1. 0 Lecture Notes ECON 437/837: ECONOMIC COST-BENEFIT ANALYSIS Lecture Six

2. 1 ECONOMIC VALUATION OF TRADABLE GOODS & SERVICES

3. 2 Applying the Postulates to Determine Economic Evaluation of Tradable Goods and Services The framework for the estimation of economic prices was presented for the case of non-tradable goods. They are also applicable to the valuation of tradable goods. The methodology for the estimation of the economic prices of internationally tradable goods and services when there are distortions in their markets is also based on the three postulates. These distortions may include customs duties on imported inputs of a project or those imported items that the project output will replace or substitute.

4. 3 Tradable Commodities A good or service is considered tradable when an increase in demand (or supply) by a project does not affect the amount demanded by domestic consumers. An increase in demand for an IMPORTABLE commodity results in an increase in demand for imports. An increase in demand for an EXPORTABLE commodity results in a reduction in exports. An increase in supply of a tradable commodity by a project will cause either a reduction in imports or an increase in exports. An Importable commodity includes imported goods and domestically produced goods that are close substitutes for imported goods. An Exportable commodity includes exported goods and close substitutes for exported goods.

5. There are usually more internationally traded goods and services than non-traded goods and services in economy. Smaller countries tend to have more traded goods and services than large countries. Small countries cannot produce many goods and services efficiently. The public sector tends to produce non-traded goods and services but uses many traded goods and services as inputs. E.g., when analyzing infrastructure projects that produce domestic services, the techniques for the economic valuation of tradable goods are important for determining the economic cost of inputs to the project. Tradable Commodities (cont’d) 4

6. Classification of a Project’s Outputs and Inputs Outputs TradableNon-Tradable ImportableExportable Inputs TradableNon-Tradable ImportableExportable Project 5

7. Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic cost of importable input 2.Economic value of importable good production 3.Economic value of export production 4.Economic cost of exportable input 6

8. 7 Importable Good Distorted World Supply Price Price Q Quantity per year domestic supply domestic demand D S E m * P CIF * (1+T m ) + F m dodo soso Q PmPm Imports = Q - Q E m = Market Exchange Rate T m = Rate of Import Tariff F m = Domestic Freight to Market soso dodo P CIF = Price of imports at entry point to country, including international freight and insurance charges expressed in units of foreign currency

9. Project Demands More of an Importable Good Project requirements will be met by additional imports (world supply). Domestic consumption is not affected. Price Quantity S domestic Q s 0 Q d 0 Q d 1 D domestic D w/project S world E m * P CIF * (1+T m ) + F m 8

10. Project Purchases Importable Inputs Input subject to Import Tariff Financial cost is E m P w (1+t) (Q 1 d - Q 0 d ) Economic cost is E m P w (Q 1 d – Q 0 d ) + Foreign exchange premium World Supply Q s 0 Price P d P w (1+t) P w S 0 Quantity World Supply After Tariff D 0 D 0+P 0 d 1 Q Q d 0 = E m EmEm 9

11. Estimating the Economic Prices of Tradable Goods 1. Adjust for commodity - specific trade distortions Financial prices for the commodities demanded (or supplied) by a project must be adjusted for commodity-specific distortions and costs that drive a wedge between their international prices and their domestic market prices. Taxes and subsidies are transfers between consumers, producers, and the government. Therefore, they are not part of the real resources consumed or produced by a project. 2. Value the foreign exchange at the economic (shadow) exchange rate (E e ) Multiply the CIF and FOB prices at the border by the economic price of foreign exchange (E e ). Alternatively, add a foreign exchange premium [(E e /E m ) – 1], per unit of foreign exchange demanded (or supplied) by a project. 3. Adjust for handling and transportation costs The economic costs of handling and transportation that are necessary to move commodities to or from the point of entry must be included. In the case of imported commodities, these costs should be added to the CIF price. In the case of exported commodities, these costs should be subtracted from the FOB price. 10

12. Visayas Communal Irrigation Project Basic Facts The National Irrigation Administration (Philippine National Agency) proposes to rehabilitate 55 damaged communal irrigation systems and to build 25 new systems in Visayas. The project’s additional components include water protection and erosion control, the strengthening of irrigation association, and the development of agricultural extension services. The goal of the project is to alleviate poverty, while improving environmental sustainability of the region. The life of project is 20 years. The economic benefits arise from the increased production of rice and corn, which must otherwise be imported. The foreign exchange premium is 24.6%. The project is expected to cost approximately 480.91 million pesos (US$19.78 million). The project will be financed with US$15.1 million loan from the International Fund for Agricultural Development, and remaining funding would be provided by the Philippine government. 11

