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UNIT-5
Shadow Pricing
Shadow prices reflect true values for factors and
products for the calculation or estimations of prices in social cost-benefit analysis. J. Tinbergen defines them, “Shadow prices are prices indicating the intrinsic or true value of a factor or product in the sense of equilibrium prices. These prices may be different for different time periods as well as geographically separate areas and various occupations (in the case of labour). They may deviate from market prices.”
General principles of Shadow
Pricing
Taxes
Consumer Willingness to Pay
Tradable inputs and outputs
Externalities
Shadow pricing of Taxes
If the project augments domestic production,
taxes should be excluded
If the project consumes existing fixed supply
of non-traded inputs, tax should be included
Shadow pricing of Consumer
Willingness to Pay(CWP)
What a consumer wants to spend for a
product or service
The difference between CWP and actual
Shadow pricing of Tradable
inputs and outputs
For a fully traded good, shadow price is border price
translated into the domestic currency at shadow foreign exchange
People may be affected by erosion and flood conditions
brought about by changes to the river which result from the construction activities of a bridge
Environmental pollution created by brick field
A project of planting trees for commercial purpose may
Shadow pricing of
Externalities
Although valuation of external affects is difficult as they
are often intangible in nature and there is no market price, shadow pricing of externalities may be made indirect
The harmful effect of bridge may be measured by the
consumer willingness to pay for the output of the people which has been reduced due to the bridge
The cost of pollution may be estimated in terms of the
Shadow pricing of Capital
Shadow price of physical assets is calculated
in the same manner in
which inputs and
outputs are calculated
Opportunity cost of capital (shadow price of
Social cost benefit analysis (SCBA)called Economic
analysis, is a methodology developed for evaluating
investment
projects from the point of view of the
society as a whole.
SCBA aids in evaluating individual projects within the
planning
framework
which
spells
out
national
economic
objectives
and
broad
allocation
of
resources to various sector. In other words , SCBA
is concerned with Tactical Decision making within
the framework of macro level.
Advantages
• The ability to identify the projects that maximize
the welfare of the country.
• The ability to objectively assess and quantify
the purpose projects in relation to community
needs.
• Exposure of the basis for decision-making for
projects and opportunity for public criticism.
Disadvantages
Difficulty in measuring social costs and benefits
and converting them in to monitory term.
Over statement of the value of social benefits
Complexity
Conflict between social welfare and financial
I.M.D Little and J.A Mirrlees have developed an
approach to social cost benefit analysis which
became popular as Little-mirrlees approach
(L-M approach).
There is a considerable similarity between the
UNIDO approach and L-M approach.
Issues in Little- Mirrlees Approach to SCBA
Numeraire:
L-M’s numeraire is “present uncommitted social income measured in terms of convertible foreign exchange of constant purchasing power”
L-M’s Shadow Price:
L-M’s approach measures costs and benefits in terms of international price as against UNIDO method that
measures costs and benefits in terms of domestic prices.
L-M Shadow Price for traded goods:
The shadow price of traded good/service is equal to its border because it represents the appropriate social
L-M Shadow Price for Non- Tradable Goods: Non tradables include goods like land, building and
services like power, internal transport etc. Shadow price for non-tradables is arrived at in terms of marginal social cost and marginal social benefit.
L-M Shadow Wage Rate:
It is an important but difficult to determine element in social cost benefit analysis. It is a function of several factors:
The marginal productivity of labour
The cost associated with urbanisation
The cost of having an additional amount committed to consumption
Accounting/ Average rate of return method
Differences between UNIDO approach
and L-M approach
1. UNIDO approach is limited to domestic boundaries (measures cost and benefits in terms of domestic rupees) where as, L-M approach considers international aspects also (measures cost and benefit in terms of international/border prices).
2. UNIDO approach measures cost and benefits in terms of consumption where as, the L-M approach measures cost and benefits in terms of uncommitted social income.
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Project implementation plan
includes:
The following methods may be used to
answer the above questions:
Gantt chart
Critical Path Method (CPM) or Net work
analysis
Project Evaluation and Review Techniques
(PERT)
