Partial equilibrium B/C - A (Cost Benefit Analysis DEC 51304) R. Jongeneel Zerbe & Dively Ch.7-8

Lecture Plan  Partial equilibrium analysis  CS and PS revisited  Examples - monopolist with constant costs - taxation - technical progress - external effects  Multiple market - equilibrium analysis  Multiple price changes + Footnote on welfare economic analysis and applied CBA

Partial equilibrium analysis  Assumption only one one market is affected  Examine effects in this market only  Partial equilibrium (PE) analysis  PE  MME  GE (general equilibrium)

CS and PS revisited  Demand curve  approx WTP  CS: excess of WTP over what is actually paid  Supply curve  opportunity costs of output provision  PS: excess of payments over opportunity costs (quasi-rents)  External effects give rise to CS and PS changes  Transfers: neither benefit nor cost

CS and PS revisited Fundamental equation of welfare change  W =  CS +  PS +  GR +  EE CS: consumer surplus PS: producer surplus GR: government revenue EE: external effects

Examples: Monopolist  W=  CS +  PS = A - (A+B+C) + (B-0) = -(B+C) + B = -C butter price Q0Q0 MR Q1Q1 demand A B C P1P1 P0P0 DWL-triangle MC E

Examples: Taxation  W=  CS +  PS +  GR = -(B+C) B = -C excess burden of taxation quantity price Q0Q0 Q1Q1 A BC P1P1 P0P0 S(=MC) S+t t

Examples: Taxation  W=  CS +  PS +  GR = -(B+C+D) - (E+F) + (B+C+E) = -(D+F) = DWL cons + DWL prod price quantity A B C D E F G D S0S0 S 1 =S 0 +t t PDPD P0P0 PSPS Q1Q1 Q0Q0

Example: taxation & welfare loss Bishop’s rule : absolute values of elasticities t: percentage tax (e.g. 0.25) Lessons ….?

Some Lessons  Distortionary taxation is not P-Eff.  DWL is quadratic function of t (broad tax base-argument)  DWL increase the more elastic are demand and supply (Ramsey)  The relative inelastic-side of the market pays the main burden

Examples: Technical progress  W=  CS +  PS = (B+C+D) + (F-B+E) = C+D+F price wheat A B C D E F D S1S1 S0S0 P0P0 P1P1 Q1Q1 Q0Q0

Examples: External effects + tax  W=  CS +  PS +  GR +  EE = -(B+C+D+E+F)+ 0 + (B+D) + (E+F+G) = -C + G A B C D E F G D P1P1 P 0 + D P0P0 Q1Q1 Q1Q1 Q0Q0 t LRS+t LRS+D (=soc. cost) LRS=MC

Multiple Market Equilibrium (MME) analysis  MME analysis takes into account relevant related markets  Harberger’s rule Add to the standard PE-analysis the change in GR’s in the related distorted markets  In non-distorted related markets marginal costs and marginal benefits of changes in production and consumption will just offset each other.

Multiple price changes  Multiple price changes require sequential welfare measurement  W =  CS +  PS +  GR +  EE

CBA in Individual consumer economy & Small project A footnote on welfare economic (surplus) analysis and applied cost benefit analysis

CBA in Individual consumer economy & Small project  Single individual  Single price change / income kept constant  No 2 nd market price effects  First-best economy (no other distortions)  Marshallian CS good approximation  PS good approximation

CBA in Individual consumer economy & Small project P 1.0 P 1.1 P 2.0 q 1.0 q 1.1 q 2.1 q 2.0 d e a b c Tax/levy

CBA in Individual consumer economy & Small project  Change in CS : P 10 a b P 11  Income constant : change in spending is zero!  q 10 c b q 11 – P 10 a c P 11 – q 21 d e q 20 = 0  Change in welfare (dU)  dU = P 10 a b P 11 = P 10 a c P 11 + abc  dU = q 10 a b q 11 + q 21 d e q 20

CBA in Individual consumer economy & Small project P 1.0 P 1.1 P 2.0 q 1.0 q 1.1 q 2.1 q 2.0 d e a b c + --

CBA in Individual consumer economy & Small project  Change in welfare: dW continued .  Small project: price changes small . Total benefits- method => income effect-method