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Chapter 11 Input Markets and Cost-Benefit Analysis • 11.1 Net Discounted Present Value There are entire texts on how to perform Cost-Benefit Analysis.

• 11.2 Cost-Benefit Analysis in the Not-For-Profit Sectors • 11.3 Cost-Benefit Framework • 11.4 andd Beneficiaries 11 4 Identifying Id tif i Cost C t Bearers B B fi i i

This one is Thi i from f Cambridge University Press.

• 11.5 Measuring Costs and Benefits • 11.6 Choosing the Discount Rate • 11.7 Limitations of Cost-Benefit Analysis • 11.8 Using Cost-Benefit Analysis: Public Library Case • 11.9 Using Cost-Benefit Analysis: Health Warnings on Tobacco Products

Private Cost-Benefit Analysis • Net Discounted Present Value • How is the “Bottom Line” affected?

Where: Ct = the projected after-tax cash flow in time period t, K = the risk-adjusted discount rate, I = the dollar amount of the initial investment, and N = the number of periods for the project or asset.

The Benefits Ratio

Social Cost-Benefit Analysis •

Two differences from private cost-benefit: 1. In private cost benefit only outcomes that affect the bottom line are considered. In social costbenefit analysis a wider measurement of the costs and benefits is used. 2. Social cost-benefit analysis must often value costs and benefits that have no market equivalents.

The Process of Cost-Benefit

• Benefits Ratio = B/C

• Alternatives: Consider all the projects, policies, or programs that are to be evaluated (including the option of “the status quo.”

•

• Costs: Determine an opportunity cost (or proxy opportunity cost) that reflects each alternative.

Where

• B = Benefits

• Benefits: Determine the benefits for each alternative

• C = Costs

• Identify Cost Bearers and Beneficiaries: Determine what groups are affected by the project, policy, or program.

• The rule of thumb would be that we would undertake any project for which the benefits ratio exceed unity:

• Evaluate Cost, Benefits, and any Transfer Payments: Determine the pattern of benefits reception and cost bearing.

•

If B/C > 1

• Consider Distributional Impact: Evaluate the equity of the expected outcomes. • Choose a Discount Rate: Determine the present values of costs and benefits over time.

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Shadow Prices Table 11.3

The Discount Rate • May itself be a shadow price • The longer the project, the more impact it has

Skokie Library Example • What is cost benefit analysis and why is it useful? • H How ddoes private i t CBA differ diff from f social i l CBA? • How does the government value nonmarketed benefits of a project? • What discount rates should be used?

Measuring Non-Monetized Costs and Benefits • Valuing time

See page 387

Libraries Public Crises in America • Public-sector budgetary crisis

– “time is money”

• Valuing life – Constructive method: what would the individual have earned? – Revealed preference method: How much extra income do individuals need to compensate them for an increase in the chances of death, as reflected in market wages for riskier jobs?

– Declining state and local government revenues – Resistance to raising tax rates – Cuts in budgets for libraries, as well K-12 and higher education, and even fire and police

• Valuing public goods

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Public Crises in America • If an objective, external agency were to ask your cardholders about the library services they receive, the value they get, and their willingness to support taxes for services, what would your cardholders say? • Could you use the results… – to improve the management of your library? – bolster budgetary support for your library?

Purpose of Study • Develop a practical, conservative, transportable methodology to estimate a lower bound for libraries’ direct return on taxpayer investment. – How much benefit do public library patrons receive for each dollar of annual tax support? – What return do citizens get for the capital invested in their public library?

– How?

METHODOLOGY

Methodology • Cost-benefit analysis – Measure dollar value of direct benefits to libraryy ppatrons – Measure library costs – Measure return to taxpayer investment

• Benefits measured conservatively based on scientific surveys of local library users

• Research question: How valuable is your public library to the community it serves? • Strategy: estimate defensible lower bound • Analytical A l ti l tools: t l – Cost-benefit analysis (CBA) – NOT economic impact analysis

• Valuable to whom? • Why? How much?

