Economic Analysis

March 2004Maine

Economic Principles

Types of Economic Analysis

• With/Without• Benefit Cost Analysis• Cost Effective

Analysis• Partial Budget• Marginal Analysis• Enterprise Budgets• Net Worth Statement

Future With and Future Without

• Compare future with conservation to the future without it

• Benefits of conservation determined by the difference between with and with out

• Always have the effects of “do nothing” compared to effects with conservation installed

Benefit

Time

Yield

Benefit

Time

Yield

Sediment

Damage

Benefit Cost Analysis

• Total benefits compared to total costs – usually expressed as a ratio (such as $1.10 to $1)

• >$1/$1, GOOD!• <$1/$1, NOT AS GOOD• Used mostly for area-wide projects and

national programs• Required by law for certain programs

Benefit Cost Analyses of Conservation Programs

Economics of CRPEconomics of CRP

+Increased net farm income $2.1 to $6.3 billion

+Value of future timber $3.3 billion

+Preservation of soil productivity $0.6 to $1.7 billion

+Improved surface water quality $1.3 to $4.2 billion

+Reduced windblown dust $.3 to $.9 billion

+Enhanced small game hunting$1.9 to $3.1 billion

$9.5 to $19.5 billion

-Higher food cost to consumers $2.9 to $7.8 billion

-Veg. Cover establishment $2.4 billion

-USDA tech. Asst. $.1 billion

$5.4 to $10.3 billion

Net Value = $4.1 to $9.2 billion

Source: Osborn and Konyar (1990)

+Increased net farm income $2.1 to $6.3 billion

+Value of future timber $3.3 billion

+Preservation of soil productivity $0.6 to $1.7 billion

+Improved surface water quality $1.3 to $4.2 billion

+Reduced windblown dust $.3 to $.9 billion

+Enhanced small game hunting$1.9 to $3.1 billion

$9.5 to $19.5 billion

-Higher food cost to consumers $2.9 to $7.8 billion

-Veg. Cover establishment $2.4 billion

-USDA tech. Asst. $.1 billion

$5.4 to $10.3 billion

Net Value = $4.1 to $9.2 billion

Source: Osborn and Konyar (1990)

National benefits/costs

Kenduskeag Watershed Project Economic Benefits

Type of Economic Benefit Average Annual $

Increased fishing opportunities $71,050

Recreation $62,700

Maintaining yields $18,510

Yield improvements $48,450

More efficient fertilizer use $17,730

More efficient pasture mgmt. $69,300

Total Benefits $287,740

Total Costs $270,040

Benefit – Cost Ratio $1.07

Adapted from Watershed Plan – EA, Kenduskeag Stream Watershed, November, 1988

Monetary vs. Non-Monetary Benefits

• Market goodsMarket goods

lumber, grain, cars, pencils, etc.

• Non-market goodsNon-market goods

clean water, scenic farmland, wetland functions/values, wildlife

Non-monetary Benefits

How to put a $ value on goods/services not traded in the market?

• Contingent valuation

• Travel cost method

• Hedonic Studies

?

Environmental QualityPollution Level

Property Price ($)

Hedonic Studies

Maine Lakes

• willingness of users to pay for water quality: $2 to $6 million per year

• >200,000 Mainers spend ~$100 million per year in recreation associated with lakes

• 1 meter reduction in summertime water clarity: 3 - 5% reduction in lakefront property value

Source: 2000 National Water Quality Inventory Report, EPA, p. 64. www.epa.gov/305b

Cost Effectiveness

• A tool to measure the effectiveness of a practice or plan relative to its cost

• Used to obtain a set objective at the least cost, OR

• To obtain the best results at a set cost

Cost Effectiveness

• Best Buy• What is the better

deal when comparing the amount of physical effects and the cost to get it

• 1 fish per 50 mile trip or 3 fish per 100 mile trip???

Two hypothetical questions that cost-effectiveness would try to answer:

• If we have $1 million, how can we get the most conservation possible?

Constant cost

• If we want to reduce pollution by 40 percent, what is the cheapest way to do that?

Constant effects

Cost-effectiveness (cont.)

• Costs are associated with a particular unit reduction or increase (the effect)

Lbs of N prevented from reaching streamsTons of soil savedAcres of habitat createdNumber of life-years savedDucks made happy (?)

