lesson 3 updated version

7/28/2019 lesson 3 updated version

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Chapter 3

Evaluating

Trade-Offs: BenefitCost Analysis and OtherDecision-Making Metrics


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8 underground cities and tunnels youcan visit
http://cdn1.matadornetwork.com/blogs/1/2011/12/cappa.jpg


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ON APRIL 28, 2011, LIM SIGNED A MEMORANDUM OFUNDERSTANDING (MOU) WITH CHINA, WHICH ISWITNESSED BY CHINESE PREMIERWEN JIABAO AND

MALAYSIAN PRIME MINISTERNAJIB TUN RAZAK ON THEPROPOSAL OF THE CONSTRUCTION OF THREE ROAD ANDTUNNEL PROJECTS IN PENANG ISLAND, INCLUDING A 6.5KM UNDERSEA TUNNEL, A THIRD LINK BETWEEN THEISLAND AND BUTTERWORTH ON THE MAINLAND.ACCORDING TO LIM, THIS WOULD EASE TRAFFIC

CONGESTION IN THE AREA AND TO IMPROVE THE LINKS

BETWEEN THE ISLAND AND THE MAINLAND.[

Going Underground

TUNNELS: What role in

town and country?
http://en.wikipedia.org/wiki/Memorandum_of_understandinghttp://en.wikipedia.org/wiki/Memorandum_of_understandinghttp://en.wikipedia.org/wiki/Wen_Jiabaohttp://en.wikipedia.org/wiki/Prime_Ministerhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Penang_islandhttp://en.wikipedia.org/wiki/Butterworthhttp://en.wikipedia.org/wiki/Butterworthhttp://en.wikipedia.org/wiki/Penang_islandhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Najib_Tun_Razakhttp://en.wikipedia.org/wiki/Prime_Ministerhttp://en.wikipedia.org/wiki/Wen_Jiabaohttp://en.wikipedia.org/wiki/Wen_Jiabaohttp://en.wikipedia.org/wiki/Memorandum_of_understandinghttp://en.wikipedia.org/wiki/Memorandum_of_understanding


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Chapter 3 Evaluating Trade-Offs: BenefitCost Analysis and Other Decision-MakingMetrics

Introduction

Normative Criteria for Decision Making

Applying the Concepts

Divergence of Social and Private DiscountRates

Cost-Effective Analysis

Impact Analysis


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A reply to The Malaysian Insider Lim Guan

Eng

A reply to The Malaysian Insider Lim Guan EngMarch 14, 2013

MARCH 14

I refer to your editorial and a plethora of articles opposing

the proposed 3 separate highway and one third link tunnel projectawarded by the Penang state government by open competitive

tender recently for RM6.3 billion.

I hope that you will allow the state government to explain

the rationale for this desperate effort to decongest trafficcongestion on the island and bring about smoother traffic flow

on the mainland of Seberang Perai.


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Introduction

This chapter illustrates the use of severaldecision-making metrics that can assist usin evaluating options.


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Normative Criteria for DecisionMaking

Evaluating Predefined Options: BenefitCostAnalysis

Let B be the benefits from a proposed action and C bethe costs. Our decision rule would then be:

If B > C, support the action

Otherwise, oppose the action

Benefits and Costs- valued at their effects


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Total benefits are the value of total willingness topay, which is the area under the market demandcurve from the origin to the allocation of interest.

Opportunity cost is the net benefit lost whenspecific environmental services are forgone in theconversion to the new use.

Total costs is the sum of marginal opportunitycosts, which is the area under the marginal costcurve.



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FIGURE 2.8 Monopoly andInefficiency

Monopoly will sell at OA, PRI

At OF. Producer surplus-HFE

Society to lose EDC

An efficient market will produce at 0B, Price at OG

Monopoly Price

Normal Price

Total Costs


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Marginal Opportunity Cost Curve

Define the additional cost of producinganother unit of electricity as a result fromthe associated incremental loss of netbenefits due to reduced opportunities forother activity/investment white watercanoeing


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The Butterfly Effects
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EXAMPLE 3.1


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Consider the net benefits from preserving astretch of river using Figure 3.1. Lets suppose

that we are considering preserving a four-mile

stretch of river and that the benefits and costs of

that action are reflected in Figure 3.1. Should that

stretch be preserved? Explain why or why not?



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FIGURE 3.1 The Derivation of NetBenefits

Normative Analysis in3 steps 1. Identify an optimal

outcome

2. To Discern theextent our institutionsproduce optimaloutcomes , anydivergences betweenoptimal and actual?

3. Policy solution


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Issues

Depleted Ocean Fisheries - defining optimal stock or optimal rare of

harvest

- compare actual stock and harvest levels.

