8 . BENEFIT-COST ANALYSIS: Part 2

1. 8. BENEFIT-COST ANALYSIS: Part 2

2. 8.1. Steps in Conducting Project Evaluation

3. Identification of Benefits and Costs  Identify all relevant costs and benefits, Costs or benefits can be either direct or indirect. They are also tangible or intangible. All kinds must be identified as they are relevant. Beware of double counting of costs and benefits

4. Calculation of Benefits and Cost in Monetary Value Whenever possible any relevant cost or benefit be converted to monetary value The problem of intangible costs and benefits are generally not convertible into monetary

5. 8.2 Differences between Benefit-Cost Analysis of Government Projects and that of Private Projects

6. For private projects, market price is applicable for any component of benefits and costs. • In contrast, for government projects market price is not applicable to certain types of goods and inputs. • For instance, roads, electricity and drinking water cannot be priced at market price. Instead, shadow price will be used in valuing these items

7. Other factors that make market price may not applicable for certain types of component of benefits and cost of government project include: monopoly, tax, unemployment and

8. Monopoly • Price used in evaluation of government project depends on impact of usage of input in a project • If a goods used as input in government project cause output increase as much as input used in the project, opportunity cost that the society faces is the marginal cost of production

9. If a goods used as input in government project did not cause increase output in market as much as input used in the project, value of input used government project is market price. This is because its use compete with that by other consumers.

10. Prevalence of Tax • When the government project uses goods upon which some tax has been imposed: • If production increases, tax must be excluded from the paid price • If production does not increase, market price is used in evaluating the project

11. Unemployment • Use of unemployed labor does not reduce production of goods in economy. • If used unemployed labor in government project, shadow pricing must be used to determine their wage. • If used employed labor in government project, their wage rate will be the same as the market wage rate. The reason is this. They were employed in other sectors, taking them from these sectors will reduce outputs of these sectors.

12. 8.3. Determination of Interest Rate for Government Project

13. Determination of interest rate is of crucial for government projects. Different rate will produce different result. • For illustration, observe the following case of two projects (Project-1 and Project-2)

14. From the table, it is clear that high interest rate makes NPV of the project which produce benefit for a longer period of time become smaller • Level of interest rate is selected for the project depends on potential risk faced by the project.

15. Normally, for government projects social discount rate is used. This rate has reflected inflation and tax. • According to Arrow, government implements a variety of projects so that overall government projects are risk-free.

16. 8.4. Some Examples of Social Discount Rate

17. 8.5. Advantage and Disadvantage of the Cost -Benefit Analysis • Advantage:  Its application in projects ensure that use of resources in projects are efficient • Disadvantage  B-C analysis requires quantitative data. In fact, not all components of benefit and cost can be measured quantitatively . This can result in a wrong conclusion

18. 8.6. Readings Mangkoesoebroto, Guritno. 1999.”Ekonomi Publik”. Yogjakarta: BPFE. Chapter 7 Stiglitz, Joseph E. 2000. “Economics of the Public Sector”. New York: W.W. Norton and Company. Chapter 11