Below is a very good documentary on the construction of the largest dam in the world – the Three Gorges Dam in China. However in its construction there are both costs and benefits including private and external. This is a topic in Unit 1 of the CIE A2 Economics syllabus and is found under – Externalities. Remember that we have both positive and negative externalities of production and consumption.
THE DIFFERENCE BETWEEN PRIVATE AND SOCIAL COSTS
Externalities create a divergence between the private and social costs of production.
SOCIAL COST = PRIVATE COST + EXTERNAL COST (externality)
Private costs are the costs to a ‘firm of producing a good or service and to an individual of consuming a product.
External costs are the spill over effects on third parties.
Social costs are obtained by adding the private and external costs together. They reflect the total cost to society of an economic decision.
The same concept applies for Private and Social Benefits:
SOCIAL BENEFIT = PRIVATE BENEFIT + EXTERNAL BENEFIT (externality)
Benefits and Costs of building the Three Gorges Dam
The biggest benefit that is seen from the dam’s construction is that it produces renewable energy from hydro electricity. The Three Gorges Dam alone can provide China with 10% of its annual energy consumption. Increasing the proportion of hydroelectricity alternative to coal burning plants, will cut their emissions greatly which will help reduce the overall emissions all over the world – carbon emissions will be reduced 100 million tonnes compared to alternative coal generation.
In class recently I have been covering the cost-benefit analysis of running an event like the Olympics. Rio de Janeiro in 2016 had major short falls in funding and for a city with a lot of poverty one questioned their motive for hosting.
The 1976 games in Montreal was the start of the financial issues for host cities – the blowout of $1.5 billion was paid by city’s rate payers and it wasn’t until December 2006 that the final payment was made. The projected cost of $124 million was billions below the actual cost. The 1980 Olympics was held in Moscow under the communist system but in 1984 the first real commercial games in Los Angeles took place. Because of the cost overruns in Montreal there was little interest in hosting the games in 1984 and therefore Los Angeles were able to negotiate favourable terms with the International Olympic Committee (IOC). With a lot of the infrastructure already in place and an increase TV rights – $34.9m Montreal 1976 to $286.9m Los Angeles 1984 – the latter was the only city to make a profit from hosting the Olympics – $215 million. See chart below for initial budgets and actual costs from 1996 – 2016..
However the financial success of Los Angeles games encouraged more cities to apply to become hosts with the desire to demonstrate their progress on the world stage. These countries invested massive sums to create the necessary infrastructure. With all Olympics there are specialised facilities that are only used for the games itself and have limited use post-Olympics. Almost all the facilities used in the 2004 Athens Olympics are derelict and ultimately the debt incurred with hosting the games contributed to the financial crisis in Greece. This was a similar story with the Rio Olympics where stadiums and the athlete’s village were left unused and the government was unable to sell them to the private sector.
Did the Olympics benefit London 2012? The London Olympics which had a budget blow-out but did transform east London. From a rundown area into a community called East Village. The video from CNBC goes into more detail below:
With the end of a long first term (11 weeks) approaching I try to add a bit of humour to the classroom as generally people are tired and add to that the numerous disruptions to COVID. Later this year the football World Cup takes place in Qatar and I hark back to the last World Cup where we saw the same old tricks played by players to try and influence the decision of the referee.
France’s Lucas Hernandez admitted to flopping in France’s 2-1 win against Australia in an attempt to get Australian midfielder Mathew Leckie sent off.
Spanish defender Gerard Piqué accused Portugal’s captain Cristiano Ronaldo of exaggerating a fall to secure a penalty kick in their 3-3 nail-biter. Piqué said Ronaldo has a habit of “throwing himself to the ground.”
Neymar rolling around in what seemed to be excruciating pain when there was contact on his ankle and that was on the sideline. What would he have done if it was in the penalty area and Brazil were 0-1 down?
That being said it was hoped that the VAR system would start to see this sort of tactic removed from the ‘beautiful game’. Some of the techniques of faking an injury are below – HT to Kanchan Bandyopadhyay.
The Economist has looked at this area and I thought that I would delve a little deeper. There is no doubt that if you study the costs and benefits of faking an injury there are certain sports where it is perceived as quite worthwhile – i.e. the benefits outweigh the costs. Cost benefit analysis is part of Unit 3 of the AS Level course. What is cost-benefit analysis (CBA)?
Cost Benefit Analysis (CBA) refers to estimating the private and external benefits of an investment project – airport, rail link, road etc against the private and external costs. Once these costs/benefits are established a decision is made as to whether the project should go ahead.
CBA can be applied to any decision you make and below is a table outlining the cost and benefit of faking a peanalty or injury in particular sports. I see the benefit in soccer of diving in the box and being awarded a penalty outweigh the costs by a significant amount. Firstly, if the appeal for a penalty is turned down it is very unlikely that the referee will administer any punishment to the player faking a foul. In too many cases they are happy to let the game play on as they feel under so much pressure anyway for not awarding it. Whilst in ice-hockey a suspension of either 2 or 4 minutes has acted as a deterrent to those caught “embellishing”. I have put some values in the end column which will no doubt encourage a lot of discussion – remember Warren Gatland, the Welsh coach in the Rugby World Cup 2011, considered informing a player to fake an injury so there would be no pushing in the scrums. This was after their captain, Sam Warburton, was sent off early in semi-final against France.
