The theory of cost-benefit analysis

Abstract

The use of cost-benefit analysis (CBA) for investment appraisal at the public sector level is on the increase. The practitioners of the technique attempt to evaluate the social impacts of alternative proposals by quantifying their costs and benefits, and thereby supplying decision makers with information on the total implications of resource allocation options. The last two decades have seen rapid increase in use of the approach. Although the neoclassical theory of welfare economics on which CBA relies evolved in the nineteenth century, its practical application to questions of resource allocation only began in the early 1950's with the publication of the well known "Green Book" in the United States. Economists such as McKean, Krutilla and Ecstein were the first to formalise the basis for CBA, and since then its use has become very widespread. One of the major reasons for this growth is the requirement by most International Lending Agencies for loan applications to be accompanied by an economic evaluation, and it has been this pressure which has stimulated major developments with the technique in application to investment decisions in less developed countries.