C-E Example 1: Constant Effects

Plan A B C D

Cost ($/year) 50,000 12,000 10,000 30,000

Effect (T/A/Y saved)

10 10 10 10

Ratio ($/T/A/Y)

5,000 1,200 1,000 3,000

C-E Example 2: Constant Cost

Plan A B C D

Cost ($/year) 50,000 50,000 50,000 50,000

Effect (T/A/Y saved)

10 8 15 3

Ratio ($/T/A/Y)

5,000 6,250 3,333 16,667

C-E Example 3: Costs & Effects Vary

Plan A B C D

Cost ($/year) 50,000 20,000 90,000 6,000

Effect (T/A/Y saved)

10 8 15 3

Ratio ($/T/A/Y)

5,000 2,500 6,000 2,000

Cost-effectiveness in Ranking Systems

0

50

100

150

200

250

300

$0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000

Costs

Po

ints

E

HG

B

F

CJ

I

K

D

L

AM

Partial Budgeting

• A planning and decision-making framework used to compare the costs and benefits of alternatives faced by a farm business.

Partial Budgeting

• Systematically displays the positive and negative effects of a change

• Only those factors that change are considered

• Useful tool for analyzing almost anyany type of change

Situations where a farm might use partial budgets

• Substituting one crop for another

• Adding a few head to a livestock enterprise

• Taking advantage of an early payment discount on a fertilizer bill

• Adopting a new production practice

• Participating in a government program

Partial Budget Elements

Added Income

+ Reduced Costs

______________

Total Positive Effects

Added Costs

+ Reduced Income

_______________

Total Negative Effects

Partial BudgetPositive Effects

(+)Negative Effects

(-)Reduced Costs Increased Costs

Increased Income Reduced Income

1. ____________________________

2. ____________________________

3. ____________________________

1. ____________________________

2. ____________________________

3. ____________________________

1. ____________________________

2. ____________________________

3. ____________________________

1. ____________________________

2. ____________________________

3. ____________________________

Total + ________ Total - ________

Positive Effects (+) Negative Effects (-)

Additional income Reduced income

+ CREP rental rate ($60/ac x 8 ac x 15 yr) 7,200$ - Pasture income ($35/ac x 8 ac x 15 yr) 4,200$

+ Bonus rate (70% of rental rate) 5,040$

Cost-share (100%)

+ trees 4,600$

+ fence 6,970$

+ spring development and trough 3,000$

Total 26,810$ Total 4,200$

Reduced costs Increased costs

+ Streambank stabilized ? -Tree establishment and maintenance ($575/ac x 8 ac) 4,600$

+ Improved herd health ? -Fencing ($2/foot x 3,485 feet stream length) 6,970$

- Spring development and trough 3,000$

-Potential tree harvest income from 1st 50 feet foregone ?

- Potential development value foregone ?

Total Total 14,570$

Net change in income (sum of all totals): 8,040$

Item Current System

Clear forest, till additional

land

Shorten system

Move and shorten system

Irrigated acres 62 73 50 55

Crop income $7,440 $8,760 $6,000 $6,600

Reduced income -- -- $370 $216

Land clearing -- $257 -- --

Mitigation -- $206 -- --

Move & shorten -- -- -- $515

Fuel $1,122 $1,122 $1,122 $1,122

Labor & Maintenance

$3,720 $2,920 $2,000 $2,200

Insurance $868 $868 $868 $868

Net Income $1,730 $3,386 $1,640 $1,679

Change from current system

-- $1,657 -$90 -$51

Marginal Analysis

• Think at the margin - we look at the last increment

• Trying to find the most economical input level

• Marginal Benefit equal to or greater than Marginal Cost

• Common sense to have the income or value of the product greater than the cost

PRODUCTION FUNCTION

0

2,000

4,000

6,000

8,000

10,000

1 2 3 4 5 6 7 8

Fertilizer (100 lb)

Hay

Yie

ld (

lbs)

Fertilizer is $11 for 100 poundsHay is worth $60 per ton

Fertilizer (lbs)

Hay yield (lbs)Marginal Cost

(MC)

Marginal Product

Marginal Value

Product (MVP)

0 1950 none none none100 4875 11.00$ 2925 $87.75200 7150 11.00$ 2275 $68.25300 8450 11.00$ 1300 $39.00400 9100 11.00$ 650 $19.50500 9425 11.00$ 325 $9.75600 9620 11.00$ 195 $5.85700 9620 11.00$ 0 $0.00800 9490 11.00$ -130 -$3.90

Marginal Analysis

WHERE DO WE WANT TO BE?WHERE MVP >=MC