Microeconomic theory provides the basic technical foundations for CBA. This chapter begins with a review of the major concepts of microeconomic theory as they apply to the measurement of social costs and benefits. Most of these concepts should be at least somewhat familiar from your previous exposure to economics. After that we move to welfare economics, which concerns the normative evaluation of markets and of policies. We explain how to use microeconomic theory to assess benefits, costs, and net social benefits in CBA.

For purposes of simplicity, we assume the presence of perfect competition throughout this chapter. Specifically, we assume that there are so many buyers and sellers in the market that no one can individually affect prices, that buyers and sellers can easily enter and exit the market, that the goods sold are homogeneous (i. e., identical), that there is an absence of transaction costs, that information is perfect, and that private costs and benefits are identical to social costs and benefits (i. e., there are no externalities). Chapter 4 considers how to measure benefits and costs when some of these assumptions do not hold; that is, various forms of market failure are present.