SCBA

Commercial Cost Benefit Analysis

(CBA)

•Benefit > Cost is desirable here.

•So it is nothing but a profitability analysis.
•But what will be the costs and/or the benefits
that a society may have to bear and/or get
from the proposed project are not considered
here.
 Social Cost Benefit Analysis
So, to reflect the real value of a project to society,
we must consider the impact of the project on
society.
• Impact
• Positive or Negative
• (Social Benefit)
• (Social Cost)
Thus ,when we evaluate a project from the view point
of the society (or economy) as a whole, it is called
Social Cost Benefit Analysis (SCBA) / Economic
Analysis
SCBA received a lot of emphasis in the decades of
1960s and 70s in view of growing importance of
public investments.
 SCBA
• SCBA can be applied to both public and private
investments
• Public Investment: SCBA is important specially
for the developing countries where govt. plays a
significant role in the Economic development
• Private investment: Here, SCBA is also important
as the private investments are to be approved
by various governmental and Quasi-
governmental agencies.
 Objectives of SCBA

The main focus of SCBA is to determine

• Economic benefits of the project in terms
of shadow prices
• The impact of the project on the level of savings
and investments in the society
• The impact of the project on the distribution
of income in the society;
• The contribution of the project towards the
fulfillment of certain merit wants (self-
sufficiency,
employment etc)
 Rationale of SCBA
Basic sources of discrepancy in SCBA
are:
• Market imperfection
• Externalities
• Taxes & Subsidies
• Concern for savings
• Concern for redistribution
• Merit wants
 Market imperfection
• Market prices, which form the basis for computing the
monetary costs and benefits from the point of view of the
project sponsor, reflect social values only under perfect
competition.
• Perfect competition is rare specially in developing economies.
Therefore when imperfections exists, market prices do not reflect
the social values.
• Three common market imperfections found in developing countries are :
– Rationing- control over the prices. The consumer pays significantly less than
the
prices prevailing in the competitive market.
– Prescription of Minimum wage rate- the minimum wages paid to the labour
is more than usually prevailing wages in the competitive market.
– Foreign exchange regulation- the official rate of the foreign exchange
in developing countries, which exercise close regulation over foreign
exchange, is typically less than the rate that would prevail in the absence of
such regulations.
 Externalities

• A project may have beneficial external effects.

It may create infrastructural facility like
roads which will benefit the neighbouring
areas. Such benefits are considered in SCBA,
though these benefits are ignored by the
project sponsors because they do not
receive any monetary compensation for that.
• Likewise, a project may have harmful
external effect like pollution. In SCBA, such
cost of environmental pollution is
relevant, though project sponsors may not
incur any cost.
 Taxes & Subsidies

