebenefits.
UsesofEconomicImpactandEconomicValueAnalysis
Economicimpactanalysisandeconomicvalueanalysisareincreasinglybeingusedto
studytheeconomiccontributionsofresources,ortohelpevaluatetheconsequencesof

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publicpolicydecisionsaffectingresources.Thesekindsofanalysisarebeingusedto
makemoreinformeddecisionsaboutthefollowingkindsofissues(amongothers):

Publicfundingforresourcesmanagementandenhancement.Arethebenefits
generatedbyresourcemanagement(NationalParks,NationalForests,fisheries)
worththepubliccosts?Whatlevelsoffundingarejustified?

ResourcemanagementstrategiesWhatkindsofmanagementstrategieswill
producethegreatesteconomicbenefit?

Resourceallocation.Howshouldfishbeallocatedbetweendifferentcommercial
geargroups,betweendifferentgroupsofsportfishermen,andbetweensportand
commercialgroups?Howshouldforestsbedividedupbetweenwildernessand
logginguses?

Environmentalprotection.Whataretheeconomicbenefitsderivedfrom
environmentalmeasures,suchasrestrictionsonloggingorminingorhydroelectric
development?Dothesebenefitsjustifythereductionintheseothereconomic
opportunities?

Amorecynicalviewofeconomicimpactandeconomicvalueanalysiswouldbethatthe
analysisisnotusedtoactuallymakethesedecisions,butratherused,whereconvenient,
tojustifyargumentsofgroupsinfavorofaparticulardecision.
Foranyoneinvolvedinresourcespublicpolicy,itisimportanttohaveanunderstanding
ofatleastthebasicsofeconomicimpactandeconomicvalueanalysisthekindsof
questionswhicheachtypeofanalysiscanandcannotaddress,themethodsthatareused
foreachtypeofanalysis,andsomeofthecommonmistakesassociatedwithdoingor
interpretingeachkindofanalysis.
EconomicValuevs.EconomicImpacts
Contrasttheconceptsofeconomicvalueandeconomicimpacts.Howiseach
defined?Forwhichpublicpolicygoalsiseachrelevant?
Economicvalue(alsoreferredtoaseconomicbenefit,neteconomicvalue,ornet
economicbenefit)measureshowmuchaneconomicactivityisworthtoresidentsofa
specifiedgeographicarea.Neteconomicvalueiscalculatedbysubtractingtotalcosts
fromtotalbenefits.Totalbenefitscanincludebothmarketbenefits(whichcanbe
observedfrommarkettransactions)aswellasnonmarketbenefits(benefitswhichare
receivedwithouthavingtopayforthem).
Economicimpactsarejobs,incomeorothermeasuresofeconomicactivitywithina
specifiedgeographicareaassociatedwithorgeneratedbyaneconomicactivity.In

