Acost-benefit analysis of a project or a change in government policy sums all the benefits resulting from the project or policy and subtracts all the associated costs. Doing this requires that the values of all these benefits and costs are measured in monetary terms. Although this is often difficult to accomplish in practice, in principle it would be relatively straightforward if the changes in consumer surplus and producer surplus resulting from a change in government policy, as well as the policy's effects on government revenues, could be determined. Under most circumstances, as indicated in Chapter 3, it is changes in these values that provide conceptually correct measures of the monetary value of a government policy's benefits and costs.

This chapter and the next illustrate how changes in consumer surplus, producer surplus, and net government revenues could be readily estimated if all the pertinent market demand and supply curves were known. This chapter focuses on demand and supply curves in primary markets, while Chapter 5 examines demand and supply curves in secondary markets. Primary markets refer to markets that are directly affected by a policy or project; for example, if a city builds a new subway system, the primary markets are the market for public transportation and the market for materials used to build the subway. Secondary markets are markets that are indirectly affected—for example, the market for gasoline if some commuters switch from driving to riding the new subway.

The chapter begins with a brief discussion of why real CBA studies often fail to use conceptually correct measures of benefits and costs and what the implications are of this. We then examine how the effects of government policies in primary markets can be valued. In doing so, we emphasize the concept of willingness to pay (WTP) and, thus, demand curves and consumer surplus. We next describe the valuation of resources purchased in primary markets as inputs for government projects, stressing the concept of opportunity costs and, hence, the use of supply curves and producer surplus. Throughout this chapter we ignore the marginal excess tax burden.

This chapter also provides brief explanations of common types of market failures including monopoly, externalities, information asymmetries, public goods, and addictive goods.