Use in Cost Benefit Analysis
It may be used in estimating the value of creating a highway system, schools, or forcing environmental protection, for example. All of these things require a cost-benefit analysis where policy makers measure the social marginal cost and the social marginal benefit for each project. Almost all new policies will not even be considered until after a cost-benefit analysis has been completed. The social discount rate can appear in both calculations either as future costs such as maintenance or as future benefits such as reduced pollution emissions.
Calculating the true social marginal cost can be a lot easier than measuring the social marginal benefit. Because of the uncertainty involved with calculating benefits, problems may arise. Should you put a dollar amount on time based on average wages, contingent valuations or revealed preferences? One of the big problems today is putting a value on a life. While some might say that a life is priceless, economists usually state the value to be somewhere between three to ten million dollars. Another problem is that often the current generation will be paying for most of the costs while future generations will be reaping most of the benefit. Should we weight current and future benefits differently?
The proper discount rate should represent the opportunity cost of what else the firm could accomplish with those same funds. If that means that the money could be instead used to invest in the private sector that would yield 5% and that is the next best alternative for using that money then 5% would be the social discount rate. The government uses a variety of discount rates but something around seven percent is what the U.S. Office of Management and Budget (OMB) recommends for a pretax rate of return on private investments.
Read more about this topic: Social Discount Rate
Famous quotes containing the words cost, benefit and/or analysis:
“To call a posit a posit is not to patronize it. A posit can be unavoidable except at the cost of other no less artificial expedients. Everything to which we concede existence is a posit from the standpoint of a description of the theory-building process, and simultaneously real from the standpoint of the theory that is being built.”
—Willard Van Orman Quine (b. 1908)
“Your children get a lot of good stuff out of your work...They benefit from the tales you tell over dinner. They learn from the things you explain to them about what you do. They brag about you at school. They learn that work is interesting, that it has dignity, that it is necessary and pleasing, and that it is a perfectly natural thing for both mothers and fathers to do...Your work enriches your children more than it deprives them.”
—Louise Lague (20th century)
“Ask anyone committed to Marxist analysis how many angels on the head of a pin, and you will be asked in return to never mind the angels, tell me who controls the production of pins.”
—Joan Didion (b. 1934)