updated:09/03/2007 lecture notes econ 622: economic cost-benefit analysis lecture 4

1

Updated:09/03/2007

Lecture Notes

ECON 622: ECONOMIC COST-BENEFIT ANALYSIS

Lecture 4

2

ECONOMIC VALUATIONOF TRADABLE GOODS &

SERVICES

3

Tradable Commodities Classification of a Project’s Inputs and Outputs

A good or service is considered tradable when an increase in demand (or supply) by a project does not affect the amount demanded by domestic consumers

• An increase in demand for an IMPORTABLE commodity results in an increase in demand for imports

• An increase in demand for an EXPORTABLE commodity results in a reduction in exports

• An increase in supply of a tradable commodity by a project will cause either a reduction in imports or an increase in exports

An Importable commodity includes imported goods and domestically produced goods that are close substitutes for imported goods

An Exportable commodity includes exported goods and close substitutes for exported goods

4

Measuring the Economic Values of Tradable Goods: Four Cases

1. Economic value of importable good production

2. Economic cost of importable input

3. Economic cost of exportable input

4. Economic value of export production

5

Importable Good

Distorted World Supply Price

Price

QQuantity per year

Domestic Supply

Domestic DemandD

S

Em * PCIF * (1+Tm) + Fm

do

so Q

Pm

Imports = Q - Q

Em = Market Exchange Rate

Tm = Rate of Import TariffFM = Domestic Freight to Market

so

do

PCIF = Price of imports at entry point to country, including international freight and insurance charges expressed in units of foreign currency

6

Project Supplies More of an Importable Good

Project reduces quantity imported. No change in domestic consumption.

Price

Quantity

S domestic

S w/ project

Qs0 Qs

1 Qd0

D domestic

S worldEm * PCIF* (1+Tm) + Fm

7

Estimating The Economic Prices of Tradable Goods

1. Adjust for commodity - specific trade distortions• Financial prices for the commodities demanded (or supplied) by a project must be

adjusted for commodity-specific distortions and costs that drive a wedge between their international prices and their domestic market prices

• Taxes and Subsidies are transfers between consumers, producers, and the government. Therefore, they are not part of the real resources consumed or produced by a project.

2. Value the foreign exchange at the economic (shadow) exchange rate (Ee)• Multiply the CIF and FOB prices at the border by the economic price of foreign

exchange (Ee).• Alternatively, add a foreign exchange premium [(Ee/Em) - 1], or [(Ee/OER) - 1], per

unit of foreign exchange demanded (or supplied) by a project.3. Adjust for handling and transportation costs• The economic costs of handling and transportation that are necessary to move

commodities to or from the point of entry must be included.• In the case of imported commodities, these costs should be added to the CIF price.• In the case of exported commodities, these costs should be subtracted from the FOB

price.

8

Visayas Communal Irrigation ProjectBasic Facts• The National Irrigation Administration (Philippine National Agency) proposes to rehabilitate

55 damaged communal irrigation systems and to build 25 new systems in Visayas.

• The project’s additional components include water protection and erosion control, the strengthening of irrigation association, and the development of agricultural extension services.

• The goal of the project is to alleviate poverty, while improving environmental sustainability of the region.

• The life of project is 20 years.

• The economic benefits arise from the increased production of rice and corn, which must otherwise be imported.

• The foreign exchange premium is 24.6%.

• The project is expected to cost approximately 480.910 million pesos (US$19.78 million).

• The project will be financed with US$15.1 million loan from the International Fund for Agricultural Development, and remaining funding would be provided by the Philippine government.

9

Table 1: Project Supplies an Importable Good (Rice)

Financial Tradable Non-Tradable EconomicPrice

AdjustmentFor Taxes

Adjusted Value Content Content Value

(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)CIF World (US$) 314.8CIF per metric ton of rice 7659 1 7659 100% 0% 1884 0.00 9543PLUS

Transportation and Handling Charges 205 1 205 30% 70% 15.13 1.44 222Trading Margin 472 0.68 321 10% 90% 7.90 2.89 332

Wholesale Price in Manila 8336 8185 10096

LESSTransport cost, rice mill to Manila 515 1 515 30% 70% 38 3.61 557

Ex-mill price of rice 7821 9540LESS

Net milling cost 346 1 346 50% 50% 43 1.73 390Pre-milled value 7475 9150

Palay equivalent (65%) 4859 5947LESS

Grain dealer margin (4% margin) 194 0.68 132 10% 90% 3 1.19 137Transport and handling cost, farm to mill 130 1 130 30% 70% 10 0.91 141

Farmgate price of palay 4534 5670

Conversion Factor 1.25

Value of Forex

Premium

Value of SPNTO

Premium

10






11

Project Demands More of an Importable Good

Project requirements will be met by additional imports (world supply). Domestic consumption is not affected.

