1. 1 Civil Systems Planning Benefit/Cost Analysis Chapters 4 and 5 Scott Matthews Courses: 12-706 and 73-359 Lecture 5 - 9/11/2002

2. 12-706 and 73-3592 Going Over HW #1  Mean = xx (out of 35, xx%)  St. dev = xx  Min = xx, Max = xx  Generally no major problems

3. 12-706 and 73-3593 Externalities  Recall that external effects happen to third parties (non-consumers, producers)  Cause distortions in the market  Are by-products with no markets  Since number of externalities is large, CBA can/should be used before government intervenes to correct

4. 12-706 and 73-3594 Pollution (Air or Water) Q P Q# P# S*: marginal Private costs D S#:marginal Social costs P* Q* Typical supply functions (MC) only Describe private, not social costs. We assume parallel cost curves What do these curves, Equilibrium points tell us?

5. 12-706 and 73-3595 Pollution (Air or Water) Q P Q# P# S*: marginal Private costs D S#:marginal Social costs P* Q* Relatively too much gets produced, At too low of a cost - how to Reduce externality effects?

6. 12-706 and 73-3596 Pollution (Air or Water) Q P Q# P# S*: marginal Private costs D S#:marginal Social costs P* Q* Government can charge a tax ‘t’ on Each unit, where t = distance between The two supply curves - What is NSB? t

7. 12-706 and 73-3597 Pollution (Air or Water) Q P Q# P# S*: marginal Private costs D S#:marginal Social costs P* Q* CS = (loss) A+B PS=(loss) E+F t P# - t AB E F

8. 12-706 and 73-3598 Pollution (Air or Water) Q P Q# P# S*: marginal Private costs D S#:marginal Social costs P* Q* Third parties: (gain) B+C+F (avoided quantity between S curves) Govt revenue: A+E Total: gain of C t P# - t B F C A E C is reduced DWL of pollution eliminated by tax

9. 12-706 and 73-3599 Distorted Market - Vouchers  Example: rodent control vouchers  Give residents vouchers worth $v of cost  Producers subtract $v gov’t pays them  Likely have spillover effects  Neighbors receive benefits since less rodents nearby means less for them too  Thus ‘social demand’ for rodent control is higher than ‘market demand’

10. 12-706 and 73-35910 Distortion : p0,q0 too low Q P Q0 P0 S-v DMDM S D S: represents WTP For vouchers by all people P1 Q1 What is NSB? What are CS, PS?

11. 12-706 and 73-35911 Social Surplus - locals Q P Q0 P0 S-v DMDM S DSDS P1 Q1 B P E P1+v A C What about other people in society, i.e. nearby neighbors? Because of vouchers, Residents buy Q1

12. 12-706 and 73-35912 Nearby Residents Q P Q0 P0 S-v DMDM S DSDS P1 Q1 B P E P1+v A C Added benefits are area between demand above consumption increase What is cost voucher program? F G

13. 12-706 and 73-35913 Voucher Market Benefits  Gain (CS) from target pop: B+E  Gain (CS) in nearby: C+G+F  Producers (PS): A+C  Program cost (vouchers):A+B+C+G+E ----  Net: C+F

14. 12-706 and 73-35914 Opportunity Cost: Land Q P D b Price Government decides to buy Q acres of land, pays P per acre What is total cost of project? S

15. 12-706 and 73-35915 Opportunity Cost: Land Q P D b Price Government pays PbQ0, but society ‘loses’ CS that they Would have had if government had not bought land. This lost CS is the ‘opportunity cost’ of other people using/buying land. S 0

16. 12-706 and 73-35916 Another Example: Change in Demand for Concrete Project  If Q high enough, has effect: q’ more  Shifts demand - has supply/price effect  Moves from (P0,Q0) to (P1,Q1).. And?? Q0 P0 D a Price Quantity D+q’ S P1 Q1

17. 12-706 and 73-35917 Another Example: Change in Demand  Original buyers: look at D, buy Q2  Total purchases still increase by q’  What is net cost/benefit to society? Q0 P0 D a Price Quantity D+q’ S P1 Q1 Q2

18. 12-706 and 73-35918 Another Example: Change in Demand  Original buyers: look at D, buy Q2  Project spends B+C+E+F+G on q’ units  Project causes change in social surplus! Q0 P0 D Price Quantity D+q’ S P1 Q1 Q2 E B C FA G G G

19. 12-706 and 73-35919 Another Example: Change in Demand  Decrease in CS: A+B (negative)  Increase in PS: A+B+C (positive)  Net social benefit of project is B+G+E+F Q0 P0 D Price Quantity D+q’ S P1 Q1 Q2 E B C FA G G G

20. 12-706 and 73-35920 Final Thoughts: Change in Demand  Unless rise in prices high, C negligible  So project outlays ~ social cost  Opp. Cost equals direct expenditures adjusted by social surplus changes Q0 P0 D Price Quantity D+q’ S P1 Q1 Q2 E B C FA G G G

21. 12-706 and 73-35921 Secondary Markets  When secondary markets affected  Can and should ignore impacts as long as primary effects measured and undistorted secondary market prices unchanged  Measuring both usually leads to double counting (since primary markets tend to show all effects)

22. 12-706 and 73-35922 Primary: Fishing Days Q1 P D Price Government decides to buy Q acres of land, pays P per acre What is total cost of project? b a Q0 MC0 MC1