Energy Economics
Cost and benefit analysis is an analytical process, which is used to measure that whether the benefits or advantages associated with an activity is greater than its costs or not. It is one of the commonly used and formal tools for the assessment of efficiency. Efficiency assessment can be defined as a process in which scarce resources are examined critically so that the ways in which they can be used most efficiently can be determined. Efficiency assessment basically provides us with ways through which maximum benefits can be acquired from scarce resources. The technique of cost and benefit analysis is based on welfare economics. ("Cost-benefit analysis" 2009)[footnoteRef:2] [2: Cost-benefit analysis, (Brussels: European Commission, 2009)http://ec.europa.eu/transport/road_safety/specialist/knowledge/pdf/cost_benefit_analysis.pdf (accessed May 25, 2013), 4.]
Advantages of Cost and Benefit Analysis
Cost and benefit analysis benefits an organization in many ways. It reduces the operating costs and enhances efficiency. The major benefits of cost and benefit analysis are discussed below;
Return on Investment
Cost and benefit analysis enables the organization to analyze the return on various investments as it critically scrutinize the current and future cash flows by using different techniques such as, compounding and discounting. ("Cost Benefits analysis" 2005)[footnoteRef:3] [3: Cost Benefits analysis, (Manchester: Manchester Metropolitan University (MMU), 2005)http://www.mmu.ac.uk/bit/docs/Cost-Benefit-analysis-toolkit-v2.pdf (accessed May 25, 2013), 1. ]
Improved Performance
As the organization operates more efficiently and tries to invest in the most beneficial projects, the performance of the organization improves significantly. ("Cost Benefits analysis" 2005)[footnoteRef:4] [4: Cost Benefits analysis, (Manchester: Manchester Metropolitan University (MMU), 2005)http://www.mmu.ac.uk/bit/docs/Cost-Benefit-analysis-toolkit-v2.pdf (accessed May 25, 2013), 1.]
Better Customer Satisfaction
When the information available to the customers portrays that the organization is investing in profitable projects and its prospects for growth are very high then the customers become satisfied with the performance of the organization and they invest more in the organization. ("Cost Benefits analysis" 2005)[footnoteRef:5] [5: Cost Benefits analysis, (Manchester: Manchester Metropolitan University (MMU), 2005)http://www.mmu.ac.uk/bit/docs/Cost-Benefit-analysis-toolkit-v2.pdf (accessed May 25, 2013), 1.]
Conceptual Foundations of Cost-Benefit Analysis
The basic conceptual framework underlying the cost and benefit analysis is 'allocative efficiency'. Apart from allocative there are other conceptual frameworks, such as 'Pareto Efficiency', which also underlie the concept of cost and benefit analysis. (MacGeorge 2009)[footnoteRef:6] The major conceptual foundations that underlie the process of cost and benefit analysis are listed below; [6: Richard MacGeorge, THE CONCEPTUAL FOUNDATIONS OF BENEFIT-COST ANALYSIS AND THE USEFULNESS OF THIS TECHNIQUE IN THE AREA OF ENERGY ECONOMICS., (Christchurch: Ridgway Capital Projects, 2009)http://www.ridgway.co.nz/files/cba-energy.pdf (accessed May 25, 2013), 1-2.]
Allocative Efficiency
It can be defined as the process of allocating the scarce resources in such a way that maximum benefits can be reaped from them. This concept guides us to create a proper mix between unlimited wants and limited resources. As cost and benefit analysis is generally related with the efficient management of resources and cost efficiency. And the amount spent on the resources is directly related to both of these concepts, therefore, allocative efficiency is the fundamental conceptual framework that underlies the cost and benefit analysis. (MacGeorge 2009)[footnoteRef:7] [7: Richard MacGeorge, THE CONCEPTUAL FOUNDATIONS OF BENEFIT-COST ANALYSIS AND THE USEFULNESS OF THIS TECHNIQUE IN THE AREA OF ENERGY ECONOMICS., (Christchurch: Ridgway Capital Projects, 2009)http://www.ridgway.co.nz/files/cba-energy.pdf (accessed May 25, 2013), 1-2.]
Pareto Efficiency
This is another major concept that underlies the cost and benefit analysis. If the resources are allocated in such a way that a new or alternative allocation can make at least one person better off without making any other person worst off then this allocation of resources is 'pareto efficient. ("Conceptual Foundations of Cost-Benefit" 2007)[footnoteRef:8] [8: CONCEPTUAL FOUNDATIONS OF COST-BENEFIT, (Bangkok: National Institute of Development Administration, 2007)http://gspa.grade.nida.ac.th/pdf/Dr_Nutta/PA.640nattha_MPA_3-49/2. Efficiency/2.2.2Boardman, A. Cost Benefit Analysis Concept and practice chapter2.pdf (accessed May 25, 2013), 28-30]
The Link between Pareto Efficiency and Net Benefits
The link between Pareto efficiency is very clear and straight forward. If a policy includes positive net benefits then it has the tendency to have side payments or conditions that can make one person better off without making any other person worst off. In order to understand the link between Pareto efficiency and net benefits it is necessary to understand the following concepts; ("Conceptual Foundations of Cost-Benefit" 2007)[footnoteRef:9] [9: CONCEPTUAL FOUNDATIONS OF COST-BENEFIT, (Bangkok: National Institute of Development Administration, 2007)http://gspa.grade.nida.ac.th/pdf/Dr_Nutta/PA.640nattha_MPA_3-49/2. Efficiency/2.2.2Boardman, A. Cost Benefit Analysis Concept and practice chapter2.pdf (accessed May 25, 2013), 28-30]
Willingness to Pay (WTP)
It is the amount that the individual...
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