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contrasttoeconomicvalue,whichhasaveryspecificdefinition,therearemanypotential
measuresofeconomicimpacts(forexampletotaljobs,totalfulltimejobs,totalfulltime
jobsforresidents,etc.)
Notethateconomicvalueanalysisistheappropriatetechniquetouseifyouareinterested
inthegoalofefficiency.Forthisreason,economistsarelikelytoarguethateconomic
valueanalysisistherightmethodtouseinstudyingresourcepublicpolicyissues.
Notethateconomicimpactanalysisistheappropriatetechniquetouseifyouare
interestedingoalssuchasjobsandeconomicgrowth.Forthisreason,politicians
andinterestgroupsoftenaremoreinterestedinormoreinclinedtoseizeupontheresults
ofeconomicimpactanalysis.
Contrastthetreatmentofexpendituresinthecalculationofeconomicvalueand
economicimpacts.
Acriticaldifferencebetweeneconomicvalueanalysisandeconomicimpactanalysisis
howtheydealwithexpenditures.Incalculatingeconomicimpacts,expendituresgenerate
jobsandincome.Thusthemoreexpendituresassociatedwithanactivity,thegreaterwill
betheeconomicimpacts.Putdifferently,expendituresaregoodforcreatingeconomic
impacts.
Incalculatingeconomicvalue,expendituresareacostofusingaresource.Forexample,
ifacommercialfishermanhirescrew,buysaboat,orbuysfuel,thesearecostswhich
aresubtractedfromthevalueofthecatchinordertocalculatetheneteconomicvalueof
thefishery.Putdifferently,expendituresarebadinthesensethatthehigher
expenditures,thelowerwillbeneteconomicvalue.
LinkingEconomicImpactandValueAnalysis
toActualPublicPolicyDecisions
Whatbasicruleoflogicisimportanttorememberwhenusingeconomicimpactor
valueanalysisforactualpublicpolicydecisions?
Tousetheresultsofanyeconomicvalueoreconomicimpactanalysisforapublicpolicy
decision,theeconomicvalueoreconomicimpactanalysismustbelogicallyrelatedtothe
actualpublicpolicydecision.Surprisinglyoften,thisisnotthecase.
Whyisknowingthetotalvalueortotaleconomicimpactsofaresourceoftennot
particularlyuseful?
Manystudieshavebeendoneabouttheeconomicvalueoreconomicimpactsassociated
withvariousresources.Insomecases,theresultsofthesestudieshavebeentranslated
intoaverageeconomicvalueoraverageeconomicimpactsperfishorperacre.

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Butknowingthetotalvalueortotaleconomicimpactsassociatedwithaparticular
resourcemaynotbeparticularlyusefulifpublicpolicydecisionsdontinvolvedecisions
abouttotallyendingtheresourcebenefits.
Caremustbeusedinlinkingtheresultsofthesestudiestoactualpublicpolicydecisions.
Itisnotenoughtoknowthetotaleconomicvalueoreconomicimpacts.Youmustask
thequestionwhatspecificinformationabouteconomicvalueoreconomicimpactsis
relevanttothespecificquestionIamtryingtoanswer?Oftenthetotalvalueissimply
notrelevant.Whatisrelevantishowthetotalvaluewouldchangeasaresultofthe
policydecisionunderconsiderationandthismaybeverydifferentthanthetotalvalue,
andwhichmaynotbecloselyrelatedtotheaveragevalueeither.
Herearesomeexamplesofincorrectandcorrectusesofanalyticalresultsforpublic
policydecisionsinvolvingfisheries:
IRRELEVANT:Thecommercialfisheryprovidesnetbenefitsof$Y,andwespend$X
onfisheriesmanagement.Thisisirrelevantbecause(usually)nooneisproposingdoing
awaywithallfisheriesmanagement.Theactualpublicpolicydecisionrelatesto
increasingordecreasingmanagementexpendituresbysomeamount.
RELEVANT:Changingfisheriesmanagementexpendituresby$Ywouldchangenet
benefitsofthecommercialfisheryby$X.
IRRELEVANT:ThenetbenefitsgeneratedbytheCookInletsportfisheryare$Y,
whilethenetbenefitsgeneratedbytheCookInletcommercialfisheryare$X.Thisis
irrelevantbecausethepublic(usually)doesnotfaceanallornothingchoicebetweenthe
sportorcommercialfishery.
RELEVANT:Theproposedmanagementactionwouldchangethenetbenefitsofthe
sportfisheryby$Ywhilechangingthenetbenefitsofthecommercialfisheryby$X.
IRRELEVANT:Thetreesproposedforharvesthaveavalueof$Y,whilethesalmon
inthestreamareworth$X.Thisisrelevantonlyifharvestingthetreeswouldendall
salmonharvestsinthestream.
RELEVANT:Thetreesproposedforharvesthaveavalueof$Y;harvestingthem
wouldreducethevalueofsalmonharvestsby$X.
Inpractice,assessingtheactualeconomicimpactsoreconomicvaluesrelevanttospecific
publicpoliciescansometimesbeverydifficult,becauseitinvolvespredictingthe
consequencesofspecificmanagementactions.Lookattheexamplesabove:ineach
case,itwouldbealoteasiertocalculatethenumbersfortheirrelevantthanforthe
relevantstatement.

