Cost-benefit analysis

Explain what cost-benefit analysis is and what public authorities use it for before approving a project. Give an example of a project in your local municipality to which it could be applied.

A local council is considering building a cycle lane. Classify these items as costs or benefits of the project: the construction of the cycle lane, reduced congestion, annual maintenance, health improvements for cyclists, and lost parking spaces.

A village switches all its street lighting to LED: the investment costs $50.000\ \text{€}$ and saves $10.000\ \text{€}$ a year on the electricity bill. Calculate the payback period of the investment and explain what that figure means.

A municipality can only afford one of these projects: a swimming pool (cost of $500.000\ \text{€}$, estimated benefits of $650.000\ \text{€}$) or a sports centre (cost of $400.000\ \text{€}$, benefits of $560.000\ \text{€}$).

1. a) Calculate the net benefit and the benefit-cost ratio of each one.
2. b) Which would you choose and on what criterion? Reason why net benefit and the ratio can recommend different projects.

A public library does not charge admission and yet it "produces" a great deal of value. Explain why the cost-benefit analysis of a library must count benefits that are not charged for (reading, study, internet access) and what would happen if we only looked at its revenue.

A property developer requests the rezoning of a coastal wetland to build a hotel complex that would generate a net business profit of $18$ million euros over $20$ years. The environmental department quantifies the ecological services that the wetland currently provides for free:

1. Hydrological regulation: the wetland mitigates flash floods. If it disappears, it will be compulsory to build canalisations with an investment cost of $8$ million euros and an annual maintenance cost of $150.000\ \text{€}$.

2. Natural purification: it filters $1,5$ million $\text{m}^3$ of wastewater per year; treating that same water in a conventional wastewater treatment plant would cost $0,40\ \text{€}$ per $\text{m}^3$.

3. Storm buffering: reports estimate that without the wetland there will be flood damage to the urban centre with an average expected value of $500.000\ \text{€}$ each year.

1. a) Calculate the total annual shadow price (imputed economic value) of the ecosystem services provided by the wetland and obtain its accumulated value over a $20$-year horizon (without applying discounting).
2. b) With the obtained data, evaluate whether the hotel rezoning is efficient from the point of view of social welfare.
3. c) The developer claims: "Those ecological costs are theoretical; nobody pays bills for the water the wetland cleans, whereas the hotels will generate real GDP." Technically refute this argument drawing on the concepts of market failure and opportunity cost.

To protect an agricultural and urban plain from the projected rise in sea level, a sea wall barrier is planned with an immediate construction cost of $200$ million euros ($I_0 = 200$). Hydrological models predict that the project will prevent a flood catastrophe estimated at $1.000$ million euros in damage exactly $40$ years from now ($t = 40$).

1. a) Calculate the social Net Present Value (NPV) of the project by applying a social discount rate standard in infrastructure works of $r = 5\ \%$ (where the discount factor is $(1 + 0,05)^{40} \approx 7,04$). Determine whether the project would be carried out under this criterion.
2. b) Recalculate the social NPV using the rate proposed by economist Nicholas Stern for intergenerational climate risks of $r = 1,4\ \%$ (where $(1 + 0,014)^{40} \approx 1,74$). How does the technical investment decision change?
3. c) A critic argues: "Using a positive discount rate in environmental problems implies treating future generations as second-class citizens." Justify the ethical argument of this criticism and present what financial argument supports the use of positive discount rates.

A cycle lane costs $300.000\ \text{€}$, has annual maintenance of $10.000\ \text{€}$ and benefits (time, health, less congestion) are estimated at $60.000\ \text{€}$ a year.

1. a) Calculate the net benefit over ten years (without discounting).
2. b) What key assumptions would you review before approving it (actual number of users, valuation of time)? Explain how the decision would change if users were half of those expected.

The city council in plenary session debates whether to transform a centrally located public plot of land valued at $12$ million euros into a park with mature trees or sell it to a commercial developer who will create $80$ direct jobs. A neighbourhood spokesperson states: "A park, lung health, or quietness are priceless; trying to measure them in euros degrades politics and distorts reality." The Councillor for Urban Planning replies: "If economists do not try to put a monetary value on those intangible benefits, the tacit value assigned to them in the final decision will be exactly zero euros."

1. a) Interpret the councillor's warning: why can refusing in principle to monetise intangible goods paradoxically lead to decisions that go against environmental and social protection?
2. b) Design a methodological proposal to estimate the value of the park in euros by applying two different economic valuation methods for non-market goods (such as hedonic pricing in nearby housing, travel costs, or avoided health costs). Explain what each one would measure in this case.
3. c) Suppose that the estimated value of the park's benefits amounts to $14$ million euros, but $85\ \%$ of that gain is concentrated in the property appreciation of adjoining high-income homes. Reason why a favourable social cost-benefit analysis alone does not guarantee that the decision is equitable or fair.

The Directorate-General for Traffic is assessing resurfacing and signage improvements on a high-accident road section at a total cost of $6$ million euros. Road engineering models forecast that the intervention will prevent a statistically proven $3$ deaths over the next five years. To evaluate whether the project is a priority through a cost-benefit analysis, the technical team applies the official "Value of a Statistical Life" (VSL) of $1,8$ million euros per person (obtained from willingness-to-pay surveys for marginal risk reductions).

1. a) Calculate the net social benefit of the project and determine what the formal technical recommendation derived from the cost-benefit analysis would be.
2. b) Upon learning that the work is being rejected based on the technical calculation, a citizens' group protests: "Human life is priceless; setting a monetary figure to decide whether to save people on the road is immoral." Justify why in the real management of public spending it is inevitable to implicitly or explicitly assign a monetary limit to road safety measures, and what would happen to the health and education budgets if we acted under the premise that a life has infinite economic value.
3. c) Based on this case, refute the idea that "cost-benefit analysis is a neutral and objective mathematical technique." Identify two ethical-political value judgements that completely determine the final outcome of this type of study.

Many grandiose projects end up costing twice the budget and receiving half the announced users (the "white elephant syndrome").

1. a) What biases and interests explain why they get approved (promoters' optimism, the political gain of a big project)?
2. b) Propose two improvements to the analysis process that reduce the problem (comparing with similar projects already built, review by independent experts) and explain how they work.