Consumer and Producer Surplus in Benefit-Cost Analysis pot

The market prices of project inputs or outputs will NOTchange if:- the inputs or outputs are TRADED ie.. price is determined in world markets - the project is SMALL relative to the size

Consumer and Producer Surplus in

Benefit-Cost Analysis (Campbell & Brown Chapter 7)

Harry Campbell & Richard Brown

The market prices of project inputs or outputs will NOTchange if:

- the inputs or outputs are TRADED ie price is

determined in world markets)

- the project is SMALL relative to the size of the

economy in which is undertaken

Examples of project outputs or inputs whose prices

might change:

- output: a bridge - price of trips across a river

- input: wage of skilled labour in a local market

eg ICP case study (Ch.7, p.26)

Suppose the market price of project output is predicted

a social benefit-cost analysis?

Referent Group Analysis: calculate the aggregate

net benefits in the usual way

How do we account for the fall in price of the original

net benefit of the project?

is a net benefit which is included in the efficiency net

benefits

When the fall in price does not represent a fall in cost, onegroup is better off (consumers) and another group is worse

simply a transfer from consumers to firms and it nets out in

Suppose that the fall in product price is not matched by

a fall in production cost.What is the effect on aggregate referent group benefits of allowing for the change in

output price, compared to the case in which there is no

change in price?

1 Suppose that the private firm is not a member of thereferent group (as in the ICP case study):

efficiency net benefits fall but private net benefits fall

even more, hence RG net benefits rise Consumers

benefit at the expense of the firm

2 Suppose that the private firm is a member of the

referent group Then efficiency net benefits are the same

as RG net benefits, and hence RG net benefits fall Thereason for the fall is the lower value placed on the extraoutput produced by the project

The social benefit-cost analysis implements the Hicks (K-H) criterion by assessing whether a project

Kaldor-is a potential Pareto improvement

A potential Pareto improvement exists if the gainers from

a project could compensate the losers and still be

better off

Gains and losses are measured as COMPENSATING

VARIATIONS

Compensating variations are measured as areas of

consumer surplus under demand curves, or as

areas of producer surplus above supply curves

Applying the Kaldor-Hicks criterion: suppose I said that

I was going to change the lecture time from 4 pm to 8 am.That would suit some people (the gainers) and not suit

others (the losers)

To apply the K-H criterion, I ask each gainer to work out how much money I could take away from them and still

leave them as well off as before the change And I ask

each loser to work out how much money I would need

to pay to them to leave them as well off as before the

change These sums are the compensating variations (CVs)

I ask each person to write their CV amount on a piece of

paper (positive for gainers, negative for losers) I then pass the hat around: each person puts their piece of paper in thehat and if the net value of the aggregate CV is positive, thechange is a potential Pareto improvement

Effects of a worker training program:

On employers: skilled wage rate falls from

On the original skilled labour force: skilled

while their opportunity cost is measured

Value of extra output of food = BCQ1Q0 (Fig 7.7)

Value of extra output = Value of extra income

Suppose that extra labour is used on the irrigated

land Under the incomes approach this would be

reflected in extra value of output

Suppose that the extra labour was hired away from

a neighbouring valley Then there would be an

equivalent fall in value of output in that valley Thisopportunity cost of labour would have to be

subtracted from the value of extra output

If wages rise as a result of competition for labour,labour is better off and employers are worse off -the effect of the wage increase nets out if both

Compensating variation is the sum of money to betaken from (paid to) a gainer (loser) so as to maintaintheir original level of utility.

Hence we measure compensating variation underutility constant demand curves