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Importance of Social Cost Benefit Analysis

Importance of Social Cost Benefit Analysis

Social cost benefit analysis is a part of calculating the merits of a project or a government policy. As the name suggests, social cost-benefit analysis of anything is associated with its social impact. This means that how a project or a policy will affect people is analyzed. Only after calculating the opportunity cost of a project, it is approved.

The scope of social cost benefits can be applied to public investment and also to private investment. In case of public investment, it plays a major role in the economic development of a developing country. And, in case of private investments social cost benefit analysis is important as investments are to be sanctioned and are monitored by the government. There are two aspects of calculating the cost benefit analysis of any project. One is the private cost-benefit analysis and the other is social cost-benefit analysis. Though, social cost-benefit analysis is usually undertaken by the government.

Social cost is often in contrast with private cost. Major differences between social cost benefit analysis and private cost benefit analysis are as follows:

1. In social cost benefit analysis, not only profit but also other effects like how will it affect life of others are considered. Whereas, in private cost benefit analysis, the focus of the analysis is on maximizing profits.

2. For calculating social cost benefit, market prices for the factors to be considered cannot exist. Therefore, market price is not the main factor taken into consideration while calculating social cost benefit. Whereas, for private cost benefit analysis market price forms the base of the analysis and the key factor that determines if a project is viable.

Social Cost = Negative Impact
Social Benefit = Positive Impact

Social cost benefit analysis has been introduced to develop systematic ways of analyzing cost and benefits of factors which do not have market prices, like effect on environment and traffic. Social cost-benefit calculates non-monetized benefits/ losses. It is normally used for large fund projects like constructing a dam, a road. Such projects have higher social cost-benefits and also affects the price level to an extent.

Example: If a bridge is to be constructed then how much will it benefit the people who live in that particular area, is to be analyzed. Therefore, how many people are willing to use the bridge, how much traffic will be reduced and what is the increase in cost of traveling, will have to be assessed as a whole to come to a conclusion. Suppose, if people are not willing to use the bridge if the cost of traveling from the bridge is $5 and if $7 has to be charged per vehicle to make this project feasible, then the government may consider dropping the project out.

On the other hand, if people are willing to travel using the bridge, being indifferent to the toll price-difference of $2, and the traffic is reduced by a good amount, then the government will sanction the project. Therefore, it is beneficial to take up a project if its total benefits (B) are more than its total costs (C).

It can be put up as, a project should be undertaken if, B/C > 1 or even when B=C. That is, when the cost-benefit ratio exceeds unity or when benefit derived and the cost of the project is equal. Before sanctioning a project, cost and benefit of alternative projects are assessed too. For example, the opportunity cost of setting up a hospital instead of a school.

Importance of Social Cost Benefit Analysis

The importance has been explained with the help of the following factors that affect the general masses as a whole.

Market Failure
Market failure when a big project is not affecting everyone but only a few. A private firm would only look at profitability and related market prices to take up a deal but the government has to look at other factors. To determine the social cost in case of market failure and when market prices are unable to define them. These social costs are known as shadow prices.

Savings & Investment
Impact of the project on general savings and investment level. A project that induces more savings are investment in an economy and not the other way round.

Distribution & Redistribution of Income
The project should not lead to accumulating income in the hands of a few but, it should equally distribute the income.

Employment and Standard of Living
How a project affects employment and standard of living will be taken into account as well. The deal should lead to increase in employment and standard of living.

Externalities
Externalities are impacts of a project which can be both harmful and beneficial. Therefore, both the effects are to be assessed before sanctioning a deal. Positive-externalities could be in the form improvement in technology and negative-externalities could be in the form of increase in pollution and destruction of ecology.

Taxes and Subsidies
In a general cost benefit calculation, taxes and subsidies are considered as expenses and income respectively. Though in case of social-cost benefit analysis, taxes and subsidies are considered as transfer payments.

Social cost benefit analysis enables the government to take up new developments which will benefit everyone and not just a few. Also, it helps in bringing about an overall development in an economy and can help make decisions that will increase employment, investments, saving and consumption, thus, improving the economic activities in an economy.