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Sometimesitisevendifficulttopredictwhatthepublicpolicyactionsmightbethat
wouldbecarriedoutinresponsetoacutinmanagementfunding,orachangein
allocationbetweensportorcommercialfisheries.Thismakesitevenmoredifficultto
analyzetheeconomicconsequences.
Butthisdifficultyisnoexcuseforsloppylogic.Themostsophisticatedanalysisof
economicimpactoreconomicvalueisworthlessforapublicpolicydecisionunlessit
relates(orcanberelated)tothatactualdecision.
Averagevs.MarginalEconomicValueandImpacts
Contrasttheconceptsofmarginaleconomicvalueandaverageeconomicvalueand
impacts.Whatisthedefinitionofeach?Whichislikelytobelarger?Whichismore
likelytoberelevantforpublicpolicyanalysis?
Thefollowingdefinitionsarestatedintermsoffisheries,butcanbeappliedtoother
resourcesbysubstitutingothermeasures(forexample,acres)fornumberoffish.
Averageeconomicvalueperfishisthetotalvaluedividedbythenumberoffish.
Marginaleconomicvalueofafishistheextravaluederivedfromonemorefish.Note
thatmostoftheirrelevantexamplesaboveinvolvedtotaloraveragevalue,whilemost
oftherelevantexamplesaboveinvolvedmarginalvalue.
Averageeconomicimpactperfishisthetotalimpactdividedbythenumberoffish.
Marginaleconomicimpactofafishistheextraimpactderivedfromonemorefish.
Thecontrastbetweenaverageandmarginalisveryimportantinmanyareasof
economics,includingeconomicvalueandeconomicimpactanalysis.Economistsusually
arguethatmarginalvalueormarginalimpactismorerelevantformostpublicpolicy
decisions.Butitisofteneasiertocalculateaveragevaluesorimpactsandaverage
valuesandimpactsareoftenaneasierconceptforthepublictounderstand.
Averagevaluemaybeverydifferentfrommarginalvalue;averageimpactsmaybevery
differentfrommarginalimpacts.Acommonmistakeistoassumethataverageand
marginalvalueorimpactsareequaltoeachother.
Infisheries,forexample,inthesportfishery,themarginalvalueassociatedwithone
morefishislikelytobelessthantheaverageeconomicvalue.Thisisbecauseofthe
principleofdecliningmarginalutilitywegetlessenjoymentfromthefifthfishthat
wecatchthanfromthefirstfishthatwecatch.Toseethis,assumethattherearenocosts
incatchingsportfish(oftenaveryincorrectassumption).Ifyouget$50worthof
enjoymentfromcatchingonefish,and$75worthofenjoymentfromcatchingtwofish,
thentheaveragevalueneteconomicvalueperfish(whenyoucatchtwofish)is$37.50,
butthemarginalvalueofthesecondfishisonly$25.

