The Difficult Job of Cost-Benefit Analysis

So far we have seen that the government provides public goods because the private market on its own will not produce an efficient quantity. Yet deciding that the government must play a role is only the first step. The government must then determine what kinds of public goods to provide and in what quantities.

Suppose that the government is considering a public project such as building a new highway. To judge whether to build the highway it must compare the total benefit of all those who would use it to the costs of building and maintaining it. To make this decision the government might hire a team of economists and engineers to conduct a study called a cost-analysis the goal of which is to estimate the total costs and benefits of the project to society as a whole.

Costs-benefit analysis have a tough job. Because the highway will be available to everyone free of charge there is no price with which to judge the value of the highway. Simply asking people how much they would value the highway is not reliable. Quantifying benefits is difficult using the result from a questionnaire and respondents have little incentive to tell the truth. Those who would use the highway have an incentive to exaggerate the benefit they receive to get the highway built. Those who would be harmed by the highway have an incentive to exaggerate the costs to them to prevent the highway from being built.

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