However, with the perceived benefits of diving in soccer it does encourage players to even practice this activity. This reminded me of a great advertisement run by the Guardian Newspaper for the Euro 2004 Soccer Cup – see below
For more on Cost-Benefit Analysis view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Reading Michael Cameron’s blog this morning I was intrigued to read that New Zealand’s Transport Minister Michael Wood did not provide the cost-benefit data when he announced the new $785m Auckland harbour cycle bridge earlier this month. However it has now been revealed the initial assessment by Waka Kotahi is only 0.4 to 0.6. That meant for every dollar spent on the bridge, there would effectively be a 40 to 60 cent loss. If a project is less than 1.0, the project’s costs outweigh the benefits, and it should not be considered.
You wonder about the rationale for this amount of expenditure when there is an opportunity cost – money that could be spent on the areas that seemed to be constantly deprived of government funds e.g. Health (especially with the vaccine rollout), Education etc.
Evaluation of Cost-Benefit Analysis It is clearly more efficient for public spending to be subject to rigorous analysis, rather than based on the whims of politicians. However, there are a number of criticisms of CBA when projects are given the green light
1. It is often very costly to undertake, though usually this forms a very small proportion of total project spending. 2. Assessing the monetary value of external costs and benefits is often very difficult. What precisely is the value of the congestion that would be reduced if a new bi-pass were built around a busy town? How much extra tourist revenue will actually be gained from a new airport? How long will the building be used as a venue, as in the case of the Viaduct area in Auckland for the 2020/21 America’s Cup. One solution to this problem is shadow pricing, where analysts attempt to place a value on the costs and benefits of a decision or a project where an actual market price does not exist. 3. Changing circumstances can make initial projections appear grossly inaccurate. The Wembley Stadium project in London went considerably over-budget, and the majority Olympic Games are far more costly than originally estimated. For instance the Montreal Olympics in 1976 was eventually paid off in December 2006. Higher interest and inflation rates, and falling exchange rates can all dramatically affect costs. 4. Actual costs can also rise above planned costs as a result of moral hazard, where project managers go over budget because they expect that those who fund the project will make extra funds available, providing an insurance against their over-spending. 5. Ultimately, decisions to go ahead with projects are only guided by CBA, leaving politicians to make the final decision. Politicians are free, of course, to ignore the results of an appraisal. It looks like they have with the cycle bridge.
I was fortunate enough to be out in the spectator fleet for yesterday’s America’s Cup racing between Emirates Team New Zealand and Luna Rosa Prada Pirelli – honours were even in the two races. As with most events, analysts attempt to work out the multiplier effect and the impact it will have on an economy. In 2017 forecast, predicted that the America’s Cup would add between $600 million and $1 billion to the New Zealand economy. Employment would be boosted and in the longer term for every $1 put into infrastructure would generate $7.50 of economic activity. However with the impact of COVID-19, New Zealand will suffer a loss on the $249.5 million it invested in the America’s Cup, but there maybe benefits over time.
The Multiplier Explained
Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.
The value of the multiplier can be found by the equation 1 ÷ (1-MPC) You can also use the following formula which represents a four sector economy 1 ÷ MPS+MRT+MPM
Source: CIE Revision Guide by Susan Grant
The economic impact is based a lot on the multiplier effect but the use of cost benefit analysis also considers those external costs and benefits which are not easily convertible into a monetary value.
Evaluation of CBA It is clearly more efficient for public spending to be subject to rigorous analysis, rather than based on the whims of politicians. However, there are a number of criticisms of CBA, including:
1. It is often very costly to undertake, though usually this forms a very small proportion of total project spending. 2. Assessing the monetary value of external costs and benefits is often very difficult. What precisely is the value of the congestion that would be reduced if a new bi-pass were built around a busy town? How much extra tourist revenue will actually be gained from a new airport? How long will the building be used as a venue, as in the case of the Viaduct area in Auckland for the 2020/21 America’s Cup. One solution to this problem is shadow pricing, where analysts attempt to place a value on the costs and benefits of a decision or a project where an actual market price does not exist. 3. Changing circumstances can make initial projections appear grossly inaccurate. The Wembley Stadium project in London went considerably over-budget, and the majority Olympic Games are far more costly than originally estimated. For instance the Montreal Olympics in 1976 was eventually paid off in December 2006. Higher interest and inflation rates, and falling exchange rates can all dramatically affect costs. 4. Actual costs can also rise above planned costs as a result of moral hazard, where project managers go over budget because they expect that those who fund the project will make extra funds available, providing an insurance against their over-spending. 5. Ultimately, decisions to go ahead with projects are only guided by CBA, leaving politicians to make the final decision. Politicians are free, of course, to ignore the results of an appraisal.
