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M11.L04 — Government Provision of Public Goods: Cost-Benefit Analysis

Module: Module 11 — Public Goods and Common Resources Lesson: L04 of 05 Duration: ~30 minutes Level: Introductory Provenance: Principles of Microeconomics (Curtis and Irvine) | MIT OCW 14.01 Principles of Microeconomics

Learning Objective

Evaluate public projects using cost-benefit analysis principles.

Cost-Benefit Analysis

Governments use CBA to determine efficient provision: 1. Identify all costs and benefits 2. Quantify in monetary terms where possible 3. Discount future values to present terms 4. Compare aggregate benefits to costs

Australian practice: - Infrastructure Australia: Requires CBA for major projects - Sydney Metro: Justified through transport time savings - Bruce Highway Upgrade: Safety benefits quantified

Challenges include valuing non-market goods (e.g., environmental impacts).

Worked Example

Evaluating a New Hospital 1. Costs: - Construction: $500 million - Annual operations: $50 million 2. Benefits: - Health outcomes valued at $60 million/year - Reduced travel time: $10 million/year 3. Over 30 years (discounted): - Present cost: $1.1 billion - Present benefit: $1.3 billion 4. Net benefit → Project proceeds

Common Misconception

"All government spending is wasteful"

CBA provides systematic evaluation. While imperfect, it prevents arbitrary decisions. Australian projects like the Snowy Hydro scheme show successful applications.

Key Takeaways

  • CBA compares societal costs and benefits
  • Discounting adjusts for time preferences
  • Non-market valuation remains challenging
  • Australian institutions employ rigorous methods

Practice

  1. Why discount future benefits in CBA?
  2. How might you value cleaner air near a school?
  3. Critique this CBA element: "Increased property values near new rail line"

Further Resources

Provenance: Principles of Microeconomics (Curtis and Irvine) | MIT OCW 14.01 Principles of Microeconomics