Introduction to benefjt-cost analysis of safety investments Eric Marsden <eric.marsden@risk-engineering.org> Would this project provide a net benefjt to society?
1 Understand concepts of consumer surplus, willingness to pay, net present value 2 Understand how a benefjt-cost analysis can be used to analyze the value of a safety investment 3 Be able to undertake a critical review of a benefjt-cost analysis 2 / 45 Learning objectives
data probabilistic model event probabilities consequence model event consequences risks curve fjtting costs decision-making criteria Tiese slides 3 / 45 Where does this fjt into risk engineering?
data probabilistic model event probabilities consequence model event consequences risks curve fjtting costs decision-making criteria Tiese slides 3 / 45 Where does this fjt into risk engineering?
data probabilistic model event probabilities consequence model event consequences risks curve fjtting costs decision-making criteria Tiese slides 3 / 45 Where does this fjt into risk engineering?
multiple, partially confmicting criteria into account: • protection of human lives and health • environmental considerations • economic aspects: profjts, jobs • societal demand for greater transparency ▷ Difgerent people put difgerent weights on these criteria • they are not expressed in the same units ▷ Decision-makers need tools to help them establish tradeofgs between these considerations and to explain decisions to stakeholders and citizens 4 / 45 Context ▷ Public decisions on questions related to industrial safety must take
benefjts with their cost ▷ Societal benefjts: • fewer fatalities and injuries in industry • improvements in citizens’ health or well-being • cleaner air and water • economic development, jobs ▷ bca is based on monetization of these criteria • based on citizens’ preferences and their “willingness to pay” for marginal changes in risk 5 / 45 Benefjt-cost analysis ▷ Method to assess projects or decisions by comparing their societal
▷ Widely used in usa & Anglo-Saxon countries • analysis of transport projects (freeway, railway infrastructures) • environmental impact assessments • regulatory impact assessments ▷ Used at the eu level for regulatory impact assessment • example: impact of proposed Clean Air For Europe ( cafe ) legislation was assessed using a bca before decision to implement it 6 / 45 Applications of BCA
• consumers, fjrms, taxpayers… ▷ Consequences measured are marginal variations in utility of the afgected agents • for a fjrm, measure the variation of profjts • for an individual, measure “willingness to pay” ▷ Decision rule : bca suggests that a decision should be taken if the net variation in utility is positive • i.e. the project has a net benefjt to society 7 / 45 Principles of BCA ▷ Implementation of a project afgects the utility of economic agents
them • is ofuen more than they would actually need to pay • example: price of water supplied to a household is ofuen less than willingness to pay ▷ Costs are valued according to willingness of others to pay for the resources involved • refmects the best alternative forgone (the opportunity cost ) • example: a painter who paints their own house does not have to pay for labour, but their labour still has an opportunity cost as they could have been doing something else in the time spent 8 / 45 Principles of BCA ▷ Benefjts are valued according to the willingness of individuals to pay for
▷ Financial analysis only takes into account the market price (and total revenue) of supplying the service relative to its cost of production ▷ bca also takes into account • the value of the service to consumers beyond the price paid • the cost beyond what is paid to the factors of production ▷ bca should also take into account any externalities • externalities: other costs and benefjts that afgect people outside those involved in the transaction 9 / 45 BCA is difgerent from classical fjnancial analysis
• maximization of welfare / utility • emphasizes results of an action, rather than following rules/principles • values are determined through personal preferences and casting dollar “votes” • example: vaccination of children against polio is “good” even if a (very small) number of children will sufger bad efgects from the vaccine • benefjt-cost analysis is compatible with this ethical framework ▷ Duty-based (deontological) ethics : adherence to rules that bind you to your duty • the intrinsic value of safety, or the moral imperative not to cause harm • an action is “good” if that choice of action would be good for all people at all times • not easily compatible with bca 10 / 45 Ethical framework for BCA ▷ Utilitarian ethics : “the greatest good for the greatest number”
benefjt from a project that would improve their utility • utility represents satisfaction / happiness / abstract wealth ▷ If the project has negative consequences for a person, wtp will be negative • becomes a “willingness to accept” as compensation for the detrimental impact ▷ Philosophically difgerent from classical “paternalist” approaches to public policy • bca is a “democratic” or “populist” approach • value is determined by what consumers are willing to pay for an amenity, not what a politician or an expert thinks the value should be 11 / 45 Willingness to pay ▷ Willingness to pay ( wtp ): what a person would be prepared to pay to
▷ Market price is the minimum amount that consumers who buy the good are willing to pay for it ▷ Willingness to pay for a project that afgects consumption of a market good can be estimated by the variation of the consumer surplus and the producer surplus • consumer surplus = wtp – actual price • measures the utility that consumers derive from their consumption of goods and services, or the benefjts they derive from the exchange of goods 12 / 45 Willingness to pay for a market good ▷ Willingness to pay is not simply market price × consumption
Tie difgerence 𝑄 − 𝑄 ∗ is their surplus. willing to pay more than 𝑄 for the good. Tie difgerence 𝑄 ′ − 𝑄 is their surplus . 13 / 45 producer surplus . 𝑅 ∗ At quantity 𝑅 ∗ , some producers would be willing to produce for a lower price 𝑄 ∗ . producer surplus Tie set of points between the supply curve and the equilibrium price is the Tie sum of the consumer surplus and the consumer surplus producer surplus is the net social benefjt of this market good. 𝑄 𝑅 new supply curve A change to the supply curve changes the size of the net social benefjt. Tiis delta must be counted as a benefjt or a cost in a bca . 𝑄 ∗ points on the demand curve and the equilibrium price is the consumer surplus . marginal costs per unit). quantity demand curve For market goods, the “law of demand” states that decreasing the price increases demand (the amount sold). supply curve Increasing price generally leads to an increase in the quantity supplied (lower Markets reach an equilibrium between price supply and demand. At price 𝑄 , quantity 𝑅 is sold (the equilibrium point ). 𝑄 𝑅 Some consumers at (𝑄 ′ , 𝑅 ′ ) would be 𝑄 ′ 𝑅 ′ Tie set of all these difgerences between Variation in surplus and net social benefjt of a market good
Tie difgerence 𝑄 − 𝑄 ∗ is their surplus. willing to pay more than 𝑄 for the good. Tie difgerence 𝑄 ′ − 𝑄 is their surplus . 13 / 45 producer surplus . 𝑅 ∗ At quantity 𝑅 ∗ , some producers would be willing to produce for a lower price 𝑄 ∗ . producer surplus Tie set of points between the supply curve and the equilibrium price is the Tie sum of the consumer surplus and the consumer surplus producer surplus is the net social benefjt of this market good. 𝑄 𝑅 new supply curve A change to the supply curve changes the size of the net social benefjt. Tiis delta must be counted as a benefjt or a cost in a bca . 𝑄 ∗ points on the demand curve and the equilibrium price is the consumer surplus . marginal costs per unit). quantity demand curve For market goods, the “law of demand” states that decreasing the price increases demand (the amount sold). supply curve Increasing price generally leads to an increase in the quantity supplied (lower Markets reach an equilibrium between price supply and demand. At price 𝑄 , quantity 𝑅 is sold (the equilibrium point ). 𝑄 𝑅 Some consumers at (𝑄 ′ , 𝑅 ′ ) would be 𝑄 ′ 𝑅 ′ Tie set of all these difgerences between Variation in surplus and net social benefjt of a market good
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