13. Project uses an Importable Good (Pesticides) Farm Local Market Importer Depot, Manila Port, Manila Transport (+) Transport Tariff, Port Charges 12

14. 13 Economic Cost of Importable Goods: With Tariff, Trade Margin and Domestic Freight EmEm

15. Table 1: Project Uses an Importable Good (Pesticides) 14 Financial Price Conversion Factor for Nontradable Services Value of FEP Economic Value CIF World Price per 1000 liters of pesticides US Dollars166.00 Local Currency4,038.00 993.355,031.35 Plus: Tariff 201.00 0 Price at Port4,239.00 5,031.35 CF at the Port1.19 Plus: Handling/Transportation from Port to Manila Markets Handling540.000.90 486.00 Transportation225.001.20 270.00 Plus: Traders' Margin2000.7 140.00 Plus: Handling/Transportation from Manila Markets to Farm Gate Handling600.000.90 540.00 Transportation250.001.20 300.00 Price at the Farm Gate6,054.00 6,767.35 CF at the Project Site1.12

16. Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic cost of importable input 2.Economic value of importable good production 3.Economic value of export production 4.Economic cost of exportable input 15

17. Project Supplies More of an Importable Good Project reduces quantity imported. No change in domestic consumption. Price Quantity S domestic S w/ project Q s 0 Q s 1 Q d 0 D domestic S world E m * P CIF * (1+T m ) + F m 16

18. Project Supplies an Importable Good (Rice) Farm Whole saler, Manila Port, Manila Farm-gate price of paddy Grain dealer margin Transportation & handling Milling cost Transportation Transportation & handling Trading margin Price of rice at the port (+) (-) Pre- milled (paddy) Ex- milled (rice) Rice Mill Paddy equivalent (65%) 17

19. Table 2: Project Supplies an Importable Good (Rice) 18 Financial Price Conversion Factor for Nontradable Services Value of FEP Economic Value CIF World Price per ton of Rice US Dollars314.80 Local Currency7,659.00 1,884.119,543.11 CF at the Port1.25 Plus: Transportation/Handling Charges Port-Manila Handling50.000.90 45.00 Transportation100.001.20 120.00 Traders' Margin472.000.70 330.40 Wholesale Price in Manila8,281.0010,038.51 Less: Transportation from Rice Mill to Manila515.001.20 618.00 Ex-Mill Price of Rice7,766.00 9,420.51 Less: Milling Cost345.001.10 379.50 Pre Milled Value7,421.00 9,041.01 Paddy Equivalent (65%)4,823.65 5,876.66 Less: Grain Dealer's Margin (4%)192.950.70 135.06 Handling/Transport from Farm to Mill: Handling50.000.90 45.00 Transportation80.001.20 96.00 Price of Paddy at Farm Gate4,500.70 5,600.60 CF at the Project Site1.24

20. Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic cost of importable input 2.Economic value of importable good production 3.Economic value of export production 4.Economic cost of exportable input 19

21. 20 Exportable Good Quantity per year Distorted World Demand Price Price Q domestic supply domestic demand D S E m * P FOB * (1-t x ) - F x dodo soso Q PmPm Exports = Q - Q E m = Market Exchange Rate t x = Export Tax F x = Freight and Trading Costs to Port dodo soso P FOB = Price of exports at point of export from country in units of foreign currency

22. Project Supplies More of an Exportable Good Project increases exports. Domestic consumption remains unchanged. Price Quantity S domestic S w/ Project Q d 0 Q s 0 Q s 1 D domestic D world E m * P FOB * (1-t x ) - F x 21

23. Project Produces Exportable Goods subject to Export Tax (No domestic transportation costs) Financial benefit is E m P w (1-t) (Q 1 s -Q 0 s ) Economic benefit is E m P w (Q 1 s – Q 0 s ) + Foreign exchange premium EmEm P d =E m P w (1-t) Economic values of exportable goods are based on the FOB values of demand for exports 22

24. IRRI Supply an Exportable Good (Seeds) IRRI GatePort (-) Port charges Transportation 23

25. Table 3: IRRI Supply an Exportable Good (Seeds) 24 Financial Price Conversion Factor for Nontradable Services Value of FEP Economic Value Price per ton of Seeds US Dollars410.00 Local Currency9,975.002,454.0012,429.00 Plus: Export Subsidy (10% of Price)998.00 Price at the Port10,973.0012,429.00 CF at the Port1.13 Less: Handling/Transportation Charges from IRRI to Port Handling120.000.90 108.00 Transportation50.001.20 60.00 Price at IRRI Gate10,803.0012,261.00 CF at the Project Site1.14

26. Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic cost of importable input 2.Economic value of importable good production 3.Economic value of export production 4.Economic cost of exportable input 25

27. Project Demands More of an Exportable Good Project requirements will reduce quantity exported. Consumption of previous consumers remains unchanged. Price Quantity S domestic Q d 0 Q d 1 Q s 0 D w/ Project D domestic D world E m * P FOB * (1-t x ) - F x 26

28. Project Uses an Exportable Good (seeds) Farm Local Market IRRI Exporter Port, Manila Transportation Transportation Dealer’s margin Port Handling Transportation (-) (+) 27

29. Table 4: Project Uses an Exportable Good (Seeds) 28 Financial Price Conversion Factor for Nontradable Services Value of FEP Economic Value Price per ton of Seeds US Dollars410.00 Local Currency9,975.00 2,454.0012,429.00 Plus: Export Subsidy (10% of Price)998.00 Price at the Port10,973.00 12,429.00 CF at the Port1.13 Less: Handling/Transportation Charges from IRRI to Port Handling120.000.90 108.00 Transportation50.001.20 60.00 Plus: Dealers' Margin370.000.70 259.00 Plus: Transportation Cost from IRRI to Farm635.001.20 762.00 Price at Farm Gate11,808.00 13,282.00 CF at the Project Site1.12

30. Summary Economic Cost of Imported Input = CIF (adj. for economic exchange rate) + Economic Cost of Freight from Port to Project Economic Value of Importable Good Production = CIF (adj. for economic exchange rate) + Economic Cost of Local Freight from Port to Market - Economic Cost of Local Freight from Project to Market Economic Value of Exportable Production = FOB (adj. for economic exchange rate) - Economic Cost of Local Freight from Project to Port Economic Cost of Exportable Input = FOB (adj. for economic exchange rate) + Economic Cost of Local Freight from Export Producer to Project - Economic Cost of Local Freight from Export Producer to Port 29

31. Additional Examples on Calculation of Tradable Goods 30

32. Example 1: The Import of Pneumatic Tires (with an import duty) 31 Financial Price Conversion Factor for Nontradable Services Value of FEP (15%) Economic Value CIF World Price US Dollars40.00 Local Currency @39 pesos per US Dollar1,560.00 234.001,794.00 Plus: Tariff @30%468.00 VAT @10%202.80 Price at the Port2,230.80 1,794.00 CF at the Port0.804 Plus: Handling/Transportation from Port to Project Site Handling18.000.90 16.20 Transportation with Subsidy9.001.25 11.25 Price at the Project Site2,257.80 1,821.45 CF at the Project Site0.807

33. Example 2: The Export of Shoes (with an export subsidy) 32 Financial Price Conversion Factor for Nontradable Services Value of FEP (15%) Economic Value FOB World Price of Shoe US Dollars200.00 Local Currency @39 pesos per US Dollar7,800.00 1,170.008,970.00 Plus: Export Subsidy (10% of Price)780.00 Price at the Port8,580.00 8,970.00 CF at the Port1.045 Less: Handling/Transportation Charges from Port to Project Site Handling67.200.90 64.48 Transportation with Subsidy80.001.25 120.00 Price at Project Site8,432.80 8,785.52 CF at the Project Site1.042

34. Example 3: The Export of Garments (with an export tax) 33 Financial Price Conversion Factor for Nontradable Services Value of FEP (15%) Economic Value FOB World Price of Garments US Dollars800.00 Local Currency @39 pesos per US Dollar31,200.00 4,680.0035,880.00 Less: Export Tax (5% of Price)1,560.00 Price at the Port29,640.00 35,880.00 CF at the Port1.211

35. 34 MEASUREMENT OF ECONOMIC PRICES OF NON-TRADABLE GOODS

36. 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). 35

37. 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 36

38. 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 market where demand is being diverted towards or away from (w d ). 3)Correct for distortions in the markets for the inputs used to produce the item. Correction is applied to the proportion of the item produced by other suppliers in the market (w s ). 4)Correct for the foreign exchange premium and the shadow price of non-traded outlays (SPNTO) on tradable and non- tradable components of the non-tradable good or service. 37

