Measuring Costs and Benefits

1
Measuring Costs and Benefits

• Measuring Benefits and Costs (See Chap 4)
• Consumers Willingness to Pay (WTP)
• Consumer Surplus (CS)
• Producers Surplus (PS)
• Social Surplus (SS)
• Measuring Benefits in Secondary Markets
  (See Chap 5)
• Only measure if there are significant price
  changes in secondary markets

2
Measuring Benefits
Utility Theory
Utility
Quantity Consumed
3
Measuring Benefits

• Diminishing marginal utility
• What evidence do we have that individuals
  utilities have this property?
• Revealed preferences
• At lower prices, people consume more.
• As prices increase, the amount people consume
  decreases

4
Measuring Benefits
Demand Curve
Price
P0
X0
P1
X1
D
Q0
Q1
Quantity Consumed
5
Measuring Benefits

• Demand curve shows actual expenditure behaviors
  of individuals
• When goods are scarce, people willing to pay high
  price
• When goods are abundant (people are already
  consuming a lot), people willing to pay only a
  lower price
• Measured in monetary terms
• Note Consumers expenditure behaviors are
  constrained by their budgets!
• Demand response has both substitution (pure
  preferences) and income effects

6
Measuring Benefits

• Demand curve Willingness to pay
• In market exchanges, consumers to not actually
  pay all that they would be willing to pay.
  Markets are not able to discriminate prices
  charged for each unit sold.

7
Measuring Benefits
Price
Market Equilibrium
WTP0
S
Pe
Actual Expenditures
D
Q0
Quantity
Qe
8
Measuring Benefits

• Difference between WTP and actual expenditures is
  Consumer Surplus CS.
• WTP is the theoretically correct measure, and CS
  is only an approximation, but widely used in
  empirical studies

9
Measuring Benefits
Price
Market Equilibrium
Consumer Surplus
WTP0
S
Pe
Actual Expenditures
D
Q0
Quantity
Qe
10
Measuring Benefits

• WTP and CS do not change if market price does not
  change
• Perfectly elastic demand curve

11
Mozambique market for electricity
DM
DSA
PSA
QD0
QS0
QS1
12
Local Market for Cable Connections
D (Marginal WTP)
A (CS0)
C (?CS)
P
B (EXP0)
D (?EXP)
Q0
Q1
13
Measuring Costs

• Area under supply curve (MC curve)
• Analogous to consumer, in market exchanges,
  producers revenues are greater than minimum
  necessary to meet their production costs
• Assumptions
• Perfect competition
• Profit-maximization (MR MC)

14
Measuring Costs
TC
Total Revenue, Cost
TR
TRe
Profit
TCe
Quantity
Qe
15
Measuring Costs
Marginal Revenue, Cost
SMC
PMR
Profit
Quantity
16
Measuring Benefits in Secondary markets

• Only measure benefits in secondary markets if the
  project causes prices in secondary markets to
  change (by a significant amount)

17
Social Surplus

• Social Surplus Consumer surplus Producer
  Surplus
• Social surplus is maximized in competitive
  markets
• Assuming no market imperfections!