cost benefit analysis

Question 1

Define cost benefit analysis.

Answer 1

This is a technique designed to determine whether a project should go ahead -Do the benefits outweigh the costs?
- Cost Benefit Analysis not only includes private monetary costs but also EXTERNALITIES and NON MONETARY costs

Question 2

Briefly explain Social costs, Private costs, External costs, and their relationship.

Answer 2

socials costs: come from whole society (individual, firm, government,
social costs include private costs and external costs
private costs: need of fuel and maintenance
external costs: taxpayer pays/ pollution

if no external cost, private cost= social cost, e.g. education

Question 3

Procedure of cost-benefit analysis

Answer 3

1. ALL costs and benefits are identified. These include external and non monetary
2. A monetary value is assigned to each costs and benefit. A common value must be used, this is difficult for putting a value on noise, pollution
3. Account is taken of future costs and benefits; these will also be discounted, for example, $100 now is worth more than $100 in the future
4. Some costs may have a probability of occurring e.g. accident has a 10% chance of occurring but would cost $6,000. Therefore the cost is 0.1 * $6,000 = $600

Question 4

Benefits of economic growth

Answer 4

Higher rates of economic growth mean that levels of production are increasing. In order to produce
more, there will be increased demand for resources such as labour. This will result in a lowering of the
unemployment rate and also give more workers the opportunity to change jobs. A further benefit of a
growing economy and lowered levels of unemployment is that incomes will rise for those who are
currently in work or who are now able to find work.
A growing economy can help to improve the nation’s international trading position. As more production
takes place in areas, such as mining and agriculture, export markets can be developed which will bring
money and new investment into the country.

Question 5

Negative effects of growth on an economy

Answer 5

• If growth is at too fast a pace, shortages can occur and inflation (rising prices) will take place.
• This disadvantages those whose incomes do not rise at the same rate as inflation and also makes it harder for local producers to compete against overseas made products.
• One of the main effects of economic growth is in the area of externalities. An externality is an effect on
  a third party not directly involved in the production process that results from production. These can be
  either positive or negative.
• For example, a positive externality which will occur from holding the Olympics in Brisbane in 2032 is
  that many new sports venues will be built and made available for the community to use after the
  conclusion of the Games. A negative externality could be that parklands may be destroyed in order to
  build the new venues, possibly affecting the quality of life of people who currently use them.

Question 6

Cost and benefits of increasing domestic supply of gas as the gas resources are close to depletion.

Answer 6

The federal government has redirected some of the contracted gas to the local market, which has increased
supply and lowered prices. However, this has the potential to disrupt energy supplies to major markets in
Japan, China, Singapore and Korea who have long term contracts with Australian suppliers. If Australia
becomes a less reliable supplier, then some fear that this could impact future foreign investment into
Australia’s energy market.
Alternatively, the government could encourage more exploration or the opening up of new gas fields in the
southern States. A problem with this is that many States have placed limits on gas exploration or have
banned activities, such as fracking, due to environmental concerns.
Added to the above is that the government has introduced a safeguard mechanism (refer to Section 4 –
Overcoming Market Failure) in order to reduce Australia’s CO2 emissions. New large-scale projects would
need to comply with the guidelines in order to meet its standards for emissions. This could mean that some
projects would not be commenced.

Question 7

What are the approaches that determine whether the project should occur? Briefly explain them.

Answer 7

Simplest method is whether total benefits > total costs
Pareto approach. This means that everybody has to benefit from the project or at least no-one is worse off as a result. A pareto improvement may involve voluntary compensation to those who could potentially lose out.
Hicks-Kaldor Criteria. The Hicks-Kaldor Criteria is less stringent. Hick-Kaldor efficiency occurs when in theory, those who gain from project could adequately compensate those who lose out.
Allow the project to go ahead with regulation

Question 8

What are some problems with using a cost benefit analysis?

Answer 8

• Converting into monetary value. - Direct costs are easier to identify and place value upon than indirect costs.
• Agreeing on the benefits of landscape, noise, cost of human life, etc. Viewpoints will differ.
  the unpredictable, e.g. Chernobyl
• Planning takes a long time and benefits and costs may change frequently e.g. the NBN (large infrastructure project constructed over many years)
• Choosing a value for future benefits and costs
• Identifying externalities (unintended consequences)