January 30, 2011

Behavioral Economics and the Conduct of Benefit-Cost Analysis: Towards Principles and Standards

by James K. Hammitt and Lisa A. Robinson

- As traditionally conducted, benefit-cost analysis is rooted in neoclassical welfare economics, which assumes that individuals act rationally and are primarily motivated by self-interest, making decisions that maximize their own well-being. Its conduct is now evolving to reflect recent work in behavioral economics, which integrates psychological aspects of decisionmaking. We consider several implications for analyses of social programs. First, benefit-cost analysis often involves valuing nonmarket outcomes such as reductions in health and environmental risks. Behavioral research emphasizes the need to recognize that these values are affected by psychological as well as physical attributes. Second, benefit-cost analysis traditionally uses exponential discounting to reflect time preferences, while behavioral research suggests that individuals’ discounting may be hyperbolic.

Hammitt, J.K. and L.A. Robinson (2010). "Behavioral Economics and the Conduct of Benefit-Cost Analysis: Towards Principles and Standards." LERNA Working Paper No. 11.02.336, Oct 2010.