Cost Benefit analysis

Cost Benefit Analysis is typically used by governments to evaluate the desirability of a given intervention in markets. The costs and benefits of the impacts of an intervention are evaluated in terms of the social benefits or social cost. The guiding principle is to list all of the parties affected by an intervention, and place a monetary value of the effect it has on their welfare.

The process involves monetary value of initial and ongoing expenses vs. expected return. Constructing plausible measures of the costs and benefits of specific actions is often very difficult.

For example, governments can use the technique to decide whether to introduce business regulation, build a new road or offer a new drug on the state healthcare. In this case, a value must be put on human life or the environment, often causing great controversy.

The cost-benefit principle says, for example, that we should install a guardrail on a dangerous stretch of mountain road if the dollar cost of doing so is less than the implicit dollar value of the injuries, deaths, and property damage thus prevented.

Cost-benefit analysis is also used to assess the value for money of very large private and public sector projects. This is because such projects tend to include costs and benefits that are less amenable to being expressed in financial or monetary terms (e.g. environmental damage), as well as those that can be expressed in monetary terms.