The theory of cost-benefit analysis

Abstract

This chapter develops a general equilibrium model of the economy to study the theory of shadow prices and their application in cost-benefit analysis. Shadow prices are defined as the marginal effect on social welfare of a unit increase in the supply of a good from the public sector. The model accounts for the planner’s objectives and the constraints that circumscribe the choice of policy instruments. The key results obtained show that shadow prices generally differ from producer prices and that the desirability of aggregate production efficiency is not a general result. The chapter then examines the use of shadow prices for traded and non-traded goods, the shadow wage, and the discount rate. It also addresses the evaluation of private projects and the implications of using different numeraires. – AI-generated abstract.