Engineering Economic Analysis

510 ECONOMIC ANALYSISIN THE PUBLIC SECTOR

1

makers than for those in the private sector. Another difference between the public and

private sectors lies in how the interest rate (MARR) is set for economic studies. In the

private sector, considerations for setting the rate include the cost of capital and opportunity

costs. In government, establishing the interest rate is complicated by uncertainty in speci_

fying the cost of capital and the issue of assigning opportunity costs to taxpayers or to the

government.

The benefit-costratio is widely used to evaluateandjustify government-fundedprojects.

This measure of merit is the ratio of the equivalentworth of benefitsto the equivalentworth

of costs. This ratio can be calculated using PW, AW,or FW methods. AB/Cratiogreater

than 1.0indicates that a project should be invested in if funding sources are available.

For consideringmutually exclusive alternatives,an incremental method should be used to

evaluate the merits of additional cost. This method results in the recommendation of the

project with the highest investment cost that can be incrementallyjustified. Two versions

of the BICratio, theconventionalandmodifiedBICratios, produce identical recommen-

dations when single projects or sets of competing alternatives are being considered. The

differencebetween the two ratios is in the way that annual operating and maintenancecosts

are handled-as an added cost in the denominator in the former, or as a subtracted benefit

in the numerator in the latter.

PROBLEMS

,

16-1 Economic analysis and decision making in the pub-

lic sector is often called "a multi-actor or multi-

stakeholder decision problem." Explain what this

phrase means..

16-2 Compare the general underlying objective of public

decision making versus private decision making.

16-3 In the text the authors describe a general recommen-

dation regarding the scope of viewpoint that is ap-

propriate in public decision making. What do they

suggest? What example is given to higWight the

dilemma of viewpoint in public decision making?

16-4 In government projects, what is meant by the phrase

"most of the benefits are local." What conflict does

this create for the federal government in terms of fund-

ing projects from public monies.

16-5 Discuss the alternative concepts that can be employed

when setting the discounting rate for economic anal-

ysis in the public sector. What is the authors' final

recommendation for setting this rate?

16-6 What is the essential difference between theconven-

tionalandmodifiedversions of the benefit-cost ratio?

Is it possible for these two measures to provide con-

flicting recommendations regarding invest/do-not-

invest decisions?

16-7 List the potential costs, benefits, and disbenefits that

should be considered when one is evaluating a nuclear

power plant construction.

16-8 Describe how a decision maker can use each of the

following to "skew" the results of aBjC ratio anal-

ysis in favor of his or her own position on funding

projects:.

(a)Conventional versus modified ratios.

(b)Interest rates.

(c) Project duration.

(d) Benefits, costs, and disbenefits.

16-9 Think about a major government construction project

under way in your state, city, or region. Are the de-

cision makers who originally analyzed and initiated

the project currently in office? How can politicians

use "political posturing" with respect to government

projects?

16-10 Consider the following investment opportunity:

Initial cost

Additional cost at end of Year 1

Benefit at end of Year 1

Annual benefit per year at end

of Years 2-10

$100,000

150,000

o

20,000

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