Benefit-cost analysis
Benefit-cost analysis (BCA), also known as cost-benefit analysis, is a systematic approach used to evaluate the economic feasibility of projects by comparing their expected benefits to their costs. Originating from the work of French economist Jules Dupuit in the 19th century, BCA gained prominence in the United States through its application in water development projects by the U.S. Army Corps of Engineers. The concept was formally recognized in the 1936 Flood Control Act, which emphasized the importance of ensuring that the benefits of federal water improvements exceed their costs.
In practice, BCA involves quantifying the monetary values of expected benefits and costs associated with a project, which can range from infrastructure developments to environmental management initiatives. Analysts utilize the "time value of money" to convert future costs and benefits into present values, aiding decision-makers in determining whether a project should proceed. A significant challenge in BCA is accurately assigning monetary values to intangible benefits, such as ecosystem services, which may not be directly marketable. Despite these complexities, BCA serves as a valuable tool for planners and policymakers, facilitating informed discussions around the economic implications of proposed actions and fostering a deeper understanding of the trade-offs involved.
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Subject Terms
Benefit-cost analysis
DEFINITION: Method of determining the benefit of undertaking a program or project based on its costs
Benefit-cost analysis is used to determine the value of many types of projects and their impacts, including environmental management projects and the impacts of such projects as airport construction.
Benefit-cost analysis (also called cost-benefit analysis) is an idea that can be traced back to an article by nineteenth century French economist Jules Dupuit. Early use of the concept in the United States is seen in the water development projects of the U.S. Army Corps of Engineers, where it was used to prioritize projects concerning the nation’s waterways. The term arose in the context of the and natural resources in the Flood Control Act of 1936, which states that the “federal government should improve or participate in the improvement of or their tributaries, including watersheds thereof, for flood control purposes if the benefits to whomever they may accrue are in excess of the estimated costs.” Hence, the term “benefit-cost analysis” was established; it was later embraced by economists during the 1950s. Two important concepts in economics, the Pareto principle and Kaldor-Hicks efficiency, are related to benefit-cost analysis.
In benefit-cost analysis, the monetary measure of all expected benefits of proposed projects or activities is compared with the costs of undertaking those projects or activities. This typically involves using the “time value of money” formula, which converts the future expected streams of costs and benefits to a present value amount. This tool helps planners and policymakers to determine whether a project is worth undertaking by weighing the advantages and the disadvantages in monetary terms.
The kinds of projects for which benefit-cost analyses may be conducted include highways, training programs, and health care systems. Benefit-cost analyses can provide answers to questions about whether environmental management projects—such as constructing a new airport terminal, installing wind turbines on the Scottish coast, or building a new on a particular river—will provide benefits that outweigh the respective costs to the environment.
In conducting benefit-cost analysis, the analyst finds, quantifies, and adds up the values of the benefits of a course of action. The analyst then identifies, quantifies, and subtracts all the costs associated with the activities or project. The difference between the two indicates whether the planned action or project should or should not be undertaken. To conduct such an analysis well, the analyst must not only make sure all the costs and benefits are included and properly quantified, but also avoid double counting.
One key problem in undertaking an environmental benefit-cost analysis lies in trying to assign monetary values to intangibles associated with the project. For example, a functioning is of economic value to society, but its aesthetic functions, which may be lost because of a project and its future effects, fall outside the market system; such functions are often excluded from decision-making tools such as benefit-cost analysis. The construction of a dam or of land has benefits of water, energy, and fish supply. These benefits can be traded on the market, and a market price can be used to represent their economic value. Where benefits exist that cannot be traded on the market, shadow pricing may be used to place economic values on the benefits; this process is subjective, however.
In spite of its shortcomings for environment-related applications, benefit-cost analysis provides planners and policy makers with a method for putting all relevant benefits and costs of proposed projects on a common temporal footing so that they can make informed decisions. It also provides all parties concerned with greater understanding of the economic costs of their decisions and thus allows for arguments to be made both for and against a change based on benefit-cost considerations.
Bibliography
Boardman, Anthony E., et al. Cost-Benefit Analysis: Concepts and Practice. 5th ed., Cambridge UP, 2018.
Brent, Robert J. Cost-Benefit Analysis for Developing Countries. Edward Elgar, 2000.
Pearce, David. “The Limits of Cost-Benefit Analysis as a Guide to Environmental Policy.” Economics and Environment: Essays on Ecological Economics and Sustainable Development, Edward Elgar, 1998.
Puttaswamaiah, K., editor. Cost-Benefit Analysis: Environmental and Ecological Perspectives. Transaction, 2002.