Cost Benefit analysis is done for the public investment projects. This is used to judge the desirability of public investment of any public products or investment. In this, we don’t analyze the money cost and money benefit; but real cost and real benefit. Here it is concerned with social benefit and social cost. Cost benefit analysis is done for the public products to analysis the social benefits from the public investments. Let us take up an example of construction of a subway.
In the above figure, on the X axis we measure the number of journeys made per week and on Y axis cost per journey. DD shows the demand curve for the journey on that route.
If OP1 is the cost per journey, two wheelers are ready to pay OD as price. So, the consumer surplus is P1AD. This is the situation before the construction of a subway. Now, when a public investment on subway is decided, then the cost benefit analysis is done to see whether this particular investment is beneficial to the society. After the construction of the subway the price of the cost per journey will come to OP2 and the number of journeys will increase to OQ2 which shows that the consumer surplus will increase after the construction of the subway. Before the construction of subway consumer surplus is P1AD and after the subway it will be P2CD. This shows that there is increase in consumer surplus that will be P1ACP2.
There are two parts of the increase in consumer surplus P2 CAP1
P2BAP – increase surplus is due to decrease in the price of cost per journey.
ABC – the increase in consumer surplus due to the increase in number of journeys on that route.
The cost saving segment is the main component to the consumer surplus.
