1 Social cost-benefit analysis

 is a technique of evaluating projects from

social/economic perspectives.
 primarily used in evaluating public sector
projects

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2 6.1 Why social cost-benefit analysis?

Market Imperfections
 market prices do not reflect social values
Externalities
 are beneficial or harmful effects of a project
to the society
 benefits generated by the project and the
damages inflicted on the society are ignored in
financial analysis
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3 6.1 Why social cost-benefit analysis?

Taxes and subsidies

 are irrelevant from social point of view as they
merely represent transfer payments
Concerns for Savings
 a project may have a consumption and saving
effect, and savings are more preferred as they
lead to investment

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4 6.1 Why social cost-benefit analysis?

Concern for redistribution

 fair distribution of income among different
groups of the society is a concern in SCBA
(social cost - benefit analysis)
Merit goods
are preferences and golas not expressed in
terms of market prices. Eg. Adult education
program
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5 6.2 UNIDO Approach

It involves the following steps

1. Calculate financial feasibility based on market
prices
2. Obtain net benefits measured in
economic(efficiency) prices
3. Adjust for impact on savings and investment
4. Adjust for impact on income distribution
5. Adjust for impact on merit and demerit goods
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 6 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency) prices

 economic (efficiency) prices are also called Shadow
prices.
Issues related to shadow prices
 Numeraire-unit of account in which value of inputs
and outputs are expressed
 Tradability of goods-measured using international
price

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 7 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency) prices

Sources of shadow price
Impact of a project Source of shadow price

Consumption Consumer willingness to pay

Production Production cost

International trade Foreign exchange value

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 8 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency)

prices…
Shadow pricing for specific goods
(a) Tradable inputs and outputs
 are goods for which increase in consumption
results in increase in import and a decrease in
export, and increase in production leads to increase
in export and decrease in import
 shadow price is border price in local currency
translated at market exchange rate
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 9 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency)

prices…
Shadow pricing for specific goods
(b) Non-tradable inputs and outputs
 are goods for which import price exceeds domestic
cost of production and export prices is less than
domestic cost of production.
 shadow price is determined based on consumers
willingness to pay or cost of production
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10 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency)

prices…
Shadow pricing for specific goods
(c) Externalities
 are goods that are not deliberatly created, are
beyond the control of persons affected, and are not
traded in the market.
 value is determined indirectly

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11 6.2 UNIDO Approach

Net benefits in terms of economic(efficiency)

prices…
Shadow pricing for specific goods
(d) Labor inputs
 by hiring labor a project can have impact on the
rest of the economy in the following THREE ways
i) may take labor from other employments
ii) may induce production of new labor
iii) may involve import of workers
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 12 6.2 UNIDO Approach

Shadow pricing for specific goods

(d) Labor inputs
 Shadow price is as follows
If labor is taken from other employments
 rate others are willing to pay
If production of new labor is induced
 marginal product of labor in previous employment
 value of liesure time
 additional consumption of food when working
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 13 6.2 UNIDO Approach

(e) Capital inputs

 investment in capital goods involves conversion of
financial resources into physical assets and a reduction in
national savings that could have been used for financing
other projects
 shadow price therefore includes shadow price of
physical assets and the opportunity cost of a project given
up

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 14 6.2 UNIDO Approach

Measurement of the impact on distribution

 first, income gained or lost by individual groups within
the society is determined
 income gained or lost is the difference between
shadow price and market price
Example: Suppose that people in Gilgel Gibe area get 10mill kwh of
electricity from Gilgel Gibe II hydroelectric power generation plant
at Br 0.55 per Kwh. They were actually willing to pay Br 0.75 per
kwh. The income gain is therefore calculated as follows:
= Br 2mill (10mill kwh x (Br 0.75-Br 0.55)
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15 6.2 UNIDO Approach

Saving impacts and its value

Two important questions
1. given its impact on income distribution, what would be
effects of a project on savings?
2. value of the savings to the society
IMPACT ON SAVING
equals to
where Yi change in income as a result of the project
MPSi is marginal propensity to save of group i
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16 6.2 UNIDO Approach

IMPACT ON SAVING
Example: Consider the following data
Group Gain/loss MPS
A Br 250,000 0.40
B 150,000 0.20
C -100,000 0.30
D 200,000 0.25
E -350,000 0.10

Impact on savings equals to Br 115,000

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17 6.2 UNIDO Approach

Value of Saving
 is the present value of additional consumption
produced when a saving is invested at the margin.
 additional consumption generated by investment
depends on marginal productivity of capital and rate of
investment from additional income.

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18 6.2 UNIDO Approach

Income distribution Impact

 involves weighing the net gain/loss by each
group to reflect value of income for different
groups and summing them.
 Weights are determined as follows
wi = (b/ci)^n
where wi =weight attached to income at ci level
b = base level of income that has a weight of 1
nProject
= elasticity of the marginal utility of income
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19 6.2 UNIDO Approach

Adjustment for merit and demerit goods

 merit goods have more social value than economic value eg.
Production of Oil
 demerit goods have more economic value than social value eg.
Production of Cigarette.
 the difference between social value and economic value is
adjusted by (i) estimating economic value (ii) calculating
adjustment factor as the difference between the ratio of SV to
EV and one (iii) multiplying economic value by the adjustment
factor(iv) add the value in (iii) to NPV

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20 6.2 UNIDO Approach

Adjustment for merit and demerit goods...

Example
Suppose the present economic value of a project is Br
15mill and the ratio of SV to EV is 1.30.
Adjustment factor = 0.30 (1.30-1)
Adjustment = Br 4.5 million (0.30 x Br 15million)
Adjusted Economic value = Br 19.5mill(15mill+4.5mill)

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Project Financing and Management-Market and Demand Analysis Thursday, January 23, 2020