1 Last Updated:26 Oct.,2006 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 6

2 MEASUREMENT OF ECONOMIC PRICES OF NON-TRADABLE GOODS

3 Non-Tradable Commodities A good or service is considered non- tradable when its domestic price is determined by local demand and supply. An increase in demand (or supply) by a project could affect the amounts demanded by domestic consumers (or produced by other suppliers).

4 Defining a Price of Non-Traded Good or Service Goods and services whose domestic production satisfies all the domestic demand for these items and whose domestic prices are not affected by their world prices are referred to as non-traded goods. Distorted World Supply Price Price Quantity per year Domestic Supply Domestic Demand D S E m * P FOB * (1-t x ) - F x PmPm E m * P CIF * (1+T m ) + F m Distorted World Demand Price Domestic price

5 Steps to Estimate the Economic Value of a Non- Tradable Good or Service 1)Adjust for distortions in the market for the item (whether input to, or output of, the project). 2)Adjustment for Distortions in other markets. Because of General Equilibrium Effects.

6 Non-Tradable Goods Economic Benefits of Project Output (No Distortions) Value of Resources Saved Value of Increased Consumption Price S 0 + Project S0S0 D0D0 P0mP0m P1mP1m A C GF E B D Q s1s1 d1d1 Q Q0Q0 QTQT Quantity Step One: Adjusting for Distortions in the Market for Good or Service Economic Value = W x s P s +W x d P d If no output market distortions, then: P s = P d = P m

7 Calculating the Economic Value of Non-Tradable Goods Economic Value = W x s P s + W x d P d = weighted average of supply (P s ) and demand (P d ) price Where: W s + W d = 1 Weights expressed in terms of elasticities: W x s = Supply Elasticity  Supply Elasticity - Demand Elasticity  -  = W x d = Demand Elasticity -  Supply Elasticity - Demand Elasticity  -  = WxsWxs WxdWxd =  -- P s = Supply Price  = (defined positively)own price elasticity of supply P d = Demand Price  = (defined negatively) own price elasticity of demand

8 Classification of Goods and Weights on Demand and Supply Prices If rationing then Ws=0 and Wd=1 Traded: Importable Ws = 1 and Wd = 0 Exportable Ws = 0 and Wd = 1 Non-tradedWs > 0 and Wd > 0 Three classes of goods: WsWd ( S more responsive than D) 2/31/3 (Equally responsive) 1/21/2 (S less responsive than D) 1/32/3 Calculating the Economic Value of Non-Tradable Goods

9 Non-Tradable Goods Economic Benefits of Project Output (Tax on Output) Value of Resources Saved Value of Increased Consumption Q s1s1 d1d1 QQ d/s 0 Price S 0 + Project S0S0 D 0 Net of Tax P E G F J B D Quantity H A N d0d0 m0m0 P (1+t s )P m1m1 P d1d1 = P P = s0s0 m0m0 P = P m1m1 s1s1 D0D0 = W x s P m x0 + W x d P m x0 (1+ t s ) Example W x s =1/3, W x d =2/3 P m =120, t s =0.15 P e =1/3(120)+2/3(120)(1+0.15)=132 P e =40+80(1.15)=132 Economic Benefits

10 Non-Tradable Goods Economic Benefits of Project Output (other producers subsidized) Price S S P E G F J B D Value of Resources Saved Value of Increased Consumption Quantity H A s0s0 m0m0 P = / (1-k)P m1m1 P s1s1 = P P = d0d0 m0m0 P = P m1m1 d1d1 D0D0 S0S0 QQQ s1s1 d1d1 d/s 0 After Subsidy 0+Project C I After subsidy 0 Economic Benefits WxsWxs + W x d P m x0 P (1-k) Example W x s =1/3, W x d =2/3 P m =90, k =0.40 P e =1/3*(90/(1-0.4))+2/3*(90) P e =1/3(150)+2/3(90)=110

11 Non-Tradable Goods Economic Costs of Project Input (Input production subsidized) Value of Postponed Consumption Value of Additional Resources Price S P E G FJ B D Q d1d1 s1s1 QQ Quantity H A s1s1 m1m1 P= / (1-k)P m0m0 P s0s0 = P P = d1d1 m1m1 P = P m0m0 d0d0 D 0+Project S0S0 d/s 0 C I After Subsidy 0 D0D0 Economic Costs WxsWxs + W x d P m x0 P (1-k) Example W x s =1/3, W x d =2/3 P m =90, k =0.40 P e =1/3(90/(1-0.4))+2/3(90) ; P e =1/3(150)+2/3(90)=110