Social costs and benefits; cost-benefit analysis

COST-BENEFIT ANALYSIS

Social Costs and benefits

Every business activity which takes place has some benefits and costs attached to it. The benefits go both to the owners of the firm as well as to external stakeholders. In the same way the owners and the external stakeholders have to pay a cost for the activities of the business.
Social cost:-

Social cost is the sum of private cost and external cost. For example, the manufacturing cost of a car (i.e., the costs of buying inputs, land tax rates for the car plant, overhead costs of running the plant and labor costs) reflects the private cost for the manufacturer. Water or air is also polluted as part of the process of producing the car, This is an external cost borne by those who are affected by the pollution or who value unpolluted air or water. Because the manufacturer does not pay for this external cost, and does not include this cost in the price of the car. The air pollution from driving the car is also an externality produced by the car user in the process of using his good. The driver does not compensate for the environmental damage caused by using the car.

Social-Cost is the cost to an entire society resulting from an event, an activity or a change in policy. Social cost equals the sum of private cost and external cost.

When assessing the overall impact of its commercial actions in terms of social costs, a socially responsible business operator should take into account its own production expenses, as well as any indirect expenses or damages borne by others.

  • Private cost:-

It is the cost of setting up the business. The owner(s) pay for the hire of machinery, buying of materials, payments of wages. This is termed as Private Cost.

  • External Cost:-

The problems that the external stakeholders have to bear due to the firm’s activity are known as external cost. Example: cleaning a river which has been polluted by a firm’s waste products. Private firms usually ignore external cost.

Social benefits:-

Social benefits are the sum of private benefits and external benefits. For example, a college decides to slash its tuition rates by half. This encourages more people to get educated. A better-educated workforce, in turn, helps businesses produce more. Thus, even though the businesses did not pay for the reduced college tuition, they still reap a positive external benefit from the college’s move. The increase in the welfare of a society that is derived from a particular course of action. Some social benefits, such as greater social justice, cannot easily be quantified.

Social benefits is the sum of private benefits and external benefits

  • Private benefit:-

The benefit enjoyed by those involved in the production or consumption . For example, the revenue earned by the firm is a benefit for the owner and is termed as Private benefit.

  • External benefits:-

Some firms can cause external benefits. These are the benefits to the external stakeholders due to the activity of firm. For example, a firm may train workers, which might get them better wages in other firms. These external benefits are free.

 

Use of cost benefit analysis in decision making

Most of us are familiar with the term ‘cost-benefit analysis’ and have a basic grasp of it. It refers to how a project or decision might be evaluated, comparing its costs with its benefits. In many cases, it’s a like a quantified pros-and-cons list… It’s an analysis of the expected balance of benefits and costs… Cost-benefit analysis sometimes called ‘benefit–cost analysis’ is a systematic process for calculating and comparing benefits and costs of a project, decision, government policy… CBA has two purposes:

  1. Determine if it’s a sound investment/decision (justification/feasibility).
  2. Provide a basis for comparing investments, decisions, projects… It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs and by how much…

According to Nicole Gordon; cost-benefit analysis is used to decide if the cost of a solution and the economic benefits that would result from it are worth the risk. The main idea behind this strategy is that the benefits must exceed costs to justify the policy…

When performing a cost-benefit analysis, you make a comparative assessment of all the benefits you anticipate from your project and all the costs to introduce the project, perform it, and support the changes resulting from it. Cost-benefit analyses help you to:

  • Decide whether to undertake a project or decide which of several projects to undertake.
  • Frame appropriate project objectives.
  • Develop appropriate before and after measures of project success.
  • Prepare estimates of the resources required to perform the project work.
  • Everything gets a dollar value in a cost-benefit analysis.

There are some advantages and disadvantages of cost and benefit analysis.

Advantages:-

  • The main advantage of cost benefit analysis is its simplicity. You are simply looking at whether benefits outweigh costs. When you do this quantitatively, measuring the dollar amount of the benefits and the costs involved in a project, the cost benefit is very easy to see.

Disadvantage:-

  • The simplicity of cost benefit analysis can paradoxically lead to complications; to gain this simplicity, you have to use a common measurement– one of the disadvantages of CBA. Determining the quantitative benefits of a project is relatively straightforward; you basically add up the costs and benefits and compare the two. However, when you factor in qualitative benefits, the picture can become more complicated.

Example:-

You are considering implementing an employee bonus program, you will obviously incur costs. In exchange, you may receive benefits like increased employee satisfaction, decreased turnover and greater productivity. The benefits are significant but difficult to compare– apples to apples– to the costs involved… A frequently made mistake is the use of non-discounted amounts for calculating the costs and benefits; typically the cost is tangible– hard and financial– while the benefits are hard and tangible, but also soft and intangible.

Written by Tehmina Khan