Abstract
Every society is facing a number of risks and their regulation requires many considerations. From an economic standpoint, it can be said that risks impose a cost on society. Avoiding and regulating risks equally engenders costs. In order to help public decision makers come to terms with these trade-offs, economists have developed the method of cost-benefit analysis. It is based on the simple idea that things are worth doing when the benefits from doing them are greater than their costs. As simple as this basic idea is, as tricky and controversial are the implications of putting it into practice. Issues of controversy relate to valuing environmental benefits, determining the value of human health and life, balancing the interest of current and future generations by discounting, and dealing with the biases of subjective risk perception when defining a rational risk policy. This chapter will introduce the basic assumptions underlying cost-benefit analysis and the procedures involved in conducting one.
The basic rationale of cost-benefit analysis lies in the idea that things are worth doing if the benefits resulting from doing them outweigh their costs.
Amartya Sen (Cost-benefit analysis, The University of Chicago Press, Chicago, 2001 , p. 98)
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Notes
- 1.
Non-rivalness may be limited by congestion. This can concern the example of the bridge when it comes to traffic jams or the example of clean, fresh air, when a small room with many people is considered.
- 2.
Consumption can be taken as a conglomerate of all different consumption goods, including public goods and externalities. Alternatively, it could be a placeholder for a vector of all goods/bads consumed (including public goods, environmental amenities, health etc.) that affect human well-being. When considering only private goods lifetime consumption will be constraint by lifetime income, closely related to wealth of an individual, i.e., U(W) in Chap. 3, [40]. However, in welfare economics, personal well-being is most often considered to depend on consumption (not income), because not all types of consumption require expenditures.
- 3.
The assumption of concavity implies a societal preference for equality. The closer the welfare function is to a linear function, the easier it is to balance utility of somebody very poor against utility of somebody very rich.
- 4.
Kenneth J. Arrow received the Nobel prize jointly with John R. Hicks in 1972 “for their pioneering contributions to general economic equilibrium theory and welfare theory”. In its award ceremony speech the prize committee stated with regard to Arrow’s contribution “This conclusion, which is a rather discouraging one, as regards the dream of a perfect democracy, conflicted with the previously established welfare theory” [28].
- 5.
The weak Pareto criterion is weaker in the sense that every project that passes the weak test also passes the strong test, but not vice-versa. Obviously, fewer projects will pass the weak test.
- 6.
A mathematical proof would maximize net benefits subject to the constraints.
- 7.
Sunstein [41] underlines the uncertainties related to the health damage estimation and states that the number of lives saved by the regulation may vary between 0 and 112.
- 8.
In their analysis, Raucher et al. [33] assume a Value of a Statistical Life of US-$7 million.
- 9.
Here we drop the subscript i to keep things simple.
- 10.
One could also argue that the utility of wealth when dead is zero. This would mean U 0(W)=0. This assumption is often made. Relaxing the assumption means that we accommodate a bequest motive, that is people value bequeathing wealth to their children etc. at the end of their life.
- 11.
To make values comparable across different studies all results have been corrected for inflation to US-$ values for the year 2000.
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Acknowledgement
The author thanks Pierre Dehez, Charles Goldie, Claudia Klüppelberg and three anonymous reviewers for helpful comments on earlier drafts of this paper.
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Roosen, J. (2014). Cost-Benefit Analysis. In: Klüppelberg, C., Straub, D., Welpe, I. (eds) Risk - A Multidisciplinary Introduction. Springer, Cham. https://doi.org/10.1007/978-3-319-04486-6_11
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