• From private point of view, taxes are

definite monetary costs and subsidies are
definite monetary gains.
• From social point of view, taxes and
subsidies are regarded as transfer payments
and hence considered irrelevant.
 Concern for Savings
• Private firms are not concerned how the project
benefits are divided between consumption and
savings.
• From Social point of view, the division of benefits
from consumption and savings (lead to
investment) is relevant.
• From social point of view, a rupee of benefits saved
is deemed more valuable than a rupee of
benefits consumed.
• In SCBA, higher valuation is placed on savings
and lower valuation is put on consumption.
 Concern for Redistribution
• A private firm is not bothered how the
benefits are distributed among various
groups in the society.
• A society is concerned how the benefits
are distributed among various groups in
the society.
• A rupee of benefit going to an
economically poor section is considered as
more valuable than a rupee of benefit
going to an affluent section.
 Merit wants
• Goals and preferences not expressed
in the market place, but believed by
policy makers to be in the larger interest.
• Eg. Govt. may prefer to promote an
education
adult progra or a
nutrition m balanced for
children even though
program schoolthese
goingare not
sought by consumers in the market place.
• Not relevant from private point of
view but important from social point of
 Approaches to SCBA
Two approaches for SCBA
• UNIDO Approach:- This approach is mainly based
on of UNIDO ( Nation
Industrial
publication Development United named
Guide to Practical Project Appraisal in 1978.
Organizations)
• L-M Approach :- IMD Little and J.A.
Mireless approach for analysis of Social Cost
Benefit in Manual of Industrial Project “
Analysis in Developing countries and project
Appraisal and planning for Developing Countries.
 UNIDO Approach for SCBA
• The UNIDO method of project appraisal
involves five stages:
1. Calculation of financial profitability of the
project measure at market prices.
2. Obtaining the net benefit of the
project at economic (shadow) prices
3. Adjustment for the impact of the project on
Savings and investment
4. Adjustment for the impact of the
project on Income distribution
5. Adjustment for Merit and Demerit Goods
whose social values differ from their
economic values.
 UNIDO Approach
Stage - 1
Calculation of financial profitability of the project
a) A good technical and financial analysis
must be done before a meaningful
economic (social) evaluation can be made
so as to determine financial profitability.
b) Financial profitability is indicated by the
Net Present Value (NPV) of the project,
which is measured by taking into
Account inputs (costs) and outputs
(benefits) at market price.
 UNIDO Approach Stage - 2
Obtaining the net benefit of the project at
economic
(shadow) prices
a) The commercial profitability analysis (calculated
in stage 1) would be sufficient only if the Project
is operated in Perfect market. Because, only in a
perfect market, market prices can reflect the social
value
b) If the market is imperfect (most of the cases
in reality), net benefit of the Project is
determined by assigning shadow Prices to inputs and
outputs.
c) Therefore, developing shadow prices is very
much
 UNIDO Approach Stage - 2
• Shadow prices reflect the real value of a
resource
(input or output) to society
• Shadow Prices are also referred as economic
prices, economic / accounting efficiency prices etc
• Shadow prices can be defined as the value of
the contribution to the country's basic socio-
economic objectives made by any Marginal
change in the availability of commodities
(Output) or factor of production (input).
• Example: A project of power station may increase
the production of electricity which contributes to
one of the socio-economic Objectives of the country.
 UNIDO Approach Stage - 2
Choice of Numéraire
a)A unit of account in which the values of inputs and outputs are to
be expressed.
To define Numéraire, following questions have to be answered:
– What unit of currency, domestic or foreign, should be used to
express
benefits and costs?
– Should cost and benefits should be measured in current or
constant values?
– With reference to present or future, should costs and
benefits be evaluated?
– What use-consumption or investment- will be made of the income
from
the project?
– With reference to which group should the income of the project
 UNIDO Approach Stage - 2
b) UNIDO Numeraire can be specified as “net present
consumption in the hands of the people at the base
level of consumption in the private sector in terms of
constant price in domestic accounting process”.
Numeraire is determined at
• Domestic currency ,rather than border price.
• Present value rather than future value, because,
"a
bird in the hand is worth two in the bush”
• Constant price rather than current price
 UNIDO Approach Stage - 2
Concept of Tradability
• Key issue in shadow pricing is whether the good is tradable or
not.
• For a good that is tradable, the international price is
the
measure of its opportunity cost to the country.
• The import (CIF) price is less or the export (FOB) price is more
than the domestic cost of production
A good/service is non-tradable; if
• It import (CIF) price is greater than its domestic cost
of
production and/or
 UNIDO Approach Stage - 2
General Principles of Shadow
pricing : being
calculated,
Taxes: Whentaxes usually pose
shadow pricesdifficulties.
are
General guidelines of UNIDO w.r.t. taxes are:
• If the project augments domestic
production, taxes should be excluded
• if the project consumes existing fixed supply
of non-traded inputs, tax should be included
• For fully traded goods, tax should be ignored
 UNIDO Approach Stage - 2
General Principles of Shadow pricing :
Consumer Willingness to Pay (CWP)
• What a consumer wants to spend for a
product or service
• The difference between CWP and
actual payment is called consumer
surplus
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
• Tradable inputs and outputs
• For a fully traded goods, the shadow price
is border price translated into the
domestic currency at shadow foreign
exchange.
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
• Assuming that a project uses two indigenous
equipments costing Rs.5,00,000. These
equipments can be exported at US $ 10,000.
The Shadow foreign rate of USD 1 is
equivalent to Rs. 68.
• Therefore, shadow price of these
equipments (inputs) are (USD 10,000xRs.68)
= Rs. 6,80,000
 UNIDO Approach Stage - 2
Shadow Pricing of Resources
Non-tradable Inputs and outputs

