L Thinking like an Economist Using Cost-Benefit Analysis to Prioritize Difficult Choices The cost-benefit analysis (also

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L Thinking like an Economist Using Cost-Benefit Analysis to Prioritize Difficult Choices The cost-benefit analysis (also referred to as a CBA) is one example of disciplined economic thinking. This type of analysis is used to compare the benefits (advantages) and costs (trade-offs) of available options to determine the best course of action. When benefits are seen to outweigh costs, an option is seen to be economically viable. The option with the best benefit-to-cost ratio is said to represent the most economic choice. Cost-benefit analysis is often used early in a decision-making process to establish priorities and assess available options. In a cost-benefit analysis, costs and benefits are converted to dollar values so that they can be compared and assessed. Let's say that a company wants to improve productivity by making workers more efficient (see Figure 4.3). One strategy for improving worker productivity is an efficiency training program. The training program fee multiplied by the number of participating workers would be the cost, while a 5 percent reduction in material waste and a 5 percent reduction in unit assembly time would be the benefits. Boosting worker morale is also recognized as helpful in improving productivity, so the costs and benefits of a suggestion box program and social events are also considered. From the available options, an economist may consider the costs of placing suggestion boxes around the plant and offering monthly cash prizes for the best ideas to improve efficiency to be the most economic choice. The option of social events for workers and their families might also be added to morale-building costs, but in this case the benefits are only slightly higher than the actual costs. 7 L
Associated Enefits Net Benefits FIGURE 4.3 Sample cost-benefit analysis Option Associated Costs fc Goal Tempre company productivity by making wenkesme Efficiency $500 training fee workers training - 50000 Sreduction in material waste 525.000-503000 -512000 5 reduction in unit assembly time 50 000 Thinking and feedback about efficiency 52000 Suggestion box program Purchase and installation of three bones =5500 $21000-56500 - $14500 5500 monthly -56000 eduction in material reduction in unit assembly time -5000 reduction in material Social events 510 000 - 53000 51000 Christmas party venue entertainment.food. and gifts for guests - 55000 Summer picnic (venue, activities food and prizes for 100 guests) -54000 reduction in unit assembly time reduction in materia waste - 53000 reduction in unit assembly time 2000 When dollar values can be attributed to specific benefits and costs, a relative significance can be accurately determined. Often, especially when dealing with policy matters, a more normative value iudeement is required when assessing costs and benefits. In these cases, individual costs and benefits are assessed as being highly moderately, or minimally significant. When such value iudaements are made in a cost- benefit analysis, they should be noted in the final decision. Cost-benefit analysis can be used by a company to make economically viable business decisions and by government policy advisers to advocate for a particular prioritization of goals and strategies. Although cost-benefit analyses are sometimes customized to r
suit the programs, initiatives, or options being assessed, the general steps in Figure 4.4 are usually involved. FIGURE 4.4 Steps in a cost-benefit analysis Step Define a need, issue, or goal List available alternatives Identify and consult stakeholders Establish priorities for common and conflicting interests and goals Select measurement criteria Focus Questions • What needs our attention to achieve established targets? • What options are realistically available? Who will be affected by this decision? • What are their interests and views regarding this decision? • How can common interests be addressed? • How can conflicting views be reconciled or prioritized? • What considerations will help identify and value relevant costs and benefits? • What are the benefits (positives) and costs (negatives) for each alternative or option? • What dollar value can be determined for each benefit and cost? • Which alternative maximizes benefits while minimizing costs? • How is the decision working out? What adjustments are needed to address consequences or improve implementation? Measure all costs and benefits associated with each alternative Convert allt benefits and costs to a common currency for tangible value) Compare alternatives to find the most favourable benefits to-costs ratio Implement the most economic option and assess outcomes APPLYING ECONOMIC THINKING 1) How would you prioritize the three available options given a budget of $15 000? Explain your choice. 2) How would your decision change if your budget is expanded to $20 000? 7
3) Benefit calculations for options are based on the effect this strategy has had on other companies with similar workforces. To what degree can similar outcomes be guaranteed for this company? 4) How might government goals affect your productivity gains positively or negatively?
Net Benefits Sample cost-benefit analysiss Option Associated Costs Associated Benefits (b) Goals To improve company productivity by making workers more efficient Efficiency 5500 training fee * 26 workers 5% reduction in material training = $13.000 waste =513000 525000 - $13 000 = $12000 5% reduction in unit assembly time = $12000 Suggestion box program $21000 - $6.500 -$14500 Purchase and installation of three boxes - 5500 $500 monthly prizes - 56000 Thinking and feedback about efficiency - 51000 4% reduction in material waste - $10400 4% reduction in unit assembly time - 59600 1% reduction in material waste 52600 I reduction in unit assembly time = 52400 Social events SIO 000 - 59000 = $1000 Christmas party (venue, entertainment, food, and gifts for 100 guests) - 55000 Summer picnic (venue, activities, food, and prizes for 100 guests) = 54000 1% reduction in material waste = $2600 1% reduction in unit assembly time $2400