Reference no: EM13884310

Case 1: Benefit-Cost Analysis of Honda Civic Hybrid Sedan

BACKGROUND

In 2003, Honda released the first hybrid version of its popular Honda Civic. Since then, many states and the U.S. federal government have applied incentives to encourage individuals to purchase hybrid vehicles. The 2005 Energy Policy Act granted individuals who purchased new hybrid vehicles a tax credit, which depends on the fuel economy of the model (miles per gallon, or mpg). This tax credit expired December 31, 2009. But there have been calls in Congress to renew it. Many states also offer their own incentives programs.

Is subsidizing hybrids a wise use of public resources? This is the question this case is designed to answer. To answer this question, there are two related issues to consider.

First, taking into account society's perspective, the question to consider is whether the additional (incremental) benefits of driving a hybrid are greater than the additional (incremental) costs, compared to the non-hybrid model. Fundamentally, this question boils down to whether the value of the fuel savings from driving the hybrid are larger than the increased technology cost of the hybrid. The value of fuel savings includes the value of conserving a scarce resource - energy-- but also the value of avoiding the social costs associated with energy usage, such as CO2 emissions, local air pollution, and the risks to national security associated with importing oil. Consumers deciding whether to buy hybrids are aware of the fuel savings benefits that they will realize if they buy and drive hybrids, and will considerthe expected value of these fuel savings in their purchase decision. However, the consumer's computation of fuel savings benefits will differ from the societal perspective, because the fuel prices consumers face are distorted by fuel taxes. So the "price signals" consumers face about the value of fuel savings are likely to differ from the shadow price of fuel savings measured from a societal perspective. And of course, consumers are not fully aware of the value of the reduced global warming risks, benefits to reducing local air pollution, or reducing national security risks, because these benefits are diffuse and distributed to everyone. Thus, consumers will not fully consider these benefits in their private purchase decision.

The increased technology costs are in the form of the additional costs for the hybrid drive train, which adds to the conventional system: (1) an electric motor (2) a large capacity battery and (3) the power electronics that link these components together. The price consumers pay for Honda civic hybrid will actually be higher than these costs, because there is 7% sales tax imposed on the purchase of hybrids. The societal analysis will "shadow price" the technology cost of producing Honda civic hybrids as the price consumer's pay less the sales tax.

As always, the net-value from a societal perspective can be obtained in two equally good ways. First, by summing the net effect of driving a hybrid on all of the "stakeholders." If the net-effects are positive, the project passes the Kaldor-Hicks standard.

The stakeholders in this situation can be aggregated to the following four groups:

(1) The hybrid user;

(2) State governments, who receive additional sales tax revenue from higher hybrid sales prices, but also lose fuel tax revenue from improved hybrid fuel economy;

(3) The federal government, which loses fuel tax revenue;

(4) "the public" who gains the "societal" or external benefits of hybrid use; that is, the reduced air pollution, carbon dioxide emissions, and the value of reduced oil imports.

Summing the net effects on (1)-(4) will give the same result as directly comparing the shadow-priced value of the fuel savings against the costs - the second method for determining economic efficiency.

The complete picture is shown in Table 1. Summing the net-stakeholder effects in the bottom row of the tableau produces the societal net benefit in the rightmost bottom cell, B1+B2-C1. This is the after-tax value of fuel savings plus environmental benefits less the technology costs. You can see the same result just by comparing the benefits against the cost in the right most column of the tableau.

Note that the column for the "Buyer of the Honda Civic" shows the private perspective from the purchase of the Honda Hybrid. This column represents the financial returns and losses to the buyer of a Honda hybrid. Comparing this column to the right-most column of the tableau allows you to see how the private buyer perspective differs from the societal perspective. As mentioned above, there are two differences between these perspectives. First, there is the added benefits to society of avoided pollution and other external costs of fuel use, which the private user themselves donot experience, but society gains (B2). Hence, the private buyer doesn't take into account this external benefit when they purchase the hybrid. Secondly, part of the hybrid buyer's financial gain in avoiding fuel expenses is not a net gain from the societal perspective. That's because fuel tax savings of the hybrid driver (T2+T3) are lost to governments, i.e., to states(-T2) and the federal government(-T3). In short, what is the buyers' gain is another stakeholders loss, so, as financial transfers, these effects cancel to zero from a societal perspective.

Similarly, the additional financial loss to the buyer of paying a sales tax on hybrids (-T1) is not a net-societal loss, because another stakeholder -the state in this case, collects the sales tax (T1). Again, the loss to one stakeholder is counterbalanced by the gain to another, so these gains and losses net to zero from the societal perspective.

The first task then, is to complete Table 1 with actual values, and to see if B1+B2-C1 in the far right-hand corner is positive or negative.

If it is negative, it does not make sense for the government to promote hybrid usage, if the Kaldor-Hicks standard (Potential Pareto Criteria) is the decision-making standard.

If it is positive, we then have to look at the "Buyer of the Honda Hybrid" net result. If it is privately profitable to buy hybrid Honda Civics without assistance, then the argument for providing subsidies is diminished - whatever the merits of driving hybrids. Why subsidize people to buy Honda hybrids if they are going to buy them anyway? If, however, private hybrid buyers are taking a financial loss and yet driving hybrids has positive societal benefits, then it makes sense to offer a subsidy to promote the socially desirable behavior. Note that such a subsidy is a pure financial transfer from the societal perspective - again to the hybrid driver, and a loss of equal amount to the government. So subsidizing hybrid users has no net effect from the societal perspective. But from an equity point of view, it wouldn't make sense to transfer tax payer money to hybrid drivers, if there wasn't some larger societal purpose to do so.

