Question

When the federal government builds a project such as a dam, a road, or a bridge, it conducts a cost-benefit analysis in which the total costs of building the project are compared with the total benefits the project is supposed to bring. For example, in the aforementioned Tellico Dam, the costs of building the dam over the few years it took to build the dam and clear the land for the reservoir were approximately $100 million. The government (Tennessee Valley Authority) then estimated the total monetary benefits authorities believed would accrue over the next several decades, including tourism, planned residential developments and the like, comparing the estimated benefits to the costs of building the dam, and then said that the estimated benefits totaled more than $100 million, which meant the government would approve the project. (For example, if the government believed that in 20 years a developer would build a project that would cost $10 million to build, the government would put a total of $10 million in its up-front benefit tally.)

Given what we have covered in this class, is this (economically speaking) an accurate way to do a cost-benefit analysis? Why or why not? Explain in detail.

Answer 1

This cannot be considered as a perfect method of cost benefit analysis as the factors like inflation, value depreciation (or appreciation), international export and import values and standards for the development projects might change. Moreover the cost of labour is also a huge factor which keeps on changing and is extremely volatile with changes in inflation.

Inflation plays a major role in such governmental projects where the cost of labour, raw materials may vary with time. And thus, calculating the cost from present day is not suitable for such long term projects.

Imports and exports from materials used also changes their values because of the depreciation or appreciation of the currency in question. Hence the final value might differ which is calculated as per the today's forecasts.

Sometimes, the international standards for building and construction also changes over time and this can have a significant impact on the cost of the project.

Hence, the method is not very suitable.