Social Cost-Benefit Analysis

Social cost-benefit analysis is a process of evaluating the worth of a project by comparing its costs and benefits, including both direct and social costs and benefits; including externality effects.

When making decisions it is imperative to take into account the externalities especially when the decision is likely to affect the environment. In taking such decisions it is desirable to weigh up the costs and benefits of a scheme. If the benefits exceeds the costs if might be considered appropriate to go ahead with the decision. It is important though to take a long and wide view and not to focus too narrowly on purely financial costs and benefits.

The procedure:

Identify relevant costs and benefits

The first step is to identify all costs and benefits, this needs to cover all the direct costs of the project. Some of the costs include the production costs, labours costs etc. The indirect costs also need to be identified such as the opportunity cost – could the land be used for something else more beneficial. What are the externalities such as noise, air and river pollution?

Valuation

If the costs and benefits are to be compared then they need to be given a monetary valuation. Some of these are likely to have a market price and show if will be easy to valuate them. However for externalities, or other indirect costs and benefit without a market valuation, it is necessary to establish a shadow price.

Discounting the Future

Some of the costs and benefits from the project will occur in the future but need to be expressed in terms of their value in the present. From today’s perspective, a benefit that is immediate is more valuable than one that will only become relevant in 20 years. In order to incorporate this into calculations, we need to discount the future at an appropriate rate and calculate the net present value of the future stream of costs and benefits associated with the project.

Page last updated on 20/10/13