Price

Quantity

S domestic

Qs0 Qd

0 Qd1

D domestic

D w/ project

S worldEm * PCIF * (1+Tm) + Fm

12

Project Purchases Importable Inputs

Input subject to Import Tariff

Financial cost is EmPw (1+t) (Q1d-Q0

d)Economic cost is EmPw(Q1

d – Q0d) + Foreign exchange premium

World Supply

Qs0

Price

Pd Pw(1+t)

Pw

S0

Quantity

World Supply After Tariff

D0 D0+P

0 d1QQd

0

= Em

Em

13

Quantity of units per year (000’s)

D0

E

0

Price / unit

G

S0

A

B

C

F

D1

S0Q

d0Q

d1Q

(cif)=P1

(P1+tariff)=P2

(P2+trade margin)=P3 (P3+freight)=P4

L M K J

H I

Economic cost of Importable Goods: With Tariff, Trade Margin and Domestic Freight

Em

14

Table 2: Project Uses an Importable Good (PESTICIDES).

Financial Adjustment TradableNon-Tradable EconomicPrice For Taxes

Adjusted Value Content Content Value

(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)CIF World (US$) 166CIF per 1000 liters of pesticides 4038 1 4038 100% 993.35 5031PLUS

Tariff 201 0 0 0% 0.00 0Port charges, handling and transportation to Manila

155 1 155 30% 70% 11.44 1.09 168

Importer Price, Manila 4394 5199

PLUSTransport cost, Manila to local market 515 1 515 30% 70% 38.01 3.61 557Dealer's margin 201 0.68 137 10% 90% 3.36 1.23 141

Price at local market 5110 5897

PLUSLocal transport cost 120 1 120 30% 70% 8.86 0.84 130

Price at farm gate 5230 6026


Value of Forex

Premium

Value of SPNTO

Premium

15






16

Exportable Good

Quantity per year

Distorted World Demand Price

Price

Q

Domestic Supply

Domestic DemandD

SEm * PFOB * (1-tx) - Fx

do

soQ

Pm

Exports = Q - Q

Em = Market Exchange Rate

tx = Export Tax

Fx = Freight and Trading Costs to Port

do

so

PFOB= Price of exports at point of export from country in units of foreign currency

17

Project Demands More of an Exportable Good

Project requirements will reduce quantity exported. Consumption of previous consumers remains unchanged.

Price

Quantity

S domestic

Qd0 Qd

1 Qs0

D w/ ProjectD domestic

D worldEm * PFOB * (1-tx) - Fx

18

Table 3: Project Uses an Exportable Good (Seeds)

LESS

Financial Tradable Non-Tradable EconomicPrice Content Content Value(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)

FOB per ton of PADDY SEED (pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882

Port Handling and Transportation 155 1 155 30.00% 70.00% 11.44 1.09 168From IRRI to port of Manila

IRRI Exporter Price 6171 7715PLUS 0.00 0.00

Transport Cost, IRRI to local market 515 1 515 30.00% 70.00% 38.01 3.61 557Dealer's margin 235 0.68 160 10.00% 90.00% 3.93 1.44 165

Price at Local Market 6921 8436PLUS

Local transport cost fromMarket to farm (Project site) 120 1 120 30.00% 70.00% 8.86 0.84 130

Price at Farm Gate 7041 8566


AdjustmentFor Taxes

Adjusted Value

Value of Forex

Premium

Value of SPNTO

Premium

19






20

Project Supplies More of an Exportable Good

Project increases exports. Domestic consumption remains unchanged.

Price

Quantity

S domestic

S w/ Project

Qd0 Qs

0 Qs1

D domestic

D world Em * PFOB * (1-tx) - Fx

21

Project Produces Exportable Goods subject toExport Tax (No domestic transportation costs)

Pd = Pw(1-t)

Pw World Demand

Price

Quantity

S0+P

D0

World Demand After Export Tax

S0

0 d0Q s

0Q s1Q

Financial benefit is EmPw (1-t) (Q1s-Q0

s)Economic benefit is EmPw(Q1

s – Q0s) + Foreign exchange premium

Em

Pd=EmPw(1-t)

Economic values of exportable goods are based on the FOB values of demand for exports

22

Table 4: IRRI Supply an Exportable Good (Seeds)

Financial Tradable Non-Tradable EconomicPrice Content Content Value(A) (B) (C= A*B) (D) (E) (F=C*D*0.246) (G=C*E*0.01) (H=C+F+G)

FOB Port (US$) 260FOB Port (Pesos/ton) 6326 1 6326 100.00% 0.00% 1556.20 0.00 7882LESS

Port Charges and transportation 155 1 155 30.00% 70.00% 11.44 1.09 168from IRRI to Port

IRRI Gate Price 6171 7715

Conversion Factor (EV/PV) 1.25

AdjustmentFor Taxes

Adjusted Value

Value of Forex

Premium

Value of SPNTO

Premium

23

SUMMARY

Economic Value of Importable Good Production =CIF (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from

Port to Market - Economic Cost of Local Freight from Project to Market

Economic Cost of Imported Input = CIF (adj. For Economic Exchange Rate) + Economic Cost of Freight from Port to

Project

Economic Cost of Exportable Input = FOB (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from

Export Producer to Project - Economic Cost of Local Freight from Export Producer to Port

Economic Value of Exportable Production = FOB (adj. For Economic Exchange Rate) - Economic Cost of Local Freight from

Project to Port

updated:09/03/2007 lecture notes econ 622: economic cost-benefit analysis lecture 4

Documents