Types of Economic Analysis
Policymakers have a variety of economic analyses at their disposal to help them assess policies and programs. Cost analysis, fiscal impact analysis, cost-effectiveness analysis, and cost-benefit analysis are among the most commonly used tools. This document describes these four types of economic analysis, compares and contrasts them, and explains which circumstances warrant their use.
Cost analysis provides a complete accounting of the expenses related to a given policy or program decision. It supplies the most basic cost information that both decision makers and practitioners require and forms the foundation of all other economic analyses.
A cost analysis sounds simple, but it requires effort to perform a cost analysis thoroughly. Analysts frequently identify only the most obvious costs, such as staff salaries, and fail to account for many others. A complete cost analysis needs to consider:
- Direct costs, like equipment and fringe benefits, in addition to staff salaries;
- Indirect costs or overhead, such as central support services;
- For new programs or policies, start-up expenditures and one-time costs, including hiring and training;
- Future costs, including wage increases, contributions for increasing pension and insurance expenses, and other escalating costs; and
- Capital costs, including debt service.
For more details, see the section “Know your costs.”
Fiscal impact analysis
A fiscal impact analysis is a comprehensive study of all governmental revenues, expenditures, and savings that will result from the proposed policy or program. State and local fiscal offices routinely produce fiscal impact analyses, which are also called fiscal notes when they are prepared for draft legislation. This type of analysis helps policymakers determine whether a proposed initiative is affordable from a budgetary standpoint.
A fiscal impact analysis can help you assess how a program or policy will affect your budget but it won’t tell you whether the program or policy is an efficient use of resources. There may be less expensive options that produce equivalent results. To evaluate which program or policy creates the result you want at the lowest cost, use cost-effectiveness analysis (CEA).
Suppose that you’re comparing two job-training programs, both of which serve 1,000 ex-offenders per year. After doing a comprehensive cost analysis, you find that Program A costs $10 million and Program B $7.5 million annually (see Figure 1). Program A, which costs $10,000 per client, is more expensive than Program B, which costs $7,500 per client. Program A, however, places more of its clients in permanent employment than Program B. The appropriate measure of the programs’ cost-effectiveness is the total program cost divided by the desired outcome, in this case, the total number of job placements. The results show that Program A is more cost-effective, i.e., a better use of resources, because its cost per placement ($13,333) is lower than Program B’s ($15,000).
|Indicator||Total Cost||Clients||Cost per Client||Placement Rate||Placements||Cost per Placement|
|Program A||$ 10,000,000||1,000||$ 10,000||75%||750||$ 13,333|
|Program B||$ 7,500,000||1,000||$ 7,500||50%||500||$ 15,000|
Note that CEA is a valuable tool for weighing programs or policies with similar outcomes, but it should not be used to compare programs that have different outcomes.
Cost-benefit analysis (CBA) is a method for comparing the economic pros and cons of policies and programs to help policymakers identify the best or most valuable options to pursue. A characteristic feature of CBA is that it monetizes, or puts into dollar terms, all the benefits and all the costs associated with an initiative so that they can be directly compared. Policies and programs whose benefits outweigh their costs generate net benefits.
In contrast to CEA, CBA allows you to compare initiatives that have different purposes—such as a reduction in victimization or an improvement in program participants’ reading scores—because the outcomes have been monetized. In contrast to fiscal impact analysis, CBA evaluates the costs and benefits of programs and policies from multiple perspectives, not just that of government agencies. For example, when evaluating a criminal justice program using CBA, the costs and benefits to victims, offenders, program participants, family members, and communities need to be factored in.
Costs and benefits are measured over a long-term horizon, and future dollars are discounted to reflect the time value of money, that is, the concept that money is worth more to us in the present than at some point in the future. The result of a cost-benefit analysis is typically presented as a benefit-cost ratio that indicates the benefit received for every dollar invested, providing a bottom-line summary of the net benefit to society.
Keep in mind
Of the four types of economic analysis described above, CBA is the most comprehensive. However, it is not always necessary or advisable to conduct a cost-benefit analysis of an intervention, as CBAs can be difficult and time-consuming to perform. The other tools may be more feasible to use or may provide sufficient information. See Figure 2 for a simple comparison of the kind of information each type of economic analysis can provide.
Type of economic analysis
|Cost analysis||How much something costs|
|Fiscal-impact analysis||How your budget will be affected|
|Cost-effectiveness analysis||How many outputs you get for your dollar|
|Cost-benefit analysis||How much benefits outweigh costs|
- Direct costs
- Staff salary plus fringe benefits (e.g., health insurance, employer’s share of social security, workers compensation, unemployment insurance, pension contribution, vacation wages)
- Equipment, such as computers and office supplies
- Rent, occupancy, office maintenance, and other space-related costs
- Indirect costs
- Executive staff
- Central support (e.g., human resources, fiscal, information technology)
- Start-up and one-time costs (e.g., furniture, equipment, consultants)
- Future costs
- Wage increases, including anticipated collective-bargaining settlements
- Additional pension contributions
- Anticipated health-insurance escalation
- Capital expenses
- Project planning, design, development, and professional services
- Real estate, materials, and construction
- Debt service