39. General Formula for the Estimation of the Economic Prices of Non-Tradable Goods and Services This formula can be used to estimate the economic price of a non-tradable good, that is either an input used by a project or an output produced by it. 38

40. Step One: Adjusting for Distortions in the Market for Good or Service 39

41. D0D0 Q0Q0 0 E D n+P H PzPz J G Q2dQ2d P0mP0m P 0 s =P 0 m /(1-k z ) S 0+subsidy DnDn Q1sQ1s Q1dQ1d QzQz B C N A P1mP1m S0S0 P 1 s =P 1 m /(1-k z ) P 0 d =P 0 m (1+t z ) P 1 d =P 1 m (1+t z ) M L U R Step One: Adjusting for Distortions in the Market for Good or Service Economic Costs for Project Input (Input production subsidized and a sales tax is levied on input) Financial Cost is P 1 m (Q 1 d -Q 1 s ) Economic Cost is Q 1 d MGQ 0 + Q 0 RLQ 1 s Example W x s = 0.25, W x d = 0.75, P 0 m = 90, t = 0.15, k = 0.4 P 1 s = 90/(1-0.4)=150, P 1 d = 90 (1+0.15) = 103, P e = 0.25(150)+0.75(103) = 114 Value of additional resources Value of postponed consumption 40

42. Step Two: Adjustment for distortions in markets where diverted demand moves 41

43. Step Two: Adjustment for distortions in markets where diverted demand moves Amount of diverted demand per unit is Because of increased demand by our project, they will shift their consumption to other goods and services. If these goods and services are taxed at an average rate of d*, the additional taxes will reduce the economic cost of good X. These additional taxes are denoted as and offset initial cost. The economic cost of the non-traded good X now becomes: We should note that the larger is the value of d*, the lower will be the economic cost of a non-traded input used by a project, or the lower will be economic benefit generated by the non-traded output of a project. P e = s x W s x P + d x W d x P x d x W m x Pd* 42

44. Economic Benefits of Project Output (No distortions on output but input market distorted) 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 Economic Value = W x s P s +W x d P d If distortions on markets of input then P d = P m but P s < P m Step Three: Adjustment for Distortions (Tariffs, Excise Taxes and Subsidies) in the Markets of the Inputs Used in the Production of a Non-Tradable Good Value of distortions on inputs (taxes) no resource value 43

45. Step Three: Adjustment for Distortions (Tariffs, Excise Taxes and Subsidies) in the Markets of the Inputs Used in the Production of a Non-Tradable Good 44

46. Step Three: Adjustment for Distortions (Tariffs, Excise taxes and Subsidies) in the Markets of the Inputs Used in the Production of a Non-Tradable Good (Cont’d) W s P s might overstate or understate opportunity costs if there are taxes or subsidies on the inputs. Tradable Inputs Suppose, in the production of good x, the market of one of its tradable inputs (i) is distorted by an excise tax. These taxes are not economic costs. Need to adjust by =input-output coefficient showing the quantity of (distorted) input i used in the production of one unit of x =market price per unit of input i d i =effective rate of tariff, excise tax or sales tax on input i This correction is equivalent to substituting the economic values of the inputs (excluding the adjustment for the FEP) for their financial values. The expression for this adjustment is written in a more general form in terms of distortions d i, as, d i has a positive value if it represents an excise tax, sales tax, import tariff or a negative value if the distortion is a subsidy. 45

47. Non-Traded Inputs The fundamental objective is to remove any distortions associated with the non-traded inputs j used to produce a non-traded good X. Case I: Tax (d j ) on non-traded inputs In the case where there is just a tax on the purchase of input j, the financial cost of the input will be P j m (1+d j ) and the economic cost [W j s P j m + W j d P j m (1 + d j - d*)] where d j is the rate of tax on input j and d* is the average rate of indirect taxes on traded and non-traded goods. In this case, P s = P m. We wish to subtract the financial costs of input j from the supply price of X and then add back j’s economic cost. The adjustment to the supply price of X for the distortions input j is expressed as: Simplifying this expression, we have to do adjustment for this tax, d j, on j. Hence, the value of the distortion cause by the tax adjustment is: Step Three: Adjustment for Distortions in the Markets of the Inputs Used in the Production of a Non-Tradable Good (Cont’d) 46

