COST-BENEFIT ANALYSIS

Cost-Benefit Analysis

Cost-Benefit Analysis

Introduction

The purpose of this research report is to understand the functions and difficulties of implementing cost-benefit analysis by government. Cost-benefit analysis is a process by which business decisions are analyzed. The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted (Benjamin, 2008). Some consultants or analysts also build the model to put a dollar value on intangible items, such as the benefits and costs associated with living in a certain town. Most analysts will also factor opportunity cost into such equations.

Discussion

In governmental planning and budgeting, the attempt to measure the social benefits of a proposed project in monetary terms and compare them with its costs. The procedure was first proposed in 1844 by Arsène-Jules-Étienne-Juvénal Dupuit (1804 - 66). It was not seriously applied until the 1936 U.S. Flood Control Act, which required that the benefits of flood-control projects exceed their costs (Stokey, 2008). A cost-benefit ratio is determined by dividing the projected benefits of a program by the projected costs. A wide range of variables, including non quantitative ones such as quality of life, are often considered because the value of the benefits may be indirect or projected far into the future. To many of the more extreme type of environmentalists, no level of human destruction of the environment is acceptable.  They would demand an end to environmental problems such as pollution.

Other more moderate environmentalists and many modern economists instead turn to what is known as cost-benefit analysis (Pradhan, 1996).  This process seeks to compare the social costs and social benefits associated with a public policy decision.

Often this process is very successful.  For example, a cost-benefit analysis of pollution in Los Angeles, California revealed that the combined benefits of pollution reduction would greatly outweigh the calculated costs, and government policy was successfully affected by this finding.

One problem with cost-benefit analysis is that not everything can be expressed in money terms. How much does it "cost" society if a person dies?

There are other problems as well. It is impossible to completely predict every result of a policy decision. In other words, not every factor can be taken into account in the analysis (Mishan, 2002). Also, aspects such as health hazards have to be based on risk assessments because the exact outcome cannot be known beforehand. The fact that the concerns of future generations are not always represented in cost-benefit analyses also makes the process less reliable.

Ultimately, the goal of cost-benefit analysis is to enable a government policy that enforces environmental regulations up to the point where the marginal social cost and the marginal social benefit of these regulations are equal.

This basically means that, for example, the government should continue reducing the amount of pollution allowed up to the point where a further reduction of pollution levels would mean greater costs for polluters than benefits for society (Ministry of Economic Development, 1999).

Cost-benefit analysis heavily affects modern government policy. In the United States, the Environmental Protection Agency (EPA) ...