Cost-benefit analysis is the most commonly employed method for the evaluation of public sector projects or programmes such as investment in dams or roads, labour market training, regulation of the private economy, and environmental programmes. The basic idea behind the approach is to measure in monetary units how social welfare is affected by a particular project. In fact, the evaluations of market failures in chapter 5 are examples of simple cost-benefit analysis. For example, in the case of the bridge considered in section 5.3, the social benefits of constructing the bridge would be equal to the area below the demand curve in figure 5.3. If these benefits exceed the costs of constructing and running the bridge, the project can be viewed as socially profitable. Similarly, a change from monopoly pricing to marginal cost pricing yields benefits in excess of the costs; the net gain is captured by area C + D in figure 5.2.

These examples highlight the difference between the private ‘utility’ or profitability of a project and its consequences as measured by a social costbenefit analysis. In the former case, attention is focused on the effects that are relevant to an individual or a firm. This means that for example externalities inflicted upon other individuals and/or firms are not accounted for. On the other hand, the aim of a social cost-benefit analysis is to locate and include all effects, regardless of whom in society is affected. The ultimate goal is to translate or express the unobservable change in social welfare to observable monetary units.