48. Step Three: Adjustment for Distortions in the Markets of the Inputs Used in the Production of a Non-Tradable Good (Cont’d) Case II: Subsidy (k j ) and Tax (d j ) on non-traded inputs Suppose instead there is a tax on input of j and also a subsidy on production of j. Hence, P s = P m (1 + k j ) and P d = P m (1 + d j ). The adjustment will be: Hence, the value of the distortion created by the tax and subsidy on non- traded input is: 47

49. The expression summing up the distortions in the markets for traded inputs i (=1 through n), and non-traded inputs j (= 1 to z) is as follows: Step Three: Adjustment for Distortions in the Markets of the Inputs Used in the Production of a Non-Tradable Good (Cont’d) The distortion of tax and subsidy on non-traded input is: when, d j, a tax on non-tradable input, and d* are both positive that will reduce the economic cost of the final non-traded good X but k j is a subsidy on non-tradable supply of input j which is negative and will, thus, increase the economic cost of the final non-traded good X. 48

50. There will be a need to adjust the proportion of the tradable components (T) of the non-tradable good by the foreign exchange premium (FEP). This is expressed as follows: –Value of foreign exchange premium (FEP), (FEP = E e /E m - 1), on the tradable good components of the non-tradable input = [T  P x m  FEP)] where: T = proportion of tradable good component of the non-tradable input (x) used by the project expressed as a proportion of the financial market price P x m P x m = market price per unit of output x E e = economic exchange rate E m = market exchange rate Step Four: Adjust for Foreign Exchange Premium on Tradable Components 49

51. Step Four: Adjust for Shadow Price of Non-Tradable Outlays (SPNTO) There will be a need to adjust the proportion of the non-tradable components (NT) of the non-tradable good by the premium of non-tradable outlays (NTP). [NTP = SPNTO – 1]. This is expressed as follows: Value of the NTP adjustment for the non-tradable component of the non- tradable input = [NT  P x m  NTP] where: NT = proportion of non-tradable good component of the non-tradable input (x) used by the project expressed as a proportion of the financial market price P x m P x m = market price per unit of output x NTP = the premium on non-tradable outlays 50

52. General Formula for the Estimation of the Economic Prices of Non-Tradable Goods and Services This formula can be used to estimate the economic price of a non-tradable good, that is either an input used by a project or an output produced by it. 51

53. Price Q0Q0 Quantity P s =P m D 0+P D0D0 Q1Q1 Σ i a xi o P i m d i Economic Value of Increase in Quantity Demanded of an Input in the Case of the Infinite Supply Elasticity - Example of Electricity Supply by Thermal Generation - Project demand (Q 1 – Q 0 ) of a non-tradable Step 1 W s = 1 and W d = 0 If no direct subsidy then P s = P m Step 2 With an infinite supply elasticity of electricity, W d = 0. There is no diverted demand from other goods and services. Step 3 Need to adjust for input distortions. If supply of output is infinite elastic then supply of inputs must also be infinite elastic (tradable good inputs). Estimation of value of input distortion = Σ i a ix o P i m d i where a ix o is the input- output coefficient of the input, i, used to produce a unit of x, while P i m is the price of a specific input i, and d i is the tax wedge associated with the use of input i in the production of x. Step 4 Need to adjust for foreign exchange premium (FEP) and premium on non-tradable outlays (NTP) on tradable and non-tradable goods and services, respectively. Total costs of production made up with tradable inputs proportion (T x ) and non-tradable inputs proportion (NT x ). In the case of thermal electricity supply we would expect T x to be close to 1 and NT x to be quite small, where T x + NT x = 1. Estimation of adjustments for premiums = P x m T x FEP + P x m NT x NTP To summarize, the economic value of a unit of good x being demanded (or produced) by our project is equal to: P x m - Σ i a ix o P i d i + P x m T x FEP + P x m NT x NTP or,P x m [1 + (T x  FEP) + (NT x  NTP)] - Σ i a ix o P i d i

54. Illustrative Example: Estimating the Economic Cost of a Non-tradable Input Assume that the market for clay bricks is competitive, the market price is subject to a 14% excise tax and brick producers receive a 15% subsidy (k) on their production cost. Without the project, the quantity demanded and supplied in the market is 7 million bricks per month at a market price (P m z ) of R0.2 per brick. Now introduce a project that requires 300,000 bricks per month. Two of the inputs used in the production of bricks have distortions in their markets: (1) Clay, a non-tradable good, has a 14% excise tax levied on its market price (P m clay ) of R7 per ton, (2) Furnace oil, an importable good, has a subsidy (k oil ) of 20% on its CIF price of US $240 per ton. The input-output coefficient for furnace oil (A z oil ) is 0.180 tons of oil per 1000 bricks and that of clay (A z clay ) is 3.5 tons of clay per 1000 bricks. 53

