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LECTURE 9
Benefit-Cost Analysis
First of two related lectures:
1. Overview of benefit-cost analysis 2. Specific benefit-cost tools Remember to review the BCA packet!
Benefit-Cost Analysis
What is benefit-cost analysis? BCA is an economic technique used to: 1.Evaluate a project or investment over time 2. Compare the merits of a set of projects
BCA is conducted by comparing economic benefits of an activity with economic costs of an activity.
Key Point
As a tool for economic analysis, BCA seeks to examine potential actions with the objective of increasing well being...
seeking an activity or use that provides greater benefit than cost, or the greatest benefit among competing uses.
Key Point
Decisions are typically not made on the basis of BCA alone but BCA can be useful for providing information on economic features of projects or activities, and can therefore be useful for informing the debate.
BCA as Approach
To know whether society should build the dam, other information may be needed:
1. Are there non-economic impacts? 2. What is the opportunity cost of the dam?
Discounting
Discounting is a technique used to convert all benefits and costs to a common point in time, usually the present.
The value of a project, expressed in terms of the present, is called the Present Value.
Discounting
Discounting is based on the premise that a dollar of benefit received today is worth more than a dollar of benefit received in the future.
The bias arises because current resources can be invested.
Discounting
The rate at which a current value is compounded is called the interest rate.
The rate at which a future value is discounted is called the discount rate.
PV = Pt / (1 +
PV = present value Pt = value at time t r = interest (discount) rate t = year in which Pt is realized
t r)
Key Points
Whenever benefits and costs accrue at different points in time, amounts should be converted to present values for comparison.
BCA is a decision-support tool, not a decisionmaking tool. Discounting can be used regardless of the length of time under consideration, but discounting has implications for equity.