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Cost-Benefit Analysis

Cost-benefit analysis (CBA) is a method of economic evaluation that estimates the costs and benefits of a project or investment over a period of time, in order to determine if the project or investment is profitable or beneficial. Cost-benefit analysis is important to the study of economics because it is a strong deciding factor whether or not a program, investment, funding, etc, should be implemented. It is used to determine how to allocate resources, whether to engage in trades, if public policies should be implemented, and if major infrastructural programs should be implemented. Following this principle, one should only go ahead with the action if the gains are greater than the costs.

Cost benefit analysis includes external variables in its analysis, as well as the private economic costs. This is because cost benefit analysis takes into account the social welfare effects of a decision, meaning that the social and environmental impacts of the decision are variables that are accounted for. Also, the effects of the decision in the future are looked at, known as discounting. Discounting is an important part of cost-benefit analysis because it determines what the present value of something now would be in the future. This means that discounting reflects future benefits and costs in present value.

Once the benefits and costs have been estimated, cost-benefit analysis is presented through net present value (NPV) and benefit-cost ratio (BCR). These are two measures that cost-benefit analysis uses to present the outcome. When a cost-benefit analysis has a positive net present value, then the benefits are greater than the costs. Benefit-cost ratio is simply the ratio of total benefits over total costs. It is important to remember that discounting is applied to both measures. Although cost-benefit analysis is advantageous because it accounts for multiple variables, factors such as inflation have to be properly accounted for.

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