Applied Welfare Economics

Massimo Florio is Professor of Public Economics and Jean Monnet Chair “ad personam” of EU Industrial Policy at the University of Milan, Italy. Chiara Pancotti is Adjunct Professor of Cost-Benefit Analysis at Università degli Studi di Milano and Senior Researcher at the Centre for Industrial Studies, Italy.

Chapter 1: On Social Welfare

Overview

1.1. The concept of social welfare*

1.1.1 Gross Domestic Product as welfare measurement

1.1.2 Income and final consumption

1.1.3 A digression on money in welfare economics

1.2. The welfare assumptions behind GDP and NNP

1.3. Individual and social welfare

1.4. Determinants of individual welfare: goods

1.5. Determinants of social welfare: individual utilities

1.5.1 Aggregating individual utilities

1.5.2 Interpretation of welfare weights

1.6. Sen’s critique of individualistic Social Welfare Function

1.7. Paternalism and not (only) individualistic Social Welfare Functions

1.8. Happiness economics

1.9. ‘Positive’ analysis

1.10. Further reading

1.11. Summary of Chapter 1

Chapter 2: The two Fundamental Theorems re-examined

Overview

2.1. Theorems versus Intuitions

2.2. The Arrow-Debreu (AD) Economy (*)

2.3. The axiomatic structure (*)

2.4. Consumers, producers and government: objectives and constraints (*)

2.5. The Walrasian equilibrium

2.6. The two Theorems without ideology

2.7. The informative structure: Stiglitz’s critique

2.8. Critical analysis of the Second Theorem

2.9. The government rediscovered in second-best economies

2.10. Further reading

2.11. Summary of Chapter 2

Appendix A2.1 – Policies based on the Second Theorem: lump-sum transfers

Appendix A3.1: Some results from Drèze and Stern (1987)

Marginal social value of producer prices

Marginal social value of commodity taxes

Marginal social value of a production constraint

Chapter 3: Shadow prices and the social planner

Overview

3.1. Introductory remarks

3.2. A model for project and policy evaluation

3.3. A second best economy in the DS frame

3.4. Policy reforms and shadow prices

3.5. Multi-government setting

3.6. Why using shadow prices?

3.7. Further reading

3.8. Summary of Chapter 3

Chapter 4: The social cost of goods

Overview

4.1. Observed prices and financial analysis

4.2. Accounting prices and economic analysis

4.2.1 Conversion of market prices to shadow prices

4.2.2 Extension of project boundaries: externalities and indirect effects

4.2.3 Assessing the economic performance

4.3. Empirical approaches for guessing accounting prices

4.4. The border price rule for tradable goods

4.5. The Standard Conversion Factor

4.6. The long run marginal cost

4.7. Willingness-to-pay

4.7.1 Definition and scope of application

4.7.2 Stated preferences approaches

4.7.3 Revealed preferences approaches

4.7.4 Benefit transfer approach

4.8. Further readings

4.9. Summary of Chapter 4

Appendix A4.1: Financial analysis

The financial return on investment

The financial return on capital

Financial performance indicators

Financial sustainability

Dealing with taxes in the financial analysis

Appendix A4.2: An example of financial and economic analysis

Chapter 5: The social cost of labour

Overview

5.1. Earlier literature on the social opportunity cost of labour

5.1.1 Theoretical contributions

5.1.2 Empirical contributions

5.2. A conceptual model for the social cost of labour

5.3. The shadow wage rate and labour market conditions

5.3.1 Simplifying the Little-Mirrlees formula for the SWR

5.3.2 Empirical formulae

5.4. Empirical estimation of shadow prices for EU regions

5.4.1 Data and methods

5.4.2 Estimation of the SWRs

5.5. Further reading

5.6. Summary of Chapter 5

Chapter 6: The social cost of capital

Overview

6.1. Rationale for discounting

6.2. Estimating the social discount rate

6.2.1 The social rate of return on private investments (SRRI)

6.2.2 The social rate of time preference (SRTP)

6.2.3 The weighted average method

6.2.4 The shadow price of capital

6.3. The social discount rate as a function of time

6.4. Empirical estimates of the social discount rate

6.4.1 International evidence: SDRs recommended in selected countries

6.4.2 An example of SRTP estimation

6.5. The opportunity cost of public funds

6.6. Further reading

6.7. Summary of Chapter 6

Chapter 7: Welfare weights and distributional impacts

Overview

7.1. Why are equity considerations needed in CBA?

7.2. Deriving welfare weights

7.3. Estimation of distributional weights

7.4. The distributional characteristic of goods

7.5. Group and regional welfare weights

7.6. Basic needs and social affordability

7.6.1 The basic needs approach

7.6.2 Social affordability analysis

7.7. Further reading

7.8. Summary of Chapter 7

Chapter 8: Risk assessment

Overview

8.1. Rationale of the risk assessment

8.2. Definitions and concepts

8.3. Historical background: the World Bank model

8.4. Sensitivity analysis

8.4.1 Identification of the critical variables

8.4.2 Approaches to test the sensitivity of the CBA model

8.5. Probability analysis

8.5.1 Probability distributions of the critical variables

8.5.2 Dealing with correlations between the critical variables

8.6. Risk Analysis

8.6.1 Monte Carlo simulations

8.6.2 Evaluation of the investment’s riskiness

8.7. Further reading

8.8. Summary of Chapter 8

Appendix A8.1: Distributions of probabilities

Appendix A8.2: Monte Carlo method

Theoretical framework of the Monte Carlo method

Choice of the number of simulations

Appendix A8.3: Generating correlated random numbers

Modeling dependence through conditional distributions

Modeling dependence through copulas

Chapter 9: International evaluation practices

Overview

9.1. National traditions and operative guidelines

9.1.1 United Kingdom

9.1.2 France

9.1.3 United States of America

9.2. The use of cost—benefit analysis in the EC regional policy

9.3. Multilateral development banks

9.3.1 The European Investment Bank

9.3.2 The World Bank

9.4. Further reading

9.5. Summary of Chapter 9

Chapter 10: Ex-post project evaluation

Overview

10.1. Timing and scope of CBA

10.2. Performing ex-post CBA

10.2.1 Project border identification

10.2.2 Reference scenario

10.2.3 Demand analysis

10.2.4 Willingness-to-pay

10.2.5 Shadow prices

10.2.6 The social discount rates

10.3. International practice of ex-post CBA

10.4. CBA and the decision-making process

10.5. Interpretation of variability of ex-ante vs ex-post or re-estimated internal rates of return

10.6. Comparison between ex-ante and ex-post economic rates of return

10.7. CBA and incentives

10.8. Further reading

10.9. Summary of Chapter 10

Chapter 11: The use of cost-benefit analysis in regulatory policy

Overview

11.1. Adopting CBA for regulatory impact assessment: rationale and main elements

11.2. International practices

11.2.1 United States

11.2.2 United Kingdom

11.2.3 European Union

11.2.4 Other experiences

11.3. A key tool for good governance? Some critical considerations

11.4. Further reading

11.5. Summary of Chapter 11