AGEC 608 Lecture 1516, p. 1

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AGEC 608 Lecture 15-16

• Objective Discuss use of plug in values and
  construction of shadow prices in developing
  country context.
• Readings
• Boardman, Chapter 15-16
• Homework 4 class average 89
• Homework 5 Chapter 13, problem 3 Chapter
  14, problem 3 Chapter 17, problem 1
• due April 24

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Plug-in values
Estimation of shadow prices is costly and
time-consuming. A practical approach in many CBAs
is to use shadow prices that others have
used.In other words, one plugs-in values from
previous studies.Most useful in the cases
of value of life cost of injuries cost of
crime value of time
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Value of life
Two approaches to estimation 1. Indirect (e.g.
previously discussed hedonic method)2. Direct
(WTP or WTA via survey questions) Miller (review
of 29 studies)1. Wage premia for risky jobs2.
WTP for safety 3. Risk-avoidance behavior4. CVM
regarding safety and healthMean value of life
3.02M (1999 US)
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Cost of injuries
See Table 15.1Estimates usually
include medical rehab costs lost
wages administrative costs (sometimes) pain
suffering (e.g. WTP studies) Estimated values
tend to depend on 1. Region of body 2. Threat
to life 3. Work vs. non-work
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Cost of crime
Many projects aim to reduce crime. To estimate
impact 1. Estimate number of crimes
reported 2. Estimate value of each crime
avoidedNet benefit NPV (1 x 2) Cost See
Table 15.1 Some estimates include medical
costs, lost wages, justice system costs Should
stolen property count as a transfer?
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Value of time
Most important concept for CBA is that ofValue
of Travel Time Savings (VTTS) 1. Nonwork travel
time (commuting) typically valued at 40-50 of
after-tax wage rate per hour saved 2. Work
travel time valued at 100 of pre-tax wage
benefitsNote that some leisure time may have no
cost, or even provide benefits!
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Transferring and adjusting plug-in values
Issues to consider 1. Income and socioeconomic
factors higher values for higher incomes? 2.
Physical characteristics population density,
climate, topography, and current level of the
good all may influence WTP and value (e.g.
snow removal). 3. Temporal changes values
could change over time, due to technology,
population growth, etc.
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Example
40-mile stretch of rural road used by commuters
and business travelers (50-50) to connect two
major highways.Current speed limit is 55mph
estimated avg speed 61mph What is the annual
net benefit of raising the speed limit to
65mph? Assume new avg speed would be
70mph 5,880 vehicles per day on road, 1.6
passengers 52 additional crashes/year, 0.1 new
fatalities/year operating costs increase by
0.002 per vehicle mile average wage is
12.20/hour
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Example
Vehicle miles on road per year (5880)(365)(40)
85.85MVehicle hour savings 85.85/61mph
85.85/70 180,940Total hour savings
(180,940)(1.6) 289,510 hoursValue of time (½
business, ½ commuters) (.5)(12.20)
(.5)(12.20)(S) where S value of commuters
timeAdditional operating cost
(0.002/mi)(85.85M) 171,700 Injury costs (from
Miller) (52 accidents)(0.02)(V)Cost of fatal
accidents (0.1)(1.08)V
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NB (1,000 )
Results are very sensitive to assumed value of
life!
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Shadow pricing in developing countries
Rationale Shadow pricing is often required in
developing countries because 1. markets tend
to be more distorted than in developed
countries 2. prices of imports and exports tend
to be affected by taxes, subsidies, and quotas
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LMST Methodology
Named after Little and Mirrlees (idea) and Squire
and van der Tak (World Bank employees who applied
the methods). Approach divide all goods into two
categories 1. Tradable (not just traded, but
potentially traded) 2. Non-tradable (local
labor, electricity, services, etc.)Use world
prices for all tradable goods and local prices
for all non-tradable goods. Shadow price of good
APR x market price, where APR is the accounting
price ratio defined as accounting price /
market price
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Example 1 Import
Value an import byCIF price (CostInsuranceFre
ight) (also called the border price, i.e.
landed cost)plus any transportation
costsIGNORE tariffsUse official exchange rate
to translate foreign currency into local currency.

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Example 2 Export
Value an export byFOB price (Free on
Board) (cost of putting the good at the
port)includes cost of production export taxes
transport to portINCLUDE export taxes
(foreigners have no standing)If some inputs
would be exported in the absence of the project
then shadow price should include foregone revenue
as a cost.

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Example 3 Non-traded good
Separate cost into its traded and non-trade
components and then multiply each by its
APR. tradable component APR 1.0 domestic
transfer APR 0.0 non-traded APR some
weighted averageStandard conversion factor
(SCF) SCF (MX)/((MTm-Sm) (X-TxSx))
Tariffs and export subsidies tend to inflate
domestic prices while taxes on exports and import
subsidies have the opposite effect.

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Shadow price of labor
Different types of labor have different APRs If
labor market works well, then wage is a good
estimate If foreign workers are used, shadow
cost depends on how much of their earnings are
repatriated. If earnings are sent out, then they
have an APR of 1.Unemployment is a complicating
factor
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Harris-Todaro model of migration
Basic idea urban wages gt rural wages urban
unemployment is often very high rural workers
migrate to cities to find work Probability of
urban employment upon migration (L-U)/L
E/L Incentive to migrate as long as wU(E/L) gt
wR Migration stops when wU(E/L) wR, but wU gt
wR If project is urban, shadow wage must be
adjusted for the induced migration from the
rural area.
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Additional issues

• Discounting if govt can only fund a project by
  diverting resources (rather than raising taxes)
  then opportunity cost is forgone public
  investment (not private).
• Social Accounting goal of public expenditures in
  LDCs sometimes goes beyond economic efficiency,
  and includes economic growth and redistribution.
  LMST approach may need to be modified. NPV
  reflects efficiency only.