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    Microeconomic Foundations of CBA

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    Dandza Praditya
    This document provides an overview of microeconomic foundations and welfare economics concepts underlying cost-benefit analysis (CBA). It defines key terms like consumer surplus, producer surplus, deadweight loss, marginal excess tax burden, and how these factors are used to measure changes in social surplus and welfare from policy interventions. The assumptions of perfect competition and how they relate to measuring private and social costs and benefits in CBA are also discussed.

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    Microeconomic Foundations of CBA

    Uploaded by

    Dandza Praditya
    80 views19 pages
    This document provides an overview of microeconomic foundations and welfare economics concepts underlying cost-benefit analysis (CBA). It defines key terms like consumer surplus, producer surplus, deadweight loss, marginal excess tax burden, and how these factors are used to measure changes in social surplus and welfare from policy interventions. The assumptions of perfect competition and how they relate to measuring private and social costs and benefits in CBA are also discussed.

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    Pengenalan dasar mikroekonomi pada CBA

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    This document provides an overview of microeconomic foundations and welfare economics concepts underlying cost-benefit analysis (CBA). It defines key terms like consumer surplus, producer surplus, deadweight loss, marginal excess tax burden, and how these factors are used to measure changes in social surplus and welfare from policy interventions. The assumptions of perfect competition and how they relate to measuring private and social costs and benefits in CBA are also discussed.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    80 views19 pages

    Microeconomic Foundations of CBA

    Uploaded by

    Dandza Praditya
    This document provides an overview of microeconomic foundations and welfare economics concepts underlying cost-benefit analysis (CBA). It defines key terms like consumer surplus, producer surplus, deadweight loss, marginal excess tax burden, and how these factors are used to measure changes in social surplus and welfare from policy interventions. The assumptions of perfect competition and how they relate to measuring private and social costs and benefits in CBA are also discussed.

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    Microeconomic Foundations of CBA

    Lecture 2 SPM9716: Cost-Benefit Analysis (CBA)


    Textbook: Chapter 3

    Dr. ir. Zenlin Roosenboom-Kwee


    z.roosenboom-kwee@tudelft.nl

    Challenge the future 1


    Course Outline & Schedule

    Challenge the future 2


    Lecture 2 Learning Objective

    To review the microeconomic and


    welfare economic underpinnings of CBA
    (assuming perfect competition)

    Challenge the future 3


    Key assumptions in Chapter 3

    • The presence of perfect competition


    • Many buyers and sellers in the market (no influence to prices)
    • Easy entrance and exit
    • Homogeneous goods
    • No transaction costs
    • Information is perfect
    • Private CB = Social CB

    • Chapter 4 the presence of various forms of market failure

    Challenge the future 4


    Demand Curves
    Figure 3-1 Consumers’ Total Benefits and Consumer Surplus
    Approximation of
    WTP in CBA

    • Ordinary demand curve q = f(p)


    • Inverse demand curve p = f -1(q)

    Societal marginal benefits (MB)

    Challenge the future 5


    Figure 3-2 Change in Consumer Surplus Due to a Price
    ABC area:
    deadweight loss

    (a) Decrease (b) Increase

    Challenge the future 6


    Demand Curve & Consumer Surplus
    If the demand curve is linear
    ∗
    1
    ∆ =− ∆ − ∆ (∆ )
    2
    Still a good approximation even if the
    demand curve is not linear

    If the demand curve is not linear


    ∗
    ∗
    (∆ )
    ∆ =− ∆ − ∗
    2

    Challenge the future 7


    Taxes and Leakage
    • Taxes
    • Governments use tax to raise funds for projects
    • This results in a reduction in CS called deadweight loss (DWL)
    triangle ABC in Fig.3-2(b)

    • Leakage
    • The ratio of the deadweight loss to the total tax revenue raised

    • Small leakage

    Challenge the future 8


    Exercise 3.1
    Income; initial income
    = $40,000
    quantity price

    • An individual demand function: q = 6 - 0.5p + 0.0002I

    a. At what price will demand fall to zero (choke price)?


    b. If the market price is $10, how many will be demanded?
    c. At a price of $10, what is the price elasticity of demand for
    gizmos?
    d. At a price of $10, what is the consumer surplus?
    e. If price rises to $12, how much consumer surplus is lost?
    f. If income were $60,000, what would be the consumer surplus
    loss from a price rise from $10 to $12?

    Challenge the future 9


    Figure 3-3 Individual Firm’s Supply Curve

    Below the AVC, the


    firm would shut down

    Challenge the future 10


    Figure 3-4 Market Supply Curve

    Challenge the future 11


    Exercise 3.2

    • At the current market equilibrium, p = $40, q=10 units, price


    elasticity of supply = 2.0

    a. Find supply schedule (supply function)


    b. Calculate PS
    c. Price falls from $40 to $30, what is ∆PS?
    d. What fraction of the lost producer surplus is due to the
    reduction in the quantity supplied and what fraction is due
    to the fall in price received per unit sold?

    Challenge the future 12


    Figure 3-5 Social Surplus (NSB)
    Ignoring government surplus

    Reflects MC

    Equilibrium
    point

    Perfect
    competition Reflects MB
    maximizes
    social surplus

    Challenge the future 13


    Profits and Factor Surplus

    • Focus & assumption so far: short-run changes and some


    inputs are fixed
    • In practice, fixed costs can change in CBA projects
    • Producer surplus (PS) is captured by some particular factors
    of production (e.g. productive plot of land) or Ricardian rents
    factor surplus (FS)
    • PS = π + FS where π = economic profits

    • Social surplus and changes in social surplus:

    Challenge the future 14


    Government Surplus and
    Allocative Efficiency
    • Thus far, we have ignored changes in government surplus
    (GS)

    • When GS is non-zero:

    In a competitive market, the NSB of a project


    equals the change in the sum of CS and PS,
    plus the net change in government revenue

    Challenge the future 15


    Figure 3-6 Target Pricing Example

    “Target” price Government subsidy: area PTdePD


    ∆CS: area P*bePD
    ∆ PS: area PTdbP*
    ∆ GS loss: area PTdePD
    ∆ DWL: area bde

    Challenge the future 16


    Marginal Excess Tax Burden (METB)

    • METB is the ∆DWL that results from raising an additional


    dollar of tax revenue

    • Example from Exhibit 3-2: It costs $1.63 to transfer one


    dollar from higher-income people to lower-income people
    • METB = $0.63 (efficiency cost)

    • When METB is taken into account:

    Challenge the future 17


    Measuring Changes in Welfare

    • CBA focuses on allocative efficiency


    • Welfare concerns allocative efficiency and equity
    • Measuring welfare from measuring social surplus (or change
    in social surplus) by “weighting” each of the different types of
    surplus:

    • In practice, weights can be unclear


    • Sometimes, they are assumed to equal unity
    • Except the weight on government which is assumed to equal
    1+METB, yielding equation: ∆SS = ∆CS +∆PS + (1+METB)∆GS

    Challenge the future 18


    Lecture 2 Summary

    • CS is important in CBA due to ∆CS as a close approximation


    of the WTP

    • Any policy intervention by government in a perfectly


    competitive market reduces SS and creates a DWL

    • The ∆DWL resulting from raising an additional money of tax


    revenue is called METB

    • CBA focuses on allocative efficiency while welfare focuses on


    allocative efficiency and equity

    Challenge the future 19

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