FRAMEWORK

SERVICE-USER MATRIX

• Role of mission statement

Taxonomy Households Teachers

• Customer-focused

Books

x

Repair manuals Staff help

x

– WHOM do you serve?

• Service focus – HOW do you serve them?

• Framework for benefits: service-user matrix

x

x

x

Financial Computer

Business x

x x

x

x

x Table 11.5

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MEASURING BENEFITS • Which benefits? – Direct

MEASUREMENT TECHNIQUES: Contingent Valuation Method • Willingness to pay (WTP) – How much would a household pay to retain access to the library?

• E.g., g readingg a book for pleasure p

– Indirect benefits

– Example: Suppose that public libraries did not exist. How much would your household be willing to pay per year to establish your public library as it exists today?

• E.g., impact on intergenerational literacy

• How? – Units: dollars ! ! !

MEASUREMENT TECHNIQUES: Consumer Surplus Method (Hedonic Index)

• Willingness to accept (WTA)

If library did not exist

S (market) plus transaction cost

P + tm

• Defining the market substitutes D (market without library)

– Customer perspective, not librarian perspective D (library)

tl

– Example: dictionary

D (market with library)

QL2

QL1

QM1

QM2

• Pricing the market substitutes – Customer perspective, not librarian perspective – Example: encyclopedia or videotape

If library does exist Figure 11.1 The Consumer Surplus Approach: Library and Market Purchases/Rentals as Substitute Goods. The left graph represents the patron’s demand for library books and the right diagram represents the demand for purchasing books. Source: Courtesy of Donald Elliott, Ph. D., Southern Illinois University, an author of Elliot et al (2003).

COMPARISON OF WTP AND CS • Willingness to pay (WTP) – Based on willingness to pay taxes and fees – Negatively influenced by

INTERNET AND TELEPHONE SURVEYS • All measures require information available ONLY from library customers directly => surveys

• Free rider problems

• Random sampling

• Perceptions of tax equity

• Conducted by university survey center

• Lack of control over mix of services produced

• Pre-announcement letter (Schaumburg)

• Consumer surplus (CS) – Item by item comparison in familiar shopping format – Total spending confirmed by follow-up question

Figure 11.1

– Respondents were invited to respond by Internet. – Anyone who had responded by Internet and had NOT notified the library to decline was called.

• Post-incentives • Household survey responses weighted to ensure against response bias

• Average telephone interview time: 15 minutes

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Range of Returns to Taxpayer Investment for 3 Libraries • Returns to local operating revenues – Based on WTP, $1.04 to $1.24. – Based on consumer surplus, $1.22-$1.87.

• Returns to community investment in library assets

The Benefits Ratio • Benefits/Costs • If the ratio is larger than one, the project meets t the th criterion it i for f completion; l ti • If the ratio is less than one, the project should not be undertaken.

– Based on WTP, 1% to 3%. – Based on consumer surplus, 6% to 10%.

Results • For each dollar of taxes contributed annually to the Joliet Public Library, its patrons receive benefits of more than one dollar.

Each dollar of local operating outlays produces $1.24-$1.87 of benefits to library patrons.

• If outlays used to build library collections, new furniture, equipment, buildings, and other capital it l assets t are excluded, l d d patrons t receive i benefits of more than $1.24 for each dollar of operating outlays. • An alternative method of measuring benefits suggests benefits of at least $1.87 for each dollar of operating outlays.

$1 in taxes

$1.24-$1.87 in benefits

Benefits Ratio = 1.24 or 1.87 Benefits Ratio = Benefits / Costs

Health Warnings on Tobacco Products • Australian Commonwealth Department of Health and Ageing Spreadsheet

McKinney Stadium - Texas • Spreadsheet

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Cost-Benefit Templates • Small Scale • Large Scale

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