1、Benefit-Cost Analysis in Environmental Decision Making,Chapter 9,2,Benefit-Cost Analysis in Practice,Two major steps follow the estimation of environmental benefits and costs Making time adjustments Benefits and costs must be adjusted to account for how their values change over time Assessing relati
2、ve values Benefits and costs must be systematically compared to determine feasibility to choose among feasible options based on a decision rule,3,Time Adjustments,Purpose of these adjustments Benefits and costs do not accrue to society at the same time Benefits and costs often accrue in the future T
3、wo types of adjustments Present value determination accounts for the opportunity cost of money Inflation correction accounts for changes in the general price level,4,Present Value Determination,Discounts a future value (FV) into its present value (PV) by accounting for the opportunity cost of money
4、(its highest valued alternative use, which is the rate of return (r) on investment) Explains why money loaned in the present must be paid back in the future with interest Further explains why the present value of monies received in the future is discounted,5,Present Value Determination,General formu
5、la PV = FV1/(1 + r)t where: 1/(1 + r)t is the discount factor t is number of time periods r, the discount rate, is the only variable called the social discount rate in public policy r should reflect the social opportunity cost of funds PV determination is the means by which future environmental bene
6、fits and costs are adjusted,6,Inflation Correction,Adjusting for movements in the general price level Convert a real variable today to its future nominal value to account for expected inflation Nominal valueperiod x+t= Real valueperiod x (1 + p)t, where p is the expected inflation rate Converting a
7、nominal value to its real value Real valueperiod x = Nominal valueperiod x + t /(1 + p)t Known as deflating,7,Deriving Time-Adjusted Benefits and Costs,Present value of benefits (PVB) is the time-adjusted magnitude of incremental benefits associated with an environmental policy change PVB in real do
8、llars is PVB = S(bt/(1+rs)t) where bt represents real benefits Present value of costs (PVC) is the time adjusted magnitude of incremental costs associated with an environmental policy change PVB in real dollars is PVC=S(ct/(1+rs)t) where ct represents real costs,8,Benefit-Cost Analysis in Policy,Ste
9、p 1: Determine if an option is feasible Step 2: Select from among feasible options,9,Step One Determining Feasibility,Use the benefit-cost ratio If PVB/PVC 1 option is feasible OR Use the present value of net benefits (PVNB), which equals (PVB PVC) If PVNB 0 option is feasible,10,Step Two Select Amo
10、ng Feasible Options,Decision rule: To achieve allocative efficiency Maximize PVNB = S(bt - ct)/(1+rs)t for all t periods, among all feasible alternatives Decision rule: To achieve cost-effectiveness: Minimize PVC = S(ct/(1+rs)t) for all t periods, among all feasible alternatives that achieve a prede
11、termined benefit level,11,Reservations About the Use of Benefit-Cost Analysis,Measurement Problems Estimation is particularly problematic due to intangibles Implicit costs Equity Issues Distribution of benefits and costs may be highly skewed,12,Federal Government Support,Reagans Executive Order 1229
12、1 Explicitly called for maximizing net benefits (allocative efficiency) and choosing the least-cost alternative (cost-effectiveness) Detail of potential benefits and costs to be given in a Regulatory Impact Analysis (RIA) Applicable to any “major rule,” i.e., a regulation expected to have an annual
13、impact of at least $100 million,13,Federal Government Support,Clintons Executive Order 12866 Explicitly refers to adopting/proposing regulations for which benefits justify costs (allocative efficiency) and designing regulations in most cost-effective manner Applicable to any “significant regulatory
14、actions,” including those expected to have an annual impact of at least $100 million Detail to be given in an Economic Analysis (EA),14,Federal Government Support,Bushs Executive Order 13258 Makes only minor amendments to Clintons Executive Order 12866 Extends the use of economic criteria in policy
15、design and evaluation through an Economic Analysis,15,Regulatory Impact Analysis (RIA) Lead in Gasoline,Estimated incremental benefits included health effects and nonhealth effects, such as increased fuel economy Estimated incremental costs were estimated using an engineering cost model of the refinery industry The resulting PVNB over the 1985 - 1992 period (excluding blood pressure effects) was estimated to be $5.9 billion ($1983) and supported the proposed new lead standard,