Running out of room for landfills


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Relating Optimality to Efficiency

An allocation of resources is said to satisfy thestatic efficiency criterion if the economic surplusfrom the use of those resources is maximizedby that allocation.



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First Equimarginal Principle (the EfficiencyEquimarginal Principle):

Social Net benefits are maximized when themarginal benefits from an allocation equal themarginal costs.

In short maximize the economic surplus



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Social marginal benefits= Socialmarginal cost?

Pareto optimality:

Allocations are said to be Pareto optimal if no otherfeasible allocation could benefit at least one personwithout any deleterious effects on some other person.

The gainers could use a portion of their gains tocompensate the losers sufficiently to ensure they wereat least as well off as they were prior to the reallocation


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Comparing Benefits and Costs AcrossTime Present Value of a one-time net benefit (Bn)

received n years from now is

n

n

n

r

BBPV

)1(][

Where r is the interest rate



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The present value of a stream of net benefit {B0,, B

n)

received over a period ofn years is

n

ii

in

r

BBBPV0

0)1(

],...,[

Wherer

is the interest rate



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TABLE 3.1 Demonstrating Present ValueCalculations


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TABLE 3.2 Interpreting Present ValueCalculations


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Dynamic Efficiency An allocation of resources across n time periods

satisfies the dynamic efficiency criterion if itmaximizes the present value of net benefits

that could be received from all the possibleways of allocating those resources over the nperiods.



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Pollution Control Benefits include, not limited to, reduced death

rate, lower incidences of chronic bronchitis andother diseases, better visibility, improved

agricultural productivity and etc. Costs include

1) higher costs passed to consumers such asinstalling, operating and maintaining pollution control

equipment 2) administrative costs such as designing,

implementing, monitoring relevant policies


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EXAMPLE3.2

TABLE 3 3 S C i f B fit d


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TABLE 3.3 Summary Comparison of Benefits andCosts from the Clean Air Act-19902020 (Estimatesin Million 2006$)


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Preservation Versus Development Benefits include improved economic welfare

from increasing employment, rise of incomeand etc

Costs include degradation of ecosystem.

Example of mining in Kakadu ConservationZone



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EXAMPLE3.3


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Issues in Benefit Estimation

Primary Versus Secondary Effects

Considering both primary and secondary consequenceswhile implementing environmental projects

Accounting Stance

Who benefits? The accounting stance refers to thegeographic scale at which the benefits are measured.



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Issues in Benefit Estimation (contd.)

With and Without Principle

The with and without principle states that only thosebenefits that would result from the project should be

counted, ignoring those that would have accruedanyway.

Tangible Versus Intangible Benefits

Tangible benefits can reasonably be assigned amonetary value.

Intangible benefits cannot be assigned a monetaryvalue.

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Approaches to Cost Estimation

The Survey Approach

Involves asking polluters about their control costs

The Engineering Approach Using engineering information to estimate thetechnologies available and the costs of purchasing andusing those technologies.

The Combined Approach

Combining both survey and engineering approaches



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Distribution of Benefits and Costs Economic impact analysis

a broad characterization of who gains and who losesfrom a given policy

An equity analysis Impacts on disadvantaged groups or sub-populations



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Choosing the Discount Rate The appropriate rate to use will depend on the

nature and expected lifetime of the project, whois doing the financing and the level of risk


Divergence of Social and Private


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Divergence of Social and PrivateDiscount Rates

Risk-free cost of capital The rate of return is earned when there is

absolutely no risk of earning more or less thanthe expected return.

Risk premium It is the amount required to compensate capital

owners for potential differences betweenexpected and actual returns.

Time preference

It affects both private and social discount rates,as well as across countries.


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EXAMPLE3.4


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EXAMPLE3.4 (cont.)

Di f S i l d P i t


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A Critical Appraisal Concerns exist on the reliability of benefit/cost

analysis.

Divergence of Social and PrivateDiscount Rates


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Cost-Effective Analysis

Second Equimarginal Principle (the Cost-Effectiveness Equimarginal Principle):

The least-cost means of achieving an

environmental target will have been achievedwhen the marginal costs of all possible means ofachievement are equal (insert example 3.5).


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EXAMPLE 3.5


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Impact Analysis

An impact analysis attempts to quantify theconsequences of various actions.

Impact analysis places a large amount ofrelatively undigested information at thedisposal of the policy-maker.


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Summary

Environment: a composite asset Benefitcost analysis

Cost-effective analysis

Impact analysis Static versus dynamic efficient allocation

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