Cost Benefit Analysis Theory
In other to review the effects for the imposition of charges on the use of studded tires using Cost Benefit Analyses, it is imperative to understand the theoretical settings that surround this study. CBA compares the discounted future streams of incremental program benefits with incremental program costs with the difference between these two streams being the Net Social Benefit of the program. It examines whether a program’s benefit exceeds its cost, a positive net social benefit will therefore indicates that the program is worthwhile (Drummond et al., 2005).
According to ASEK 5.1 report, in other to determine the admissibility of a project without considering any budget constraint, ASEK recommends the use of NPV (Net Present Value) but with respect to constraint budget the decision criteria should be based on The Ratio of NPV and public sector support (RNPSS). In Swedish this ratio is indicated by NNK (VTI, 2014). There are two different NNK recommended be used. NNK-i = NPV/I (2).
This is equal to the ratio of NPV and the social cost of the investment. Where I = the social cost of investment and NNK-idu = NPV/ (I + DoU) (3).
This is equal to the ratio of NPV and the sum of the social cost of investment and the social costs of operation and maintenance during the life time of the investment. Where I = the social cost of investment cost; DoU = changes in the social costs of operation and maintenance due to the investment (VTI, 2014).
The social costs of the investment and changes in costs of operation and maintenance are including the marginal cost of public funds due to the public funding of infrastructure investments and infrastructure operation and maintenance. The social costs of investment and operation and maintenance also includes over-head costs for planning and administration. In this case, the decision criterion is: NPV ≥0 NNK-i ≥0 and NNK-idu ≥0 (4) (VTI, 2014).
Kaldor /Hicks criterion
The first theory to examine in welfare economics is that of Kaldor /Hicks criterion seen in the light of Pareto efficiency and the Pareto improvement criterion. This theory is important in this study because it will enable us to understand whether the policy put in place was authentic speaking in the light of whether it makes the society better or worse since the social welfare function links certain allocation of resources to the social utility derived from a policy initiated by the government. As a result the government may use such policies to regulate the behavior of particular agents in the society or to choose the set of regulations which maximizes total output (Angelov, 2013). According to the Pareto efficiency criterion, “a state of affair is optimal if and only if there is no alternative state that would make some people better off without making anyone worse off. Therefore, a state of affairs x is said to be at the sub-optimal level if and only if there is some state of affairs y such that no one strictly prefers x to y and at least one person strictly prefers y to x” (Britannica Encyclopedia, 2014).
On the other hand, the Pareto improvement criterion or Khador/Hicks improvement is a means of resource allocation where at least one participant would favor the effect of change or to be more precise better off and no participant would be made worse off. Therefore a policy change will represent progress if the winners from the change could compensate losers from the change and still be better off (Wonnell, 2001). Zerbe and Bauman (2005) stated that the (KH) criterion is an acceptable standard for benefit-cost analysis, but subjected to criticisms. Just like any other theory, it was criticized for not considering equity and moral sentiments. Therefore the modern version of KH has been put in place with the assumption of equal marginal utility of income, a project is efficient if it passes the Potential compensation test (PCT), and gains are measured by WTP and loses by WTA. This therefore brings us to theory of WTP/WTA. WTP/WTA comes to play because charges are imposed on studded tires in the city and this will involve how the society is willing to move with the policy.
