Extended benefit-cost analysis

It is the most important technique for project appraisal in the public sector. In classical microeconomic theory the market system leads to maximum efficiency. In practice, there are many market failures (externalities or spillover effects, absence of relevant property rights, monopoly power and taxation, for instance). None of these are generally taken into account in the production of or the demand for market products. The main technique for including these types of market failures is cost-benefit analysis. Since market-driven choices may lead to socially inferior outcomes, the cost-benefit analyst attempts to construct a set of "as if", or shadow prices; these represent the prices which, if they prevailed in the market, would lead enterprises and individuals to make economic choices that correspond to the optimal welfare of all. Cost-benefit analysis is the process of weighing the total expected costs vs. the total expected benefits of one or more actions in order to choose the best or most profitable option. Constructing plausible measures of the costs and benefits of specific actions is often very difficult. In practice, analysts try to estimate costs and benefits either by using survey methods or by drawing inferences from market behavior.