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Benefit-Cost Analysis inEnvironmental Decision Making

Chapter 9

2004 Thomson Learning/South-Western

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Adjusting for the Time Dimension ofEnvironmental Benefits and Costs

Present Value Determination a procedure

that discounts a future value (FV) into itspresent value (PV) by accounting for the

opportunity cost of moneyDiscount factor the term 1/(1+r)t, where tis the

number of periods

Social discount rate discount rate used for publicpolicy initiatives based on the social opportunity

cost of funds

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Adjusting for the Time Dimension ofEnvironmental Benefits and Costs

Inflation correction a magnitude stated interms of the current period

Nominal value a magnitude stated in terms of the

current periodReal value a magnitude adjusted for the effects of

inflation

Deflating converts a nominal value into its real value

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Adjusting for the Time Dimension ofEnvironmental Benefits and Costs

Summary of Deriving Time-Adjusted Benefitsand Costs

Present value of benefits (PVB) the time-adjusted

magnitude of incremental benefits associated withan environmental policy change

Present value of costs (PVC) the time adjustedmagnitude of incremental costs associated with anenvironmental policy change

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The Final Analysis: ComparingEnvironmental Benefits and Costs

Step One: Determining Feasibility

Benefit-cost ratio the ratio of PVBto PVCused todetermine the feasibility of a policy option if itsmagnitude exceeds unity

Present value of net benefits (PVNB) thedifferential of (PVB PVC)used to determine thefeasibility of a policy option if its magnitude exceedszero

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The Final Analysis: ComparingEnvironmental Benefits and Costs

Step Two: Decision Rules to Select AmongFeasible Options

Maximize the present value of net benefits (PVNB)

a decision rule to achieve allocative efficiency byselecting the policy option that yields greatestexcess benefits after adjusting for time effects

Minimize the present value of costs (PVC) adecision rule to achieve costeffectiveness by

selecting the least-cost policy option that achieves apreestablished objective

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Reservations About the Use of Benefit-Cost Analysis

Measurement Problems

Estimation is particularly problematic due tointangibles

Implicit costs

Equity Issues

Distribution of benefits and costs may be highlyskewed

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U.S. Government Support of Benefit-CostAnalysis

Executive order 12291: Regulatory ImpactAnalysis (RIA)

Regulatory impact analysis (RIA) a requirement

under Executive Order 12291 that called forinformation about the potential benefits and costs of

a major federal regulation

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U.S. Government Support of Benefit-CostAnalysis

Executive order 12866 Economic Analysis (EA)

Economic analysis (EA) - a requirement underExecutive Order 12866 that called for information onthe benefits and costs of a significant regulatory

action

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Reducing Lead in Gasoline: A RegulatoryImpact Analysis

Estimating the incremental benefits of thelead standard proposal health benefits

Nonhealth Benefits

Reduction in harmful emissions caused bymisfueling (i.e., the use of leaded gasoline invehicles requiring unleaded gasoline)

Lower maintenance costs

Increased fuel economy

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Reducing Lead in Gasoline: A RegulatoryImpact Analysis

Figure 9.1 Correlation Between Lead in Gasoline and AverageBlood Lead Levels

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Reducing Lead in Gasoline: A RegulatoryImpact Analysis

Estimating the Incremental Costs of the LeadStandard Proposal

Engineering cost model

Putting It All Together: Benefit-Cost Analysis The Final Decision