Select a local, regional, or national environmental problem. Explain the steps t
ID: 1227275 • Letter: S
Question
Select a local, regional, or national environmental problem. Explain the steps that would be used to conduct a benefit-cost analysis of a government policy and/or project to alleviate the problem. How would you go about identifying the potential costs of the policy initiative - the economic costs (explicit and implicit) and the social costs? Which estimation method would work best for estimating explicit costs? How would you estimate implicit costs? How do you deal with time differences if most of the costs occur initially when implementing the policy or project, while the benefits may be experienced over an extended period of time? What types of time-oriented modifications are necessary? Comment on the objectivity of benefit-cost analysis. What are some issues involved in using this method of analysis? What are its limitations?
Explanation / Answer
To explain the answer, it is important to explain the basics about both implicit and explicit cost.
Implicit Cost: Implicit cost which is also known as the notional or implied cost is the opportunity cost that must be given up by a firm to use a factor of production that it already owns and hence does not pay any rent. In other words any cost of the firm that results from using an asset instead of renting it out or selling it is known as Implicit cost.
Explicit Cost: Explicit cost is defined as the direct payment made by the firm in running the business or operations, wage and rent are both example of explicit cost.
In case of a policy decision on a Environmental problem the concepts of cost can be defined as follows:
Implicit Environmental Cost: Implicit Environmental Cost are those cost which are non-monetary in nature and has a negative impact on the well being of a society, since it is non-monetary, it is difficult to measure in practice. For example reduced product quality due to a ban on certain material input is a fine example of Implicit Environmental cost.
Explicit Environmental Cost: Explicit Environmental Cost can be measured in monetary terms. Explicit Cost includes the administrative cost, compliance cost and other enforcement cost that the government and the public sector has to incur during any project. It also includes the cost of land, labor, and capital.
Social Cost: In a policy initiative, Social cost are the cost which are incurred to compensate the society in return for the resources used so that the utility level is maintained in the society. The compensation to the society would include all price, output and income effects which arises due to a change in the regulation. For example the increased price of a household item due to the use of a recyclable packet by the producer. To make the concept of Social Cost easier to understand. Social Cost can be categorized under the following heads:
Cost Benefit Analysis:
First Step: To make a cost-benefit analysis of a policy the first step that we should consider is the Opportunity Cost measured by using the concept of Present Value determination by discounting the future value of a project to its Present value terms, which can be measured by using the below formula:
PV = FV* [1/(1+R)^t)]
Where FV = Future Value, PV = Present Value and R = Rate of return and t = Time Period
Also the rate R is the discount rate used for finding the present value of a project. In case of a public policy decision making the rate R used for discounting should reflect the social opportunity cost of funds used for the provision of a public good. Therefore in formulating a public policy the discount rate should reflect the rate of return that could have been obtained through a private spending on consumption and investment assuming the level of risk to be the same.
Second Step: Second step is to take out the present value of benefits and present value of cost
Third Step: Third step is to adjust the present value of cost and present value of benefits by taking the inflation levels into consideration.
Fourth Step: For any cost-benefit analysis of a policy is to compare the time-adjusted incremental benefit and cost and then arrive at a final decision on the basis of its relative values and this method could be repeated to find the best possible option.
Finally the benefit-cost ratio could be used such as Present Value of Benefit/ Present Value of Cost ratio. If the ratio is greater than 1 than we can consider the option as feasible and better than others if the ratio is less than 1 than we can reject the option and move to the other option until we find the right fit.
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