The Cost-Benefit Analysis Process

This is how I remember the economic calculation of cost-benfot analysis.

Firstly you examine the task been given to you so it might be that the government has limited funds and needs to decided whether it is worth investing in a project like the Olympics.

So they set two sections out - long term and short term effects. They people conducting the process must now try to think of all the possible impacts and outcomes of the Olympics and put them in a category - 'Short-term advantage' 'Short-term disadvantage' 'Long-term advantage' and 'Long- term disadvantage'.

Once this is done they must now valuate each outcome; for example if the an impact is increased tourism they must calculate exactly how much monetary value this has on the economy.

Then all the advantage values are added and divided by the sum of the disadvantage values.

The number given will firstly show whether the project involved will make a profit or a loss (indicated by the sign of the value (e.g. -60 or +60). The size of the value can be compared to the sizeof the values from other projects and the larger (and positive) the value the more economically fruitful it will be. That is the project you must choose.

So why exactly is this important?

Well if we never weighed up and made decision the government would be making some potentially terrible decisions. The government has limited funds and can't increase them very easily so for example increasing taxes would create a big controversy. If they made bad decisions then slowly they would see they are running out of revenue and would not be able to function any more.

A good example which is very closely related to us can be seen on youtube: http://www.youtube.com/watch?v=Rh7ygXiR_rs&feature=fvw

Although there are many flaws with this system:

1. Firstly it is difficult to put a value on non-monetary effects particularly when they are to do with the future (long-term) e.g. increased pollution in the future.
2. Very lengthy process - it is opportunity cost for the people completing the process.
3. A lot of the time externalities are missed out and how would you put a value on that?
4. If you were to put tax how would you know whether that was an advantage or disadvantage; who will be prioritised more the rich or the poor?