Introduction to Cost-Benefit Analysis

Transcription

1 Introduction to Cost-Benefit Analysis Course Outline 2015

2 1. Names and contact details Course Presenter: Prof. Adam B. Jaffe Telephone (04) Course Administrator: Rebecca Shingfield Course Learning Objectives Many public policy decisions involve balancing costs and benefits. Cost-benefit analysis provides a structured framework for comparing costs to benefits and analyzing which are greater overall. The objective of this course is to provide participants with an appreciation of that framework, as well as the specific quantitative steps necessary to execute a cost-benefit analysis. To that end, the course will help participants to be able to: understand the economic theory that underlies cost-benefit analysis; appropriately frame a cost-benefit analysis for a specific policy issue or question; appropriately handle costs and benefits that occur over time, including appropriate choice of and application of a discount rate; understand and utilize available methods for quantifying costs and benefits that are not immediately measurable in economic terms; recognize and deal appropriately with costs and benefits that are impossible to quantify; and present the results of benefit-cost analyses in ways that provide the proper context and the economic way of thinking by providing particular economic problems as illustrations and by conveying the nature of the tool-kit that economics profession brings to the analysis of policy issues. 3. Learning outcomes On completion of this course participants will be able: to identify when a policy question or issue would benefit from cost-benefit analysis; where appropriate, to translate a generic statement of a policy question or issue into an properly framed cost-benefit analysis; to carry out the necessary calculations to compare overall costs and benefits appropriately; to handle costs and benefits incurred at different points in time in a way that appropriately handles the discounting of future costs and benefits; 1

3 to estimate the equivalent monetary value of costs and benefits that are not immediately or obviously measured in dollar terms; to incorporate in the analysis costs and benefits that cannot be quantified; and to present the results of cost-benefit analysis to decisionmakers in an effective manner. 4. Target Audience This course will be most helpful to policy advisors who need to be able to execute cost-benefit analysis, or who need to be able to critically review cost-benefit analyses done by others. 5. Relationship to Other Subjects No previous knowledge of economics is assumed. Some familiarity with economic thinking would be helpful. The course does require a willingness and ability to carry out quantitative numerical analyses, including manipulating spreadsheets. 6. Overview of Session Topics Day 1 (4 May) 1. Economic Analysis as a Basis for Public Decisionmaking 1.1. Utilitarianism and the Greatest Good for the Greatest Number 1.1. Optimality of Competitive Equilibrium The Invisible Hand Market failure and deviations from optimality 1.2. Government intervention to correct market failure public good provision regulation or other market intervention 1.3. Benefits and costs accruing to different parties 1.4. overall net benefits as a public decision criterion 1.5. Interactions between problems and the issue of the second best 1.6. relationship of CBA to other modes of decision analysis 2. Setting up Benefit Cost Analysis 2.1. Framing the analysis set of options or alternatives specifying the counterfactual 2.2. Identifying categories of costs and benefits 2.3. Identifying categories of affected parties 2.4. time horizon 2.5. when to look at net benefits and when the B/C ratio 3. Quantifying costs and benefits 3.1. The relationship of market prices to social valuations 3.2. Estimation of non-market valuations 2

4 willingness to pay and willingness to accept associated market activities (revealed preference) survey methods (stated preference) 3.3. Issues inflation cost of taxation sunk costs marginal versus average costs 4. Group exercise Day 2 (5 May) 5. Thinking about costs and benefits over time 5.1. pure time preference 5.2. rate of return on investments and its relationship to discounting 5.3. theories of the social discount rate 5.4. inter-generational transfers 6. Uncertainty 6.1. risk neutrality 6.2. expected value 6.3. option value 6.4. social risk aversion 6.5. risk avoidance and insurance premia 7. Presentation of Results and Framing of Decisions 7.1. sensitivity analyses 7.2. explicit treatment of possible biases 7.3. distributional impacts systematic differences in impact by income group disproportionate impacts on specific indivdiuals or groups 7.4. second-order effects: networks; price changes 7.5. subsidies and other pre-existing policy interventions 7.6. inefficient behaviour and nudges 7.7. context and relationship to non-economic decision criteria 8. Group exercise 7. Teaching and Learning Methods The lectures are interactive and include class discussion of numerous real life examples of the application of CBA methods to specific public policy problems. Active participant engagement and interaction in classes is expected, meaning that all participants will be expected to participate in the discussion. Each day ends with a specific CBA exercise, where students will work in groups to prepare a CBA for a real public decision faced by New Zealand in recent years. 3