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Incontrast,inthecommercialfishery,themarginaleconomicvaluemayexceedthe
averageeconomicvalue.Thiscanoccurifthecostsofcommercialfishingarefixed,
regardlessofthesizeofthecatch(forexampleiftheonlycostoffishingweretheboat).
Inthiscase,themorefishyoucatch,themorefishthefixedcostsarespreadover.Tosee
this,supposeyouhaveafisherythatcatches100,000fishworth$1perfish,withatotal
fixedcostof$50,000.Theaverageneteconomicvalueperfishis(totalbenefitstotal
costs)/(numberoffish)=($100,00050,000)/100,000=$.50.Butthemarginalvalueof
anextrafishis(increaseintotalvalue)(increaseintotalcosts)=$1$0=$1.
Marginaleconomicimpactsarelikelytobesmallerthanaverageeconomicimpactsin
boththecommercialandsportfisheries.Thereasonisthatevenifyouspendalotof
moneyperaveragefishcaught,youdontnecessarilyincreaseyourspendingbyvery
muchtocatchmorefish.Ifallsportanglerswentfromcatchingonefishperdayto
catchingtwofishperday,theywouldstillbepayingalmostthesameamountfortravel,
food,lodging,tackle,andguideservices.
EconomicImpactAnalysis
Contrastdirectandindirecteconomicimpacts.
Economicimpactanalysistracestheeffectsofexpendituresastheywindtheirway
throughtheeconomy.Aninitialexpenditurecirculatesthroughtheeconomyandcreates
andchainreactionofadditionalexpenditures.Economistsgenerallyrefertotheeffects
oftheinitialexpendituresasdirecteconomicimpactsandtheeffectsoftheadditional
expendituresasindirecteconomicimpacts.Totaleconomicimpactsarethesumofthe
directandindirectimpacts.
Whatisaneconomicmultiplier?Howisthemultiplierrelatedtothesizeoftheregion
beingstudied?
Economistssometimessaythatthedirecteconomicimpactsaremultipliedthrough
theirindirecteconomicimpacts.Theratioofthetotal(direct+indirect)economic
impactstothedirecteconomicimpactsisfrequentlyreferredtoastheeconomic
multiplier.Theemploymentmultiplieristheratiooftotalemploymenttodirect
employment.Theincomemultiplieristheratiooftotalincometodirectincome
created.(Sometimesthetermmultiplierisreferredtotheratiooftheindirectimpacts
tothedirectimpacts.)
Ingeneral,thesmallertheregionwhichyouarestudying,thefasterexpendituresare
likelytoleakoutoftheregion,andthesmallertheemploymentandincomemultipliers
arelikelytobe.InAlaskaspendingleaksoutoftheeconomyfairlyrapidlybecausea
largeshareofexpendituresgooutsidethestate.Forthisreason,theemploymentand
incomemultipliersfortheAlaskaeconomytendtobesmallerthanfortheU.S.economy

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asawhole.Probablythesemultipliersarebothlessthan2.5fortheAlaskaeconomy.Be
suspiciousofclaimsthateachjobcreatedinAlaskabythe(sportorcommercial)fishery
createsanothersixjobs.Beespeciallyskepticalofthisclaimwhenitismadefora
specificcommunity.
Inputoutputanalysisisamethodcommonlyusedforeconomicimpactanalysis.This
methodtraceshowexpendituresinonesectorgeneratehouseholdincomeaswellas
expendituresinothersectors,andcalculatesthetotalexpendituresandincomegenerated.
Whyisthelossinjobsinaneconomythatwouldresultfromendingtheexploitationof
aresourcenotnecessarilythesameasthenumberofjobscreatedbythatresource?
Acommonbutveryimportantlogicalflawintheapplicationofeconomicimpact
analysistoresourcesistheassumptionthatthejobsorincomecreatedbytheresource
woulddisappearfromtheeconomyifthefisherydidntexist.Whilethismaysoundlike
areasonableassumption,itaintnecessarilyso.Forexample,expendituresonfishing
createjobsandincome.Butifthefisherydidntexist,thenmanyoftheexpendituresthat
weremadeinthefisherymightbemadeinanotherpartoftheeconomycreatingother
jobsandincome.Thustheactualnetchangeintotaljobsandincomesmightbemuch
lessthanwouldbeexpectedbasedoneconomicimpactanalysis.
Forexample,thereisnoquestionthatAlaskaresidentsspendagreatdealonsport
fishing,andthatthisspendingcreatesmanyjobsforsportinggoodsstoreclerks,gas
stationattendants,fishingguides,charterpilots,andsoforth.ButifallAlaskasport
fisherieswereshutdownthenAlaskanswouldntjustburyalltheirmoney.Theywould
insteadspenditonsomethingelse.TotheextentthattheyspenttheirmoneyinAlaska,it
mightcreatemorejobsforrestaurantwaiters,bowlingalleyattendants,huntingguides,
andsoforth.
However,itisverydifficulttoactuallytracehowchangesinresourcemanagementmight
changeexpendituresinotherareasoftheeconomywhichiswhythisveryimportant
issueisoftensimplyignored.Another,morecynicalinterpretationisthatitisconvenient
toignorechangesinotherexpendituresbecausethistendstoexaggeratetheextentto
whichaneconomydependsonaresource.

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