Cost-benefit analysis, also called benefit-cost analysis, is a type of economic study that measures the costs and benefits to society of existing or proposed programs. Government and industry planners use cost-benefit analyses to help them make decisions.
Cost-benefit analysts focus on a clearly stated proposal, such as plans to create a park or to extend a highway system. They try to determine the effects of the proposal on as large a number of people as possible. Analysts formulate their estimates of costs and benefits in terms of dollars or other currencies. If the program produces economic benefits that exceed the cost of putting it into action, the program is judged to be worthwhile. Projects that produce such economic benefit are called cost-effective.
Stating costs and benefits in monetary terms poses a problem for analysts. Some factors, such as labor and materials, have measurable market prices. But other factors, such as the beautification of an area or increasing safety, have no market price. Cost-benefit analysts therefore must estimate a value called a shadow price for these factors.
Analysts also have the problem of studying policies that affect people for many years. A delay in receiving something generally lowers its current value. Analysts calculate this lower value through a procedure called discounting. Analysts often calculate the ratio between the discounted value of benefits and the discounted value of costs. If this ratio is greater than one, the project is considered to be economically worthwhile.