5 8. Class Details Session Date Times Venue 1 4 May :00am 5:00pm MBIE, room G.03, 15 Stout Street 2 5 May :00am 5:00pm MBIE, room G.18, 15 Stout Street Please report to Reception on the ground floor of 15 Stout Street, Wellington. There will be a 15 minute break in each session. Coffee and tea will be provided. There will be a one hour lunch break between morning and afternoon sessions. 9. Course Costs This course is provided by the Government Economics Network (GEN) at a cost of $500 plus GST per person. 10. Course Materials 10.1 Recommended Reading To be provided later. Session Topic Reading 1 Foundation and Setup 2 Quantifying Costs and Benefits 3 Discounting and Uncertainty 4 Sensitivity Analysis and Presentation 10.2 Additional Reading 11.Assessment Participants are required to write a group report framing, planning and presenting a hypothetical cost-benefit analysis of some policy. Participants will be assigned to groups. The purpose of the report is to (1) deepen understanding of the specific analytical tools embedded in cost benefit analysis and (2) stimulate reflection on both the strengths and shortcomings of the approach. Since the collection of actual data to undertake the analysis would be beyond the scope of a project of this type, the focus will be on construction and hypothetical analysis, not analysis of real information. The report must include the following elements: 1. Definition of the policy question or issue that the report is intended to illuminate. 2. Identification of the relevant categories of costs and benefits that need to be quantified in order to carry out the analysis. 3. Description of the kind of data that would need to be collected or developed to provide the basis for quantification for each identified category of costs and benefits. 4

6 4. Specification of the analytical methods that would be applied to develop quantitative estimates of the dollar value of impacts that are intrinsically non-monetary (if any). 5. Explicit description of the parameters or assumptions (e.g. time horizon, discount rate, treatment of effects of other policies) necessary to complete the analysis. 6. Fabrication of necessary data. (Yes, just make it up.) 7. Execution of the analysis. 8. Consideration of sensitivities and caveats. 9. Presentation of the results in a decision memorandum. Proposals for the subject of the cost-benefit analysis must be submitted to the Course Presenter for approval by 5pm on 5 May Participants may wish to have thought in advance of proposals for subjects. All members of the group who contribute to the essay will be given the same mark. Group management is a matter for the group itself, including issues of free-rider behaviour. Participants may wish to note the addresses of each member of the group as they will need to do further preparation and communicate as the essay is developed. The report should consist of a 10-page document (including all tables, figures, illustrations, footnotes, references, etc.) that describes how the analysis was carried out, plus a 2-page Decision Memorandum. The Decision Memorandum must be written to be a free-standing communication, i.e. assume that the decisionmaker would not have access to the accompanying 10-page report. Grading criteria are indicated in the assessment matrix below. Criterion Mark Completeness and appropriateness of identification of costs and benefits 10 Appropriateness and justification of assumptions and choice of methods 20 Execution of the analysis 20 Consideration of sensitivities and caveats 20 Quality of the Decision Memorandum as a summary of the analysis 20 Quality of writing and presentation (both the 10-pager and the 2-pager) 10 Total 100 The essay should be typed or neatly presented and submitted in hard copy and by to the Course Administrator by close of business on the date due 5 June Participants should keep a copy of all submitted work. Successful participants will be awarded a GEN certificate of completion Plagiarism Plagiarism is unacceptable in any format. Participants should be aware that software (e.g. Turn-itin ) may be used at the discretion of GEN to review material submitted. Serious penalties may be applied in cases of plagiarism. 5

7 12. Attendance Requirements Full attendance by participants is expected and a record of attendance will be maintained in this subject. Where absence is unavoidable, notification to the Course Administrator as soon as possible is required. If a participant is absent for two sessions or more, additional work in lieu of attendance will be required to be eligible to pass this course. 13. Withdrawal from Course If a participant is unable to attend, the registration may be transferred to another person by advising the Course Administrator in writing at least 2 days before the start of the course. 14. Course Lecturer Adam B. Jaffe joined Motu as Director in May Motu is New Zealand s leading non-profit economics and public policy research institute, located in Wellington. Jaffe came to Motu from Brandeis University in Waltham, Massachusetts, U.S.A., where he was the Fred C. Hecht Professor in Economics, Chair of Economics and Dean of the Faculty of Arts and Sciences. He was previously Associate Professor of Economics at Harvard University, and Senior Staff Economist at the President s Council of Economic Advisers under President George H.W. Bush. Jaffe is the author of two books Patents, Citations and Innovations: A Window on the Knowledge Economy (with Manuel Trajtenberg, 2002); and Innovation and Its Discontents: How Our Broken Patent System is Endangering Innovation and Progress and What to Do About It (with Josh Lerner, 2004). In addition to his scholarly activities, Jaffe is active in public policy formulation and debate. He has served on numerous panels and committees for the U.S. National Science Foundation, the U.S. National Institutes of Health and the U.S. National Academy of Sciences. He was a Lead Author for the Third and Fifth Assessment Reports of the Intergovernmental Panel on Climate Change, the U.N. organization that shared the 2007 Nobel Peace Prize with Vice President Al Gore. He has also testified before the U.S. Congress on patent policy reform. In 2014 he was appointed to the MBIE Science Board by Minister of Science and Innovation Steven Joyce. 6