Thayer Watkins
Silicon Valley
& Tornado Alley

Resolving a Discrepancy in Cost Benefit Analysis

There are perceived to be two ways to do cost-benefit analysis for a project. One is to estimate the impact of the project on production of goods and services and the use of resource services. A money value is placed on the impacts on production of goods and services by, in effect, finding the area under the demand curves for the goods and services over the range of consumptions without the project to what consumptions would be with the project. The social costs of the project is the area under the supply functions for the resource services the project uses over the range of what it would be without the project to what it would be with the project.

The second way to do cost-benefit analysis is to estimate the change in consumers' and producers' surplus that results from the project. There is an assumption, unwarranted as it turns out, that both approaches will give the same answers; i.e., the net social benefit computed will be the same for the two approaches. The analysis presented graphically shows why the results will not necessarily be the same and what has to be done to eliminate the discrepancy between the results.

Thus the discrepancy of the two approaches can be resolved by adding to the consumer and resources owners surpluses the change in profits to the business which are affected by the prices changes that the project produces. In other words, the consumer and producer surpluses approach used in many cost-benefit analyses is defective in leaving out significant impacts of the project.

For a specific illustration of this type of problem see A Cost Benefit Problem.

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