WTP and WTA Theory
The WTP/WTA approaches measures how life is valuable by considering the amount that the society is prepared to pay or prepared to accept for a given government program so as to reduce risks to their lives. These approaches uses the stated or revealed preference to discover the value people place on reducing risk to life and reflects the value of intangible elements such as QoL, health and leisure. Even though the theory overcomes the theoretical difficulties of the human capital approach, it involves more empirical difficulties in measurement. Willingness to Pay and Willingness to accept could be calculated based on the compensation variation (CV) and Equivalent Variation (EV). The compensation variation refers to the amount of money that has to be given to or taken from the public to place them at their original level of utility (Zerber, 2001). This implies that the CV is the amount of money that makes the equality V (p, y – CV, z 1) = V (p, y, z 0) holds (5). Where V depicts the level of indirect utility, p is price, y is income, and z the state or level of the good, for example health or environmental quality before (0) and after (1) an improvement or deterioration. Therefore if the imposition of charges on studded tires leads to a change with improvement, the CV represents the maximum pay from the individual that will equally leave them as well off before the change. This is known as the WTP for the improvements. On the other hand, should the change be a deterioration the measure will therefore be the minimum pay made to the public to fully compensate for the change. This is known as the willingness to Accept for the change of that policy (Angelov, 2003).
Contrary is the Equivalent Variation V (p, y, Z 1) = V (p, y + EV, Z 0) (6).
This is the money that would be given or taken away from the consumer to give them equivalent utility of the proposed action (Zerber, nd). The EV proposes that the individual has a right in a change. If the change is an improvement, then the individual has to be compensated if the condition prevails but considering she cannot stay in the initial situation, they must pay to avoid deterioration (Angelov, 2003). This can also be applied in a different way.
Application in the Swedish settings
Now consider this as an example that we want to measure the welfare impact on a household if air quality is increase as a result of reduction in the use of studded tires due to charges? If the existing quality level of air service is given by Q0, and the price charge on car users for this is given by pW0, and the price of the other “composite” good is pZ0, then the improvement in air quality from Q0 to Q1 due to the imposition of a charges, with no concomitant price changes, produces a welfare gain of: CV = E (pW0, pZ0, Q0, U0) – E (pW0, pZ0, Q1, U0) > 0 (7).
Where CV is the compensating variation that provides the true measure of the welfare effect of the air quality improvement that is being evaluated, E (.) represents the consumer’s expenditure function, and U0 is the household’s initial level of welfare. It is also important to see into it that E (pW0, pZ0, Q0, U0) is simply the household’s initial income (Y0). Therefore CV is the amount of money that the consumer is willing to pay to see air quality improve from Q0 to Q1. Therefore, the maximum amount of utility (U0) is given by U0 = V (pW0, pZ0, Q0, Yo) with prices equals to pW0 and pZ0, quality Q0, and income y. Now the function [ƒ (.)] can now be re-written as a generic function as; CV = WTP = ƒ (pW0, pZ0, Q0, Q1, Y0) (8).
Sources and Method of Data Collection
Considering the fact that this study requires a combination of findings from different studies, a meta analysis is employed. Also, since a meta analysis is used, this means that articles are retrieved and reviewed systematically. Crombie and Davies (2009) suggested that “systematic review methodology is the bedrock of meta analysis and that it provides a balanced and impartial summary of the existing research which permits decisions on effectiveness to rely on relevant studies of adequate quality”. The reason for the choice of systematic review is because such review provides a quantitative estimate of net benefit aggregated over all the included studies. Articles for this study have being retrieved based on key words. Articles were retrieved from sources such as SWoPec, Orebro University Library data base, Google and Google Scholar. Majority of articles reviewed were mostly related to studies from the Swedish National Road and Transport Agency, Samhällsekonomiska principer och kalkylvärden för transportsektorn, meaning that the review has being on similar studies.
More than 40 papers were retrieved for this study. Once all these studies were identified, only empirical studies that relates to Economic evaluation for health and environmental economics passed the inclusion criteria and were included in the work and those that reviewed on CBA but not directly related to environment and health fell under the exclusion criteria. This is so because Economic evaluation methods can be applied in different field not necessarily related to the topic. Out of these 40 papers, I deliberately selected 25 of these articles not based on whether they are related to environmental economics but based on key words such as studded tires charging in Stockholm, Noise level and studded tires, congestion charges in Stockholm, travel distance during winter in Stockholm etc. which specifically relates directly to my subject matter under investigation. This means 15 of these articles were abandoned even though they related to health and environmental economics. These remaining articles were used in the analyzes.
