1. Measuring Costs and Benefits
Measuring Benefits and Costs (See Chap 4):
Consumers’ Willingness to Pay (WTP)
Consumer Surplus (CS)
Producers’ Surplus (PS)
Social Surplus (SS)
Measuring Benefits in Secondary Markets (See Chap 5)
Only measure if there are significant price changes in secondary markets

2. Measuring Benefits
Utility Theory
Utility
Quantity Consumed

3. Measuring Benefits Diminishing marginal utility
What evidence do we have that individuals’ utilities have this property?
“Revealed preferences”
At lower prices, people consume more.
As prices increase, the amount people consume decreases

4. Measuring Benefits Demand Curve Price P0 X0 P1 X1 D Q0 Q1
Quantity Consumed

5. Measuring Benefits
Demand curve shows actual expenditure behaviors of individuals
When goods are scarce, people willing to pay high price
When goods are abundant (people are already consuming a lot), people willing to pay only a lower price
Measured in monetary terms
Note: Consumers expenditure behaviors are constrained by their budgets!
Demand response has both substitution (pure preferences) and income effects

6. Measuring Benefits Demand curve – Willingness to pay
In market exchanges, consumers to not actually pay all that they would be willing to pay. Markets are not able to discriminate prices charged for each unit sold.

7. Measuring Benefits Price Market Equilibrium WTP0 S Pe
Actual Expenditures D Q0
Quantity Qe

8. Measuring Benefits
Difference between WTP and actual expenditures is Consumer Surplus CS.
WTP is the theoretically correct measure, and CS is only an approximation, but widely used in empirical studies

9. Measuring Benefits Price Market Equilibrium WTP0 S Consumer Surplus Pe
Actual Expenditures D Q0
Quantity Qe

10. Measuring Benefits
WTP and CS do not change if market price does not change
Perfectly elastic demand curve

11. Mozambique market for electricityDM
DSA
PSA
QD0
QS0
QS1

12. Local Market for Cable Connections
D (Marginal WTP) A
(CS0) C
(CS) P* B
(EXP0) D
(EXP) Q0 Q1

13. Measuring Costs Area under supply curve (MC curve)
Analogous to consumer, in market exchanges, producers’ revenues are greater than minimum necessary to meet their production costs
Assumptions:
Perfect competition
Profit-maximization (MR = MC)

14. Measuring Costs TC
Total
Revenue,
Cost TR
TRe
Profit
TCe Qe
Quantity

15. Measuring Costs
Marginal
Revenue,
Cost
S=MC
P=MR
Profit
Quantity

16. Measuring Benefits in Secondary markets
Only measure benefits in secondary markets if the project causes prices in secondary markets to change (by a significant amount)

17. Social Surplus Social Surplus = Consumer surplus + Producer Surplus
Social surplus is maximized in competitive markets
Assuming no market imperfections!