Question

What is cost-benefit analysis? How would you apply cost-benefit analysis to your decision to go to college? What are the benefits and what are the costs of going to college?

b. What happens to your analysis if the interest rate rises? What happens if the payoff period shrinks? Who is more likely to find college economically worthwhile: you for your 63-year-old professor?

c. How would you apply cost-benefit analysis to environmental policy? What are the costs of pollution? What are the benefits? Who receives the benefits, and who bears the costs? When the benefits in the costs are received in different times, how can you compare them? What happens if you use a lower discount rate or a higher one?

Answer 1

1. Cost- Benefit Analysisis a process of investigating the strengths and weaknesses of a decision in daily economic lives of people and organizations (for example in transactions,  business, investment, etc). It is used to examine the best option where expected benefits outweigh the expected costs.Benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time are expressed on a common basis in terms of their net present value,regardless of whether they are incurred at different points in time.

We can apply cost -benefit analysis to decision to go to collegeby comparing its expected cost and expected benefits.

Cost -Benefit analysis of going to college:

Costs:Financial costs, education loan, time, energy, effort, opportunity cost of working somewhere.

Benefits:Potential higher salaried job opportunities once a graduate from college, higher education standard, better standard of living, networking.

b) If interest rates increase  and if one has taken an education loan to sponsor your college studies then, your potential costs go higher. The pay-off period means the time taken to realise returns from your investment (the college education). Hence, if pay-off period shrinks and you quickly land in a good job soon after graduation then your potential benefits rise.

Lasly, cost and benefit analysis needs to be done for you and for your 63 year old professor. It depends on the cost and benefit of each entity. For you, there may be lot of benefits like potential higher salaried job opportunities once a graduate from college, higher education standard, better standard of living, networking, etc. On the other hand, for you the costs are also more ranging from financial costs, opportunity cost, time and effort. For your professor, benefits may be saving up for his post-retirement period and cover for his medical and other amenities required in old-age . His only costs are his time and effort. In both cases, it depends whose costs outweigh benefits, they are less likely to benefit from the decision of going to college.

1. In the case of environmental policy, yet again we compare the total expected costs and benefits of the policy decision.

Costs of pollution: reduction in human well-being through various respiratory illness (thus may reduce economic output too due to unhealthy workforce) equipment to recycle waste, control pollution, taxes.

Benefits of environmental policy:increase in human well-being

All receive the benefits and all bear the costs of an environmental policy implemented in a region.

If we want to compare benefits and costs occurring at different time scales discounting is needed to express future costs or benefits at today’s equivalent value. Social Discount Rate (SDR) is an estimate of how society values consumption at different points in time. The lower the discount rate, the higher the return value of the project. Conversely, the higher the discount/ interest rates the lower the future return value will be.