Note: As shown in Table 1 and discussed above, the computation of the buyer's financial effect should not include tax credits. It is necessary to compute the impact on the buyer without the tax credit, to see whether or not a tax credit is needed.

The impact on state and federal fuel tax collections is also policy relevant. States and the federal government rely on fuel tax receipts to fund transportation investments. Growing fuel economy could reduce overall tax receipts, and reduce funds for transportation infrastructure. "Erosion" of fuel tax revenue from greater fuel economy has worried some states enough to consider switching the tax base from fuel consumption to mileage. See the state of Oregon's experiments in this regard: https://www.terrapass.com/blog/posts/oregons-successful-mileage-tax-experiment

In short, it is of interest to compute the impact of hybrid driving on the receipts of state and federal tax revenues.

THE ASSIGNMENT

Your tasks are as follows:

(1) produce six tables like table 1 based on present value computations for the following scenarios;

Scenario 1: 10,000 miles per year driving, gasoline 2.50 per gal
Scenario 2: 10,000 miles per year driving, gasoline 3.50 per gal
Scenario 3: 10,000 miles per year driving, gasoline 4.50 per gal

Scenario 4: 20,000 miles per year driving, gasoline 2.50 per gal
Scenario 5: 20,000 miles per year driving, gasoline 3.50 per gal
Scenario 6: 20,000 miles per year driving, gasoline 4.50 per gal

(2) Write a no-longer-than4 page double-space memorandum (this page length EXCLUDES ANY TABLES YOU MIGHT INCLUDE)which describes the analysis, presents the results, and then makes a recommendation whether or not Congress should renew tax credits for hybrids. Your memo should be broken down explicitly into sections with bolded headers as follows:

GROUND RULES AND INSTRUCTIONS

(1) You are encouraged to form working groups and collaborate on the analysis.

(2) You must write up the memo yourself.

(3) To complete the assignment, post two things (under Assignment 2) on oncourse:

* your memo in Word, which should include the six tables as appendices;

* spreadsheet showing the six computed tables, with their backup computations. Again, link KHTs to source computations to facilitate computations of the different permutations (for miles/fuel price);

(4) Do the analysis from the end of 2011 perspective. Thus, for discounting purposes, period zero is 2011, period 1 is 2012, etc.Case 2: An Economic Evaluation of "Safer Choices"

Overview:

School programs to reduce unprotected sexual intercourse have been implemented across the United States, to reduce human immunodeficiency virus (HIV) infection, infection by other sexually transmitted diseases (STDs), and unintended pregnancy among US adolescents. Program evaluations have shown that such programs are effective in reducing unprotected sexual intercourse, substantially increasing condom use and other forms of contraceptive use among sexually active young people. Because resources to fund school-based HIV, other STDs, and pregnancy prevention programs are limited, however, program effectiveness is not sufficient to justify program implementation. Issues of practical concern to policy makers are financing (whether prevention programs are affordable) and whether the benefits of such programs exceed their costs.

Few economic studies of school programs have been conducted. Most studies of HIV prevention programs in particular have focused on those targeting intravenous drug users, adult urban women, and adult or adolescent gay and bisexual men. Moreover, few studies have assessed the reduction of STDs other than HIV, or have looked at the benefits and costs of preventingunintended teenage pregnancy. This case tries to get a better sense of the benefits and costs of a program to reduce the amount of unprotected sex, by monetizing the multiple benefits such programs can offer.

This topic is particularly policy relevant since sexually active people between the ages of 15 and 24 accounted for 50% of all new cases of sexually transmitted diseases in the United States. Researchers found about 18.9 million new STD cases occurred in 2000, for example, and 9.1 million of the cases, or roughly 50%, occurred among people between the ages of 15 and 24. This age group also accounts for the majority of unintended pregnancies, and a significant fraction of new HIV infections.

The Data and NPV Computations

Tables 1 and 2 give the basic economic data needed to compute probability distributions for the net present value of the "Safer Choices" program. The question to be answered is whether it is probable that the costs of the program are less than the expected benefits, and thus, whether such a program should be instituted widely by local school districts, assuming the financial resources are available to implement such a program. We will return to financing issues in the next section.

Costs include the usual inputs of time and materials needed to institute this kind of program. The benefits fall into the following categories:

• reduced medical costs for treating STDs

• reduced medical costs for dealing with unintended pregnancies

• increased work productivity from reducing the incidence of HIV infection

• Reduced medical costs associated with reducing the incidence of HIV infection. See Table 2 for the particular details.

Not included on this list is the quality-of-life improvement received by someone who otherwise would have contracted STDs, had an unintended pregnancy, or contracted HIV. Since it is hard to monetize the benefit "quality of life improvement," we leave it out of the quantitative assessment. However, such a benefit might affect your decision about recommending the program, even though it cannot be explicitly considered in the quantitative analysis.

Similarly, the "value of live" is not monetized in this study, for two reasons. First, the assumption that a person who now contracts HIV will live close to a normal life span, given dramatic improvements in the efficacy of antiretroviral drugs. In this particular case, we assume that life spans are 10 years shorter for the person who contracts HIV. Secondly, monetizing the value of life is a controversial issue in cost benefit analysis. But note that by not monetizing the value of life, the approach taken here, a downward bias is imparted to our estimate of the economic value of the program - that is, our estimate of the program's benefits will be conservative - because extending lifespans 10 years definitely has value. This issue can also be considered qualitatively in your assessment of the program.

Overall, the question is what is the probability that the net economic value of Safer Choices is positive, given the data in Tables 1 and 2? Given the information you have, can you recommend with reasonable confidence that Safer Choices provides positive net-benefits?