ABSTRACT
Cost-benefit analysis (CBA) is a practical way of assessing the desirability of projects, where it is important to take a long view and a wide view – that is it implies the enumeration and evaluation of all relevant costs and benefits. In CBA, we try to consider all the costs and benefits to society. That is the reason why some people refer to CBA as social cost-benefit analysis.
The costs are measured in terms of its opportunity costs, or what level of output would be reached if the factors of production were utilised in the rest of the economy. Benefits are the additional benefits to the community that would result from the realisation of the project. Costs and benefits of a project are the time streams of consumption forgone and provided.
In a CBA, there are four important steps: (a) identification of the cost and benefit items; (b) quantification of the cost and benefit items; (c) valuation of the cost and benefit items; and (d) calculation of net present value (NPV) and/or internal rate of return (IRR).
Cost and benefit items in a CBA scheme are to a large extent based on the existence of externalities. In the next section, we distinguish between positive and negative externalities.
