Economic Analysis March 2004 Maine Economic Principles
Economic Analysis
March 2004Maine
Economic Principles
Types of Economic Analysis
• With/Without• Benefit Cost Analysis• Cost Effective
Analysis• Partial Budget• Marginal Analysis• Enterprise Budgets• Net Worth Statement
Future With and Future Without
• Compare future with conservation to the future without it
• Benefits of conservation determined by the difference between with and with out
• Always have the effects of “do nothing” compared to effects with conservation installed
Benefit
Time
Yield
Benefit
Time
Yield
Sediment
Damage
Benefit Cost Analysis
• Total benefits compared to total costs – usually expressed as a ratio (such as $1.10 to $1)
• >$1/$1, GOOD!• <$1/$1, NOT AS GOOD• Used mostly for area-wide projects and
national programs• Required by law for certain programs
Benefit Cost Analyses of Conservation Programs
Economics of CRPEconomics of CRP
+Increased net farm income $2.1 to $6.3 billion
+Value of future timber $3.3 billion
+Preservation of soil productivity $0.6 to $1.7 billion
+Improved surface water quality $1.3 to $4.2 billion
+Reduced windblown dust $.3 to $.9 billion
+Enhanced small game hunting$1.9 to $3.1 billion
$9.5 to $19.5 billion
-Higher food cost to consumers $2.9 to $7.8 billion
-Veg. Cover establishment $2.4 billion
-USDA tech. Asst. $.1 billion
$5.4 to $10.3 billion
Net Value = $4.1 to $9.2 billion
Source: Osborn and Konyar (1990)
+Increased net farm income $2.1 to $6.3 billion
+Value of future timber $3.3 billion
+Preservation of soil productivity $0.6 to $1.7 billion
+Improved surface water quality $1.3 to $4.2 billion
+Reduced windblown dust $.3 to $.9 billion
+Enhanced small game hunting$1.9 to $3.1 billion
$9.5 to $19.5 billion
-Higher food cost to consumers $2.9 to $7.8 billion
-Veg. Cover establishment $2.4 billion
-USDA tech. Asst. $.1 billion
$5.4 to $10.3 billion
Net Value = $4.1 to $9.2 billion
Source: Osborn and Konyar (1990)
National benefits/costs
Kenduskeag Watershed Project Economic Benefits
Type of Economic Benefit Average Annual $
Increased fishing opportunities $71,050
Recreation $62,700
Maintaining yields $18,510
Yield improvements $48,450
More efficient fertilizer use $17,730
More efficient pasture mgmt. $69,300
Total Benefits $287,740
Total Costs $270,040
Benefit – Cost Ratio $1.07
Adapted from Watershed Plan – EA, Kenduskeag Stream Watershed, November, 1988
Monetary vs. Non-Monetary Benefits
• Market goodsMarket goods
lumber, grain, cars, pencils, etc.
• Non-market goodsNon-market goods
clean water, scenic farmland, wetland functions/values, wildlife
Non-monetary Benefits
How to put a $ value on goods/services not traded in the market?
• Contingent valuation
• Travel cost method
• Hedonic Studies
?
Environmental QualityPollution Level
Property Price ($)
Hedonic Studies
Maine Lakes
• willingness of users to pay for water quality: $2 to $6 million per year
• >200,000 Mainers spend ~$100 million per year in recreation associated with lakes
• 1 meter reduction in summertime water clarity: 3 - 5% reduction in lakefront property value
Source: 2000 National Water Quality Inventory Report, EPA, p. 64. www.epa.gov/305b
Cost Effectiveness
• A tool to measure the effectiveness of a practice or plan relative to its cost
• Used to obtain a set objective at the least cost, OR
• To obtain the best results at a set cost
Cost Effectiveness
• Best Buy• What is the better
deal when comparing the amount of physical effects and the cost to get it
• 1 fish per 50 mile trip or 3 fish per 100 mile trip???
Two hypothetical questions that cost-effectiveness would try to answer:
• If we have $1 million, how can we get the most conservation possible?
Constant cost
• If we want to reduce pollution by 40 percent, what is the cheapest way to do that?
Constant effects
Cost-effectiveness (cont.)
• Costs are associated with a particular unit reduction or increase (the effect)
Lbs of N prevented from reaching streamsTons of soil savedAcres of habitat createdNumber of life-years savedDucks made happy (?)