Shadow Price = Cost of production + Consumer

willingness to pay
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
• Assuming that for a project, one-half of the
required input is collected from additional
domestic production which has a Domestic cost
of Rs. 2,00,000 and the rest one half is collected
from diversion from other consumers who are
willing to pay Rs. 3,00,000.
• Therefore the shadow price of the inputs will
Be:
Cost of production + consumer willingness to
pay
= Rs (200000+300000) = Rs. 5,00,000
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
• Assuming that a newly establishes power
station having a total capacity of 100 million
units electricity, charges tariff at Rs. 1 for
per unit electricity consumption. The
consumers of that particular area are willing
to pay Rs.
1.20 for per unit.
• Therefore, the shadow price is (Rs. 1.20 x100
million) = Rs. 120 million, instead of Rs. 100
million
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
Externalities
• An externality is an external effect (either
beneficial or harmful) causes from a project
which is - not deliberately created by the
project sponsors but is an incidental
outcome beyond the control of the persons
who are benefited or affected by it not
traded in the market place
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
• Near about 1,00,000 people had lost lands 5680 acres
due to the project of River Bridge
• People may be affected by erosion and flood
conditions brought about by changes to the river
which
result from the construction Activities of a bridge
• Environmental pollution created by brick field
• A project of planting trees for commercial purpose
may give protection to the environment
against the increasing global warmth.
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
Shadow Pricing of Externalities
• Although valuation of external effects is difficult
as they are often intangible in nature and there is
no market price, shadow pricing of externalities
may be made ;indirect
• The harmful effect of bridge may be measured by
the consumer willingness to pay for the output of
the people which has been reduced due to the bridge
• The cost of pollution may be estimated in terms of
the loss of earnings as a result of damage to health
caused by it
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
Labour Inputs
• The principles of shadow pricing of goods can
be applied to labour as well, though
labour is considered as service.
• When a project hires labour it could have
three possible impacts on the rest of the economy:
– It may take labour away from other employments.
– It may induce the production of new workers and
– It may involve import of new workers.
• Shadow prices for labour is what users of labour
are
 UNIDO Approach Stage - 2
Shadow Pricing of Resources :
Capital
• Investment of capital in a project causes to happen
two things
a)Financial resources are converted into physical
assets
b)Financial resources are withdrawn from national pool
of savings. Thus alternative projects are foregone and
there is an opportunity cost of it
• The shadow price of physical assets is calculated in the
same manner in which inputs and outputs are calculated.
• The opportunity cost of capital (shadow price of
capital) depends on the source from which the capital
has generated.
 UNIDO Approach Stage 2
• Say the NPV of a project, after Stage 2,
comes
out to be Rs. 200 Crore.
 UNIDO Approach - Stage 3
Adjustment for the impact of the project on
Savings and investment :
The purpose of this stage is to
• Determine the amount of income gained or
lost because of the project by different
income groups (such as business, government,
workers, customers etc)
Evaluate the net impact of these gains
and losses on savings
Measure the adjustment factor for savings
and
thus the adjusted values for savings impact
Adjust the impact on savings to the net
 UNIDO Approach- Stage 3
Evaluation of the Net Impact on Savings
• Net savings Impact of the project
= ΣΔYi * MPSi
o Here, Δ Yi = change in income of group i as a

result of the project

o MPSi= Marginal Propensity (tendency) to

save
of group i
 UNIDO Approach - stage 3
Assuming that the income gained or lost by 4 group is
• Workers (W) = Rs. 2,50,000,
• Consumer(C) = Rs. -7,00,000,
• Project (P) = Rs 10,00,000,
• External (E)=Rs. 5,00,000
The Marginal Propensity to Save of these four groups is:
• MPSw=0.04, MPSc=0.25,
• MPSp=0.4 and MPSe = 0.3

Therefore, the net impact of the project on savings is:

