Cost-Benefit Analysis: Theory and Application

Cost-benefit analysis (CBA) has become a widely used (often mandatory) tool for public policy decision making on infrastructural projects or environmental and climate policies. As its name suggests CBA, identifies and estimates the expected costs and benefits resulting from projects, programmes or policies and expresses them in monetary terms. This does not only identify whether a project is economically viable but also allows a comparison across alternative projects. Students will learn to apply the appropriate decision rule for such comparisons across projects in order to make optimal choices from a societal perspective. 

CBA comprises not only the ‘private’ costs and benefits, which individual actors or entities (e.g. project, firm, industry) take into account in their cost calculations and decisions but also the wider social costs and benefits. Many of the social costs and benefits are of a non-financial nature. Think of the construction of a new highway. In such a case, not only construction costs or potential toll revenues have to be considered but also factors such as accidents avoided, travel time saved or environmental damages.

Because CBA evaluates policy and/or project proposals from the point of view of the society as a whole, there are instances where market prices used in CBA need to be corrected for potential market distortions (for example, unpriced environmental damage). Students will learn all the microeconomic concepts needed to understand all these features of analytical CBA.

Despite its analytical rigour, real-world applications of CBA face numerous challenges and limitations that will also be discussed in depth. Examples include: What discount factors are to be applied to determine the present and future costs and benefits of a policy proposal? Why and how do the private benefits and costs of a policy proposal differ from the social benefits and costs? How, if at all, can environmental damage, or human health and life risks be expressed in monetary units? Whose interest are considered in a CBA (i.e. who has ‘standing’)? Many of these questions involve ethical issues which are not easy to solve but will nevertheless be addressed.