Economics



Economics

Answer No. 1

Item to be valued

Indirect Tax

Subsidy

 

Distorting

Corrective

Distorting

Corrective

Project Output

 

 

 

 

- Satisfies new demand

Gross Price

Net Price After Tax

Net Price After Tax

Subsidy Price

- Alternative supply to existing demand

Net Price After Tax

Net Price After Tax

Net Price After Tax

Subsidy Price

Project Input

 

 

 

 

- Sourced from New Supply

Gross Price

Net Price After Tax

Gross Price

Subsidy Price

- Diverted from alternative use

Gross Price

Net Price After Tax

Gross Price

Subsidy Price

In relation to above table, which particularly relates to shadow pricing cost-benefit analyses, it can be said that the business enterprises routinely calculate the profitability of their activities, weighing the costs of producing a good or service against the revenue it generates. The objective of cost- benefit analysis is the evaluation of the production activities' of the public sector. The social profitability' of public sector projects is calculated in a manner similar to the way a business enterprise would calculate the profitability of its activities, but the resources used and the outputs produced are valued differently. In a cost-benefit appraisal, shadow prices', which reflect the social value of goods, replace the market prices that are used in the private calculation. In a perfectly competitive economy market prices and shadow prices will coincide, if we ignore complications introduced by issues of income distribution (Brent, 2008). Cost-benefit analysis and calculation of private profitability will yield the same result in this case.

Market distortions, however, will cause shadow prices and market prices to differ. This makes cost benefit analysis difficult, since shadow prices' or social values' cannot be directly observed. Past researchers examined that the relationship between market and shadow prices when market distortions take the form of a tax or subsidy that causes consumers and private producers of a good to face different prices. An example of such a tax might be an excise tax. The price which consumers pay for a good is one measure of social value of the good, as it measures what a consumer is willing to pay for an extra unit of the good (Wessels, 2006). The price which producers face is an alternative measure of social value, since in a competitive market it is equal to the marginal cost of the resources used in producing the good. In the presence of a consumer tax or other distortion these two measures will not coincide. How can one calculate the correct shadow price in this situation? One plausible procedure is the use of a weighted-average' rule, in which the shadow price ...