C-E Example 1: Constant Effects
Plan A B C D
Cost ($/year) 50,000 12,000 10,000 30,000
Effect (T/A/Y saved)
10 10 10 10
Ratio ($/T/A/Y)
5,000 1,200 1,000 3,000
C-E Example 2: Constant Cost
Plan A B C D
Cost ($/year) 50,000 50,000 50,000 50,000
Effect (T/A/Y saved)
10 8 15 3
Ratio ($/T/A/Y)
5,000 6,250 3,333 16,667
C-E Example 3: Costs & Effects Vary
Plan A B C D
Cost ($/year) 50,000 20,000 90,000 6,000
Effect (T/A/Y saved)
10 8 15 3
Ratio ($/T/A/Y)
5,000 2,500 6,000 2,000
Cost-effectiveness in Ranking Systems
0
50
100
150
200
250
300
$0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000
Costs
Po
ints
E
HG
B
F
CJ
I
K
D
L
AM
Partial Budgeting
• A planning and decision-making framework used to compare the costs and benefits of alternatives faced by a farm business.
Partial Budgeting
• Systematically displays the positive and negative effects of a change
• Only those factors that change are considered
• Useful tool for analyzing almost anyany type of change
Situations where a farm might use partial budgets
• Substituting one crop for another
• Adding a few head to a livestock enterprise
• Taking advantage of an early payment discount on a fertilizer bill
• Adopting a new production practice
• Participating in a government program
Partial Budget Elements
Added Income
+ Reduced Costs
______________
Total Positive Effects
Added Costs
+ Reduced Income
_______________
Total Negative Effects
Partial BudgetPositive Effects
(+)Negative Effects
(-)Reduced Costs Increased Costs
Increased Income Reduced Income
1. ____________________________
2. ____________________________
3. ____________________________
1. ____________________________
2. ____________________________
3. ____________________________
1. ____________________________
2. ____________________________
3. ____________________________
1. ____________________________
2. ____________________________
3. ____________________________
Total + ________ Total - ________
Positive Effects (+) Negative Effects (-)
Additional income Reduced income
+ CREP rental rate ($60/ac x 8 ac x 15 yr) 7,200$ - Pasture income ($35/ac x 8 ac x 15 yr) 4,200$
+ Bonus rate (70% of rental rate) 5,040$
Cost-share (100%)
+ trees 4,600$
+ fence 6,970$
+ spring development and trough 3,000$
Total 26,810$ Total 4,200$
Reduced costs Increased costs
+ Streambank stabilized ? -Tree establishment and maintenance ($575/ac x 8 ac) 4,600$
+ Improved herd health ? -Fencing ($2/foot x 3,485 feet stream length) 6,970$
- Spring development and trough 3,000$
-Potential tree harvest income from 1st 50 feet foregone ?
- Potential development value foregone ?
Total Total 14,570$
Net change in income (sum of all totals): 8,040$
Item Current System
Clear forest, till additional
land
Shorten system
Move and shorten system
Irrigated acres 62 73 50 55
Crop income $7,440 $8,760 $6,000 $6,600
Reduced income -- -- $370 $216
Land clearing -- $257 -- --
Mitigation -- $206 -- --
Move & shorten -- -- -- $515
Fuel $1,122 $1,122 $1,122 $1,122
Labor & Maintenance
$3,720 $2,920 $2,000 $2,200
Insurance $868 $868 $868 $868
Net Income $1,730 $3,386 $1,640 $1,679
Change from current system
-- $1,657 -$90 -$51
Marginal Analysis
• Think at the margin - we look at the last increment
• Trying to find the most economical input level
• Marginal Benefit equal to or greater than Marginal Cost
• Common sense to have the income or value of the product greater than the cost
PRODUCTION FUNCTION
0
2,000
4,000
6,000
8,000
10,000
1 2 3 4 5 6 7 8
Fertilizer (100 lb)
Hay
Yie
ld (
lbs)
Fertilizer is $11 for 100 poundsHay is worth $60 per ton
Fertilizer (lbs)
Hay yield (lbs)Marginal Cost
(MC)
Marginal Product
Marginal Value
Product (MVP)
0 1950 none none none100 4875 11.00$ 2925 $87.75200 7150 11.00$ 2275 $68.25300 8450 11.00$ 1300 $39.00400 9100 11.00$ 650 $19.50500 9425 11.00$ 325 $9.75600 9620 11.00$ 195 $5.85700 9620 11.00$ 0 $0.00800 9490 11.00$ -130 -$3.90
Marginal Analysis
WHERE DO WE WANT TO BE?WHERE MVP >=MC