exam key concept - Cost Benefit Analysis (CBA)

The cost-benefit principle is one of those core ideas that can be brought into so many discussions both in micro and macroeconomics – you should be using it in your papers

The cost-benefit principle says that you should take an action if, and only if, the extra benefit from taking it is greater than the extra cost

Here are ten examples where the principle might be built into your analysis and evaluation:

1. Costs and benefits of government subsidies e.g. the bio-fuel debate or subsidies for industries affected by globalisation
2. Costs and benefits of indirect taxes e.g. environmental taxes or taxes designed to curb demand for / consumption of de-merit goods
3. Costs and benefits of the introduction of competition into a market e.g. postal market liberalisation
4. Costs and benefits of an increase in government spending on public goods and merit goods such as flood defence schemes, free entry to museums and galleries
5. Costs and benefits of different strategies designed to reduce income and wealth inequality e.g. the national minimum wage or a rise in the top rate of income tax
6. Costs and benefits of the introduction of carbon trading as a way of reducing CO2 emissions
7. Costs and benefits of different government policies designed to reduce unemployment e.g. comparing the effectiveness of investment in training with an employment subsidy for the long term unemployed
8. Costs and benefits of major infrastructural projects such as new motorways, London 2012 et al
9. Costs and benefits of a decision by the government to relax planning controls on new house-building
10. Costs and benefits of having a floating currency and / or an independent central bank

Key revision points:
• Market failure diagrams are an excellent way of illustrating the ideas here e.g. you can draw / show private and social costs and benefits and also the welfare losses and gains from different policies. So any question on externalities (positive and negative); merit and de-merit goods etc should definitely have a cost-benefit diagram within the answer and some supporting text explaining it and applying it to the question.
• Consider short and longer term costs and benefits
• Whenever you are considering policies from a cost-benefit viewpoint, the hard part is
o Identifying the relevant costs and benefits
o Measuring and valuing them o Recognising that individual rational behaviour does not always lead to a socially optimum / desirable outcome
• When governments get their cost-benefit analysis wrong, there is always scope for government failure
• Remember – the best policies are those that are likely to be:
o Most effective in achieving an aim(s)
o Most efficient in not wasting resources or creating secondary problems / disincentive effects
o Are equitable in terms of their impact on different stakeholders

source: Tutor2u Blog