Cost Benefit Analysis Related Ideas
Benefit Cost Ratio
B/C ratio is ratio of total benefits to total costs. Logic is usually to accept project if it is > 1 and reject if < 1 or adopt the alternative with highest ratio. SOMETIMES this gives same result as "maximize net benefits" but NOT ALWAYS.
Example
Imagine two options. One is to spend $1000 on advertising with expectation of $10,000 in benefits. The other is to spend 25,000 with expectation of $100,000 in benefit.
The first option gives you a better "bang for the buck rate" (i.e., benefit/cost ratio) but provides 90,000 less in benefits. If we don't have a resource/budget constraint it is the better choice .
Problems
- Can produce results that are contrary to the maximize net benefit principle.
- Sensitive to how costs and benefits are tallied (see 146.6)
References
Stokey & Zeckhauser, p. 146