2.4 Valuing Relevant Costs and Benefits
With the relevant costs and benefits identified, the next step is to assign dollar values. The key thing is that CBA should provide a clear and consistent picture of the relative costs and benefits of alternative proposals to assist decision makers. It is not the role of analysts to decide in advance the proposals/options they believe are the most appropriate and weight the analysis accordingly (refer to the discussion on optimism bias in section 4.2).
In general, all benefits and costs should be quantified and valued in dollar terms unless it is clearly impractical to do so. This may happen because the costs and benefits:
- cannot be reliably measured, or
- are not significant[34] to the analysis, or
- are significant to the analysis but the resource/staff cost of attempting to value them outweighs the advantage of including them in the analysis.
2.4.1 Real versus nominal values
Costs and benefits should be valued in real terms (constant prices) as opposed to nominal terms (prices at the time the goods or services were provided). That is, the impact of inflation is eliminated from the analysis because we are interested in costs and benefits in a common money value. The only time that we make real adjustments to prices over time is if the price of a particular good or service is expected to increase or decrease relative to all other goods and services. In such cases the relative change should be quantified and built into the analysis. Common examples where relative price changes maybe relevant to the analysis are:
- high technology products for which prices are expected to fall in real terms e.g. the very latest computer technology
- high technology products for which prices are expected to rise in real terms e.g. health technology and defence hardware
- natural resources where supply is scarce or constrained e.g. oil/petrol and electricity, and/or
- wages and other input prices that are expected to increase faster than the rate of general inflation.
A useful working rule is that we assume the costs of a good or service will remain constant in real terms (i.e. before inflation) unless we are reasonably sure that its price will change relative to all other prices in the economy.
2.4.2 Valuing Costs and Benefits Using Market Values
Costs and benefits should normally be based upon market prices as they are the easiest to identify and usually reflect implicit opportunity costs.[35] Real or estimated market prices are therefore the starting point when attempting to value costs and benefits. However, market prices may need to be adjusted for distortions such as tax differences between options or monopoly pricing.[36]
Notes
- [34]For a cost or benefit to be significant, its impact on the analysis must be capable of influencing the final decision or final selection from a range of alternative proposals.
- [35]UK Green Book, Chapter 5, http://greenbook.treasury.gov.uk/.
- [36]A monopoly is where there is only one producer/seller in a given industry. The lack of competition allows a monopoly to significantly influence the price of a good or service; it will choose a (higher) price that maximises its profits rather than a (lower) price that that is optimal for the rest of society.
