Description

Cost-benefit analysis is a method for organising information to aid decisions about the allocation of resources. Its power as an analytical tool rests in two main features:

  • costs and benefits are expressed as far as possible in money terms and hence are directly comparable with one another; and
  • costs and benefits are valued in terms of the claims they make on and the gains they provide to the community as a whole, so the perspective is a ‘global’ one rather than that of any particular individual or interest group.

 

Why use it?

Cost-benefit analyses can provide guidance on the efficient allocation of resources in areas, of which there are many in the public sector, where no markets exist to provide this information ‘automatically’.

Cost-benefit analysis is useful in contexts where there are grounds for mistrusting the signals provided by market prices: for example, where inputs are underpriced relative to costs, or where outputs are overpriced.  Cost-benefit analysis is also helpful where, without any commercial transactions taking place, projects impose costs or benefits on third parties. Finally, the method is useful when a project is so large in scale that it is important to be fully aware of its wider economic effects.

 

How is it used?

Undertaking a cost-benefit analysis provides the decision maker with quantitative comparisons of options, together with supporting information for any costs and benefits that could not be quantified. Cost-benefit analyses serve to aid decision-making. However, a cost-benefit analysis does not replace the need for sound judgment based on a wide range of considerations, and in accordance with the various obligations officials face which can be described under regulatory law and requirements.

Cost-benefit analysis is employed in various ways. It may assist government to:

  • decide whether a proposed project or programme should be undertaken;
  • decide whether an existing project or programme should be continued;
  • choose between alternative projects or programmes;
  • choose the appropriate scale and timing for a project; and 
  • determine regulations affecting the private sector.

All of these applications are ex ante (or ‘before’) uses of the method. The method can also be used when a project or programme has matured as part of an evaluation of programme impact or outcomes. In this context the method may:

  • provide information on whether the outcomes achieved justify the resources used, relative to alternative uses; or
  • clarify the focus on different components of a project or programme, in order to see how the project or programme can be improved, and which areas should be cut back or expanded.

 

Where is it used?

Traditionally, cost-benefit analysis was used to evaluate ‘projects’ or individual activities rather than ‘programmes’ or larger groupings of such activities or indeed of policies. Moreover, it was used mainly in evaluations of a particular project type - economic infrastructure investments such as dams, roads and power stations. However, cost-benefit analysis in now applied much more widely. It is often applied to programmes as well as to projects, to activities outside the economic infrastructure sector, and to public policies. The labour market, education, the environment and scientific research are examples of areas where the method has been usefully applied.  However, it should be noted that cost-benefit analysis is only one method of evaluation.

The main constraints in using the approach are the feasibility and appropriateness of assigning money values to the costs and benefits generated by the activity. Where determining the money equivalent value of outcome is not feasible, cost-effectiveness analysis is frequently a viable alternative approach.

 

Limitations

The effective use of cost-benefit analysis requires awareness of the method’s limitations as well as its strengths. Some limitations are:

  • design weakness - cost-benefit analysis compares a project scenario with an alternative scenario based on estimates of what would have happened in the absence of the project. Any margin for error in the specification of the alternative scenario is carried over into the project analysis;
  • treatment of ‘intangibles’ - not all costs and benefits are amenable to dollar quantification and those that are not (the intangibles) may be overlooked;
  • equity concerns - the potential bias against those with a lesser ability to pay that may result from measuring benefits in dollars can be allowed for with the use of judgement, but this is necessarily external to the basic framework; and
  • obscurity - when the user’s interest is focused on the ‘bottom line’ of the analysis, the analysis itself may be rather obscure. However, the analysis will only be as good as its assumptions and these should always be set out as clearly as possible.

Purpose

Cost benefit analysis is a decision making tool that aims to assess the value of a proposal or competing proposals on a consistent basis.

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Scope

Outcome Areas Economic, Environmental, Social
Management Domains Air Quality, Land, Coastal, Urban Systems, Natural Hazards, Biosecurity, Biodiversity, Community, Waste, Freshwater
Intended End Users
  • Researcher
  • Policy Analyst
  • General Usability
Steady State or Dynamic Unknown

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Technical Considerations

Links

http://www.treasury.govt.nz/publications/guidance/planning/costbenefitanalysis

Associated Case Studies