Cambridge International as and a level Economics Ebook

SELF-ASSESSMENT TASK 
6.3
Identify and explain whether each of the following 
involves a positive or a negative externality:
a
a next-door neighbour playing music loudly
b
a person being educated beyond the compulsory 
school leaving age
c
discarding a used battery in the road
d
smoking in a public place
e
a new, well-designed and pleasant public building
f
the use of pesticides in agricultural production.
Use of cost–benefit analysis in 
decision making
Cost–benefit analysis (CBA)
is a widely practised 
technique that is used to aid decision making, 
particularly in situations where a conventional 
financial appraisal would not be entirely appropriate. 
P
2
P
1
0
Price
Quantity
Q
2
S
2
S
1
Q
1
D
Figure 6.6
 
Overproduction caused by a negative externality
P
2
P
1
0
Price
Quantity
Q
1
D
1
D
2
S
Q
2
Figure 6.7
 
Underproduction caused by a positive externality
Cost–benefit analysis (CBA):
 
a method for assessing the 
desirability of a project taking into account the costs and 
benefits involved.
KEY TERM
137
Chapter 6: Basic economic ideas and resource allocation

---

It is used by the public sector, for example, in the case 
of public goods such as a road where no direct charge 
is made to users. In general terms, CBA takes a long 
view and a wide view in assessing whether a particular 
project should be progressed. Th
e long view stems from 
the nature of most public sector investment. Because 
of the large sums involved, a project like a new road or 
rail link is appraised over 30 to 50 years. Th
e wide view 
stems from the need to take into account the full social 
costs and social benefi ts. Th
is is because we are oft en 
concerned with situations where major economic projects 
produce substantial and oft en controversial side eff ects, 
in particular where there are externalities that fall upon 
people and communities who have no direct connection 
with the particular project.
Th
ere are many situations where CBA can be used to 
aid decision making. In all types of economy there are 
numerous examples of environmental pollution that result 
in external costs being imposed on the local community. 
Th
ese can be far-reaching and substantial. CBA genuinely 
attempts to quantify the opportunity cost to society of the 
various possible outcomes or sources of action.
CBA is also widely used in the appraisal of major 
transport projects such as London’s Crossrail
 
extension, 
High Speed 2 (HS2) (see below) and the Hong Kong–
Zhuhai–Macau Bridge in Asia. Where huge investment is 
needed, CBA can provide justifi cation based on taking an 
overarching wide view of a project’s impact on users of the 
facility and on the wider community and economy over a 
given period of time.
Th
e cost–benefi t approach diff ers from private sector 
methods of appraisal in two main respects: