DEVELOPMENT OF ISSUES RELATING SOCIAL COST BENEFIT ANALYSIS

Following are the three main reasons due to which market prices of goods may not reflect their social values.

1.         (a) Government imposition of taxes, subsidies, tariffs and controls of various kinds distorts market prices

(b) Imperfections in the market will raise prices above the marginal cost of production and

(c) Prices set by private monopolists and public utilities may be mean that the prices of goods do not reflect their social value.

2.         Price of factors of production may overstate or understate the opportunity cost of using those factors i.e. their marginal product in alternative uses. For example: If there is disguised unemployment in the land the industrial wage will exceed the opportunity cost of labor; industrial wage will exceed the opportunity cost of labor drawn from agricultural sector. Foreign exchange by contrast may be undervalued (measured by the domestic price of foreign currency) at the prevailing exchange rate. The existence of external economies and diseconomies may also cause divergences between the market price of inputs and their social cost. For example if a project purchases inputs from decreasing cost industries, the social cost is equal to the price based on average cost but to the lesser figure of marginal cost.

The market prices adjusted for these various divergences and distortions are called shadow, social or accounting prices. Adjusted market prices for goods we call social prices and adjusted market prices for factors of production (including foreign exchange) we call shadow price.