55. Illustrative Example: Estimating the Economic Cost of a Non-tradable Input (cont’d) The tradable, T, (proportion of the market price) and non-tradable, NT, (proportion of the market price) good components of bricks are estimated at 0.60 and 0.40, respectively, of the market price of bricks. The market exchange rate (E m ) is R9.85 per US dollar, the economic exchange rate (E e ) is R10.44 per dollar, NTP is 1%, and the weighted average rate of indirect taxes on traded and non-tradable goods and services (d*) is 9%. 54

56. Prices, Relative Supply and Demand Weights, and Tradable and Non-Tradable Components for Brick Production Price Estimation P m z = R0.2 P s z = P m z / (1 - z k ) = 0.2 / (0.85) = R0.2353 P d z = P m z  (1 + excise tax) = 0.2  (1.14) = R0.2280 Assigning a weight of 0.67 to the supply side (W s z ) and a weight of 0.33 to the demand side (W d z ) and seems plausible. P e = 0.33 * 0.2280 + 0.67 * 0.2353 55

57. Adjustment for distortions in markets for bricks and where the diverted demand moves : P z m [1 + (t z – d*)] where t z is equal to excise tax, 14%. d* is the weighted average rate of indirect taxes on traded and non-tradable goods and services, 9%. The net adjustment is: - P z m d* = - 0.2 x 0.09 = - 0.0180 R/brick On the demand side, the tax on good t z, that other demanders will not be paying because they are now buying other goods is partially offset by the taxes they will now pay d*. Hence, the opportunity cost of the forgone consumption of others is equal to, 56

58. Estimating the value of the distortion per ton of furnace oil (Tradable component) P i m d i = CIF Price  E m  (-k) = 240  9.85  (-0.2) = -R 472.80 per ton a oilk P i m d i (the value of the distortion per brick) = a oilz * (-472.8/1,000) = - 0.18 *0.4728 = - 0.085 R/brick 57

59. Estimating the value of the distortion per ton of Clay P m clay * a clayz [W s clay (d clay – k clay ) + W d clay d*] = 7 * 0.0035 [0.67 * (0.14 – 0) + 0.33*0.09] = 0.0245 (0.0938 + 0.0297) = 0.0245 (0.1235) = 0.0030 R/brick 58

60. Estimating the Economic Price of Brick P z e = W z s P z m /(1-k z ) + W z d P z m [1 + (t z – d*)] - W z s {Σ i a iz o P m i d i + Σ j a jz o [W j s P m j (d j – k j ) + W j d P m j d*]} + P z m  T z  FEP + P z m  NT z  NTP = 0.67 (0.2353) + 0.33 (0.2280 – 0.0180) - 0.67 (-0.085 + 0.0030) + 0.2 (0.60)(0.06) +0.2 (0.40)(0.01) = 0.2270 + 0.0549 + 0.0072 + 0.0008 = 0.2899 R/brick 59

61. Conversion Factor for Bricks To estimate the commodity specific conversion factor for bricks used by a project (CSCF d z ), we divide the economic price by the financial demand price. Recall that the demand price is inclusive of the excise tax. CSCF d z = P e z / P d z = 0.2899/ 0.228 = 1.2715 60

62. Final Good X Subject to VAT or Zero Rated If final good X is subject to VAT or Zero Rated, then VAT paid on purchase of inputs can be taken as a credit against tax owed on sale of output or refunded if zero rated when final product is exported. The line item in the financial analysis reporting the net VAT payments to the government (or refunds of input taxed received from the government on exports) will have a conversion factor of zero. In calculation of conversion factors the financial price of the items include the VAT in the financial values. Final Good X Exempt from VAT If the final good X is exempt from the VAT, the value added tax paid on the inputs will have to be taken into account in deriving the economic value of output because no credit is possible against the tax on the sales of final good, because there is no tax liability. The rate of VAT on the price of input i would have to be estimated t v i. The amount of adjustment to W x s P x s is - W x s (A T xi P i m t i v ) for the economic analysis. This is the identical treatment to the case of any excise tax, sales tax or import tariff on an input. When these taxes are not used as a credit to offset any indirect taxes owed on the sales of final good or service. SPECIAL NOTE: Adjustment for VAT in the Markets of the Inputs Used in the Production of a Non-Tradable Good 61