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Glossary

Cost-Benefit Analysis

Summary: The cost-benefit analysis is an economic tool for evaluating investments, projects, or policy measures. It involves comparing costs and benefits and expressing them in monetary terms to enable comparability. The goal is to use resources efficiently and to create an optimal basis for decision-making. However, the cost-benefit analysis is not without criticism, as it relies on monetary evaluations and thus cannot consider all factors.

Introduction

The cost-benefit analysis (CBA) is a method for assessing and prioritizing investments, projects, or policy measures. It is widely used in economics, particularly in finance and investment theory, and in the public sector. The CBA aids in judging and optimizing the efficiency of resource allocations by comparing the monetary costs and benefits of different alternatives.

Objectives and Application Areas

The objective of cost-benefit analysis is to create a well-founded basis for decision-making regarding investments or measures. It helps to use resources as efficiently as possible and to verify the economic rationality of decisions. The CBA can be applied in various areas, such as:

  • Investment decisions in companies
  • Evaluation of infrastructure projects
  • Environmental policy and conservation measures
  • Healthcare
  • Education policy
  • Development aid

Procedures and Methodology

The cost-benefit analysis consists of several steps:

  1. Definition of the subject under investigation: First, the project or measure to be evaluated is clearly defined and delineated.
  2. Identification of alternatives: Possible alternatives to the planned project or measure are determined in order to weigh different options against each other.
  3. Recording of monetary costs: The costs of the different alternatives are identified and expressed in monetary values. This includes, for example, capital costs, operating costs, or maintenance costs.
  4. Recording of monetary benefits: The benefits of the different alternatives are also expressed in monetary values. This can include, for example, expected returns, cost savings, or the value of environmental improvements.
  5. Comparison of costs and benefits: The monetary costs and benefits of the different alternatives are compared to create a ranking of the options. The timing of costs and benefits, as well as the discount factor, are also considered.
  6. Decision and implementation: Based on the results of the cost-benefit analysis, a decision is made and the selected alternative is implemented.

Criticism and Limitations of Cost-Benefit Analysis

Although cost-benefit analysis is an important tool for decision-making, there is also criticism and limitations of this method:

  • Monetary valuation: The CBA relies on the monetary valuation of costs and benefits to enable comparability. However, this can be problematic when it comes to non-monetary factors, such as quality of life, social justice, or environmental impacts.
  • Uncertainty and forecasting errors: The CBA is based on estimates and forecasts of costs and benefits, which are subject to uncertainties and possible errors. This can lead to distortions and wrong decisions.
  • Ethical aspects: The CBA can run into ethical difficulties when it comes to expressing the value of human life, health, or environmental protection in monetary terms.
  • Distribution effects: The CBA generally does not consider the distribution effects of investments or measures on different population groups or regions. This can lead to undesirable social or regional inequalities.

Despite these criticisms, the cost-benefit analysis is a useful tool for evaluating and decision-making in investments and policy measures. However, it should always be considered in the context of the specific situation and taking into account possible limitations and criticisms.