{250000 x0.04+(-700000) x 0.25 + 100000 x 0.4 +
500000x0.3} = Rs. 4,75,000
 UNIDO Approach- Stage 3
Adjustment Factor for Savings (AFs)
• AFs measure the percentage by which the social
value of investment of one Re. exceeds
social value of consumption one rupee.
AFs = (MPC x MPcap) -1
( CRI- MPcap) x MPS
• Here,
MPC = Marginal Propensity to Consume
MPS = Marginal Propensity to Saving
MPcap = Marginal Productivity of
Capital
CRI = Consumption Rate of Interest (Social
 UNIDO Approach – stage 3
Adjustment Factor for Savings (AFs)
• Assuming that MPC, MPS, MPcap and CRI of
an
economy is given:
• MPC = 70%, MPS = 30%,
• MPcap=25% and CRI=10%
Therefore, adjustment factor for savings is AFs is
Afs = (70% x 25%) - 1 = 2.88 ~
3.00
[10% - 25%]x30%
Adjusted Value of the impact of the project
on savings:
• Adjusted value of Savings
 UNIDO Approach - stage 3 :
• This Rs. 14,25,000 is now added to the NPV of
the project calculated in stage 2 (Rs.200
crore)
• Therefore, the adjusted NPV at this stage will
be
Rs. (200+.1425) = Rs. 200.1425 crore
 UNIDO Approach- Stage 4
Adjustment for the impact of the on Income
distribution
project
 Govt. considers a project as an investment for the
redistribution of income in favour of economically
weaker sections or economically backward regions
 This stage provides a value on the effects of a project
on income distribution between rich and poor and
among regions
 Distribution Adjustment Factor (Weight) is calculated
and the impacts of the project on income distribution have
been valued by multiplying the adjustment factor
with the particular income of a group. This value will then
be added to the net present value re-calculated in
stage three to produce the social net present value of the
 UNIDO Approach - Stage 4
Determination of Weights
• If there are only two groups in a society, poor and rich,
the determination of weight is just an iterative process between
the analysts (at the bottom) and the planners (at the top). This is
called "bottom-up" approach.
• When more than two groups are involved, weights are calculated
by the elasticity of marginal utility of income. The marginal utility
of income is the weight attached to an income is:
Wi =(b/ ci)^n
• where Wi = weight of income at ci level
• ci = level of income of group i
• b = base level of income that has a weight of 1 (one)
• n = elasticity of the marginal utility of income
 UNIDO Approach - Stage 4 :
• Assuming that the worker group gains an income of
Rs 2,50,000 from a project, the base level of income
is Rs. 50,000 which has a weight if 1 and elasticity of
Marginal Utility of Income is 0.20.
• Wi = (50,000/2,50,000) ^ 0.20 = 0.72
• Now, weight is 0.72
• Therefore, value of the impact of the project on
income distribution to this group is
• Rs 250000x0.72 = Rs. 180000
Now this value will be added to the net present value
adjusted in stage three. Therefore, Adjusted NPV in this
stage will be Rs (200.143+ 0.018) = Rs. 200.161 crore
 UNIDO Approach- Stage 5
Adjustment for Merit and Demerit Goods :
• If there is no difference between the
economic value of inputs and outputs and the
social value of those, the UNIDO approach for
project evaluation ends at stage four.
• In practical, there are some goods (merit
goods), social value of which exceed the
economic value (e.g oil, creation of employment
etc) and also there are some goods (demerit
goods), social value of which is less than their
economic value (e.g., cigarette, alcohol, high -
grade cosmetics etc)
• Adjustment to the NPV of stage 4 is required if
there is any difference between the social and
 UNIDO Approach- Stage 5
The steps of adjustment procedure are:
• Estimating the present economic value
• Calculating the adjustment factor
• Multiplying the economic value by the
adjustment factor to obtain the adjusted value
• Adding or subtracting the adjusted value to
or from the NPV of the project as
calculated in stage four.
 UNIDO Approach - Stage 5
An alcohol factory is being constructed. The
present economic value of the project is Rs.
200.161 crore (Adjusted NPV up to stage 4). The
output of the project has no social value than its cost
of production.
The output of the project has a social value which is
less than the economic value by 40%. Therefore
cost of production is the 60% of the economic price.
Therefore, adjustment factor is: ((60/100)-1) = -0.4
Therefore, the adjusted value = (Rs. 200.161 crore x (-
0.4))
= Rs. -80.064 crore
The NPV of the project in terms of socially
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