Method of Decision Analysis
Decision for this study will be analyzed based on values from the present value for cost and benefits. If the PV(C) is greater than the PV (B) then the project will be sensible and the government should go ahead with the charge otherwise they should quit and resort to other methods of control. For the case of onetime costs, the present value annuity has being used.
Environmental Regulation Approaches: Incentive design
Incentives are the key between economics and better environmental policy. People have less incentive to protect the environment today when the social costs fall on others. For example, a producer chasing profit may not have the incentive to clean up its emission to the desired level of the society as well as vehicle owners may understand that using studded tires during summer periods causes high particle matters in the atmosphere but may not take the incentive to change their tires after winter because of their tight schedule or may not just consider it important. Therefore people willingness to protect the environment may be limited by certain contingencies which require public regulations to ensure that their private motives align with social objectives to protect the environment.
With this in mind, there are many regulative approaches to ensure that private incentives align with environmental goals. These include legal mandates and technological restrictions (e.g. air and water filtration and technology), cooperative institutions to share information between regulators, polluters and victims (e.g. voluntary agreements, coasean bargaining), and economic incentive mechanism to increase the cost of “environmental shirking” on environmental protection such Charges, subsidies, fees, tradable permits and taxes etc. (Hanley et al., 2007). Considering that we are dealing with charges, the focus will be on economic incentives which can be grouped into 3 categories namely; Price rationing (Pigovian tax), Liability rules and quantity rationing (tradable permits).
Price rationing: Emission and Ambient Charge
One method of environmental regulation is through an emission charging system. Pigovian taxes or fees are levied on the discharge of pollutants into air, water, or onto the soil or on the generation of noise. These taxes reduce the quantity or improve the quality of pollution by making polluters pay at least part of the cost of the harm they do to the environment. This will be possible if the regulator can actually measure the Marginal Social Cost that fall on the entire population, through which he could set the Pigovian tax accordingly. The regulator sets the tax t, equal to the level at which the marginal benefit equal the marginal control cost i.e. MB=MC=t. (Hanley et al., 2007).
However, due to asymmetric information such as moral hazards and adverse selection, these taxes are said to be inefficient. Thus to reduce the moral hazards problems, regulators can design a charge system based on the overall ambient concentration of a pollutant in a region. An ambient charge scheme which combines penalties and reward for exceeding or beating a particular level of total ambient concentration consisting of two parts; a per unit charge or subsidy based on the deviation from some ambient standard or a lump sum penalty for not achieving the standard ( Segerson, 1988). Adding to this, the regulator can also offer subsidies as an incentive to encourage pollution control. This can take the form of grants, loans and tax allowances.
Table of contents :
2.1 Present Value Annuity
2.2 Cost Benefit Analysis Theory
2.3 Kaldor /Hicks criterion
2.4 WTP/WTA theories
2.5 Application in the Swedish settings
3. LITERATURE REVIEW
4. RESEARCH METHODS
4.1 Approach of Study
4.2 Sources and Methods of Data Collection
4.3 Methods of Decision Analysis
4.4 Environmental Regulation Approaches
4.5 Identification of Costs and Benefits….
5. RESULTS (Quantifying Costs and Benefits)
5.1 Increased travel times
5.2 Increased Accident Risks
5.3 Cost of Information campaign
5.4 Buying of Non-studded tires
5.5 Maintenance Costs
5.6 Administrative Costs
5.7 The Initial Costs of Investment
5.8 Benefits: Decreased amounts of particles
5.9 Decreases in Noise
5.10 Decrease Road maintenance
5.11 Decrease Fuel Usage
5.12 Decrease Congestions
6. ANALYSIS OF RESULTS.
6.1 Discussion on Estimates
6.2 Decision, Sensitivity and Uncertainty analysis
6.3 Conclusion and area of further research