Cost-Benefit Analysis

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Definition of a Cost-Benefit Analysis:

A cost-benefit analysis is the comparison of the costs and benefits of a project used to determine its economic usefulness.

Detailed Explanation:

Have you ever made a list of the costs and benefits when making a difficult personal decision? In one column you may list all the costs and in the other all the benefits, including intangible costs and benefits. For example, in choosing which college to attend a student may consider proximity to home, climate, the appeal of the campus, in addition to monetary values such as tuition, or the size of a scholarship. This is a cost-benefit analysis. It is a common method used to evaluate an economic or personal decision.

Opportunity costs and trade-offs can be useful in measuring the costs and benefits of any decision you make. For example, what are some of the trade-offs in choosing to study an extra two hours this evening? Perhaps you will forgo going to the movies with friends, watching your favorite TV show, chatting with a good friend, or making some money at a job. Each of these is a trade-off. There are costs and benefits for each choice.

Businesses and governments use cost-benefit analysis when making decisions. Many local and national governments are currently facing huge deficits, meaning their expenditures are greater than their income in tax revenues. The government must weigh the costs and benefits of policy decisions. For example, in 2012 the government of Pittsburgh planned to cut 35% of the city bus service because the service was not supporting itself. This decision caused companies to reconsider expanding because some employers were concerned employees would quit their job rather than face the difficulty of getting to work.

The costs of terminating several bus service routes included: possible public outrage, decreased access for poor residents to jobs and medical facilities, higher unemployment if residents were forced to quit jobs and layoffs of public employees. Increased traffic and pollution may have resulted if residents were forced to drive themselves. The benefits included: lower deficits, the potential to lower taxes, and business growth from the increased spending resulting from lower taxes. Businesses serving automobiles such as gas stations, mechanics, and car dealerships may have benefited from increased driving. 

When the total value of the benefits exceeds the total costs, the project should be completed.

Dig Deeper With These Free Lessons:

Opportunity Cost – The Cost of Every Decision
Production Possibility Frontier
Fundamental Economic Assumptions
Marginal Analysis – How Decisions Are Made