If you have read the book Circus Maximus you will no doubt be aware that most big sporting events run over budget and in some cases don’t generate the benefits until well after the event if at all. So just because an event runs over budget is that enough to say that we shouldn’t go ahead with the event. There are a great many other benefits of hosting an event like the Americas Cup which are not measured by GDP. The sense of community and wellbeing that comes from New Zealander’s performance whether it be in rugby or at the Olympics. It tends to bring people together feel a sense of belonging which has external benefits.
A HT to former A2 economics student Shelale Mazari for this piece on efficiency and ants. According to some research, they weigh up the costs and benefits and build bridges using their bodies to allow their fellow ants to forage for food. When it becomes inefficient for them to continue doing so – i.e. when there are not enough foragers – they withdraw. And apparently, they do all this without a lead ant.
Army ants (Eciton) form collective assemblages out of their own bodies to perform a variety of functions that benefit the entire colony. Field experiments show that the ants continuously modify their bridges, such that these structures lengthen, widen, and change position in response to traffic levels and environmental geometry. Ants initiate bridges where their path deviates from their incoming direction and move the bridges over time to create shortcuts over large gaps. The final position of the structure depended on the intensity of the traffic and the extent of path deviation and was influenced by a cost–benefit trade-off at the colony level, where the benefit of increased foraging trail efficiency was balanced by the cost of removing workers from the foraging pool to form the structure. To examine this trade-off, we quantified the geometric relationship between costs and benefits revealed by our experiments. We then constructed a model to determine the bridge location that maximized foraging rate, which qualitatively matched the observed movement of bridges. Our results highlight how animal self-assemblages can be dynamically modified in response to a group-level cost–benefit trade-off, without any individual unit’s having information on global benefits or costs.
The Economist looked at this area and I thought that I would delve a little deeper. There is no doubt that if you study the costs and benefits of faking an injury there are certain sports where it is percieved as quite worthwhile – i.e. the benefits outweigh the costs. Cost benefit analysis is part of Unit 3 of the AS Level course. What is cost-benefit analysis (CBA)?
Cost Benefit Analysis (CBA) refers to estimating the private and external benefits of an investment project – airport, rail link, road etc against the private and external costs. Once these costs/benefits are established a decision is made as to whether the project should go ahead.
CBA can be applied to any decision you make and below is a table outlining the cost and benefit of faking a penalty or injury in particular sports. I see the benefit in soccer of diving in the box and being awarded a penalty outweigh the costs by a significant amount. Firstly, if the appeal for a penalty is turned down it is very unlikely that the referee will administer any punishment to the player faking a foul. In too many cases they are happy to let the game play on as they feel under so much pressure anyway for not awarding it. Whilst in ice-hockey a suspension of either 2 or 4 minutes has acted as a deterrent to those caught “embellishing”. I have put some values in the end column which will no doubt encourage a lot of discussion – remember Warren Gatland, the Welsh coach in the Rugby World Cup, considered informing a player to fake an injury so there would be no pushing in the scrums. This was after their captain, Sam Warburton , was sent off early in semi-final against France.
However, with the perceived benefits of diving in soccer it does encourage players to even practice this activity. This reminded me of a great advertisement run by the Guardian Newspaper for the Euro 2004 Soccer Championship – see below
Here is another clip from Mr Clifford. Good for teaching scarcity, choices, self-interest, incentives, cost/benefit analysis, voluntary exchange, and economics systems. I particularly like the supply and demand graph at the start.
From The Economics of Seinfeld website. Useful look at externalities and cost-benefit analysis.
A Kenny Rogers Roaster restaurant opens across the street from Kramer. He can’t stand the red glare from Kenny’s neon sign, and moves into Jerry’s apartment. But he becomes hooked on Kenny’s chicken, and eventually accepts the red glare in exchange for access to the chicken. When Kenny’s shuts down, the lights go out, and Kramer’s overall welfare falls—the benefits of the chicken outweighed the cost of the glare.
Last week I attended a PD for Teachers hosted by the University of Waikato Economics Department. Amongst the presentations was one on Developments in Environmental Policy. Questions were asked as to what is the Economic Way of Thinking about Pollution:
* What is the ‘efficient’ level of pollution?
* Rarely zero – choices have to be made* How should we get there?
* How can this be achieved at least cost?
* Who should bear the cost?
One particular example that was presented was the “Nutrient emissions reduction scenarios in the North Sea”. Ultimately for economists it is a cost benefit analysis with – Marginal Abatement Costs v Marginal Damage Costs (See graph below).
Theoretical representation of different management positions based on economic considerations and different interpretations of the precautionary principle (assuming that all cost can be expressed in monetary terms). Marginal abatement costs (ranging between AC1 and AC2) and marginal damage costs to the environment (ranging between DC1 and DC2) are shown
The letters on the horizontal axis represent the following:
A = Strict Precautionary Principle (As near as possible to pristine condition)
B = Precautionary Principle implemented through the best available technology
B – C = Safety Margin
C – E = Risk threshold zone of uncertainty
D = Implementation of the best available technology not entailed excessive costs for society
F – G = Economic Optimal zone
H = Implementation of the best available technology not entailing excessive private costs
ECONFIX 