The History of Cost Benefit Analysis
Cost-benefit analysis is the process of analyzing different alternatives to see whether benefits outweigh the costs on a project. The earliest notion of cost-benefit analysis was done in 1848 by Jules Dupuit, a French economist and engineer. A self-taught economist, Dupuit's engineering projects led to his economic work while attempting to determine the maximum toll for a bridge.
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Jules Dupuit
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Dupuit is credited with the concept of diminishing marginal utility, a mathematical curve that shows as quantities of goods are consumed in an increasing amount, the less utility the user of the good receives, so the less he wants it. A good example of marginal utility is eating ice cream. The first or second ice cream cone might taste pretty good and give the consumer a high utility, but by the 10th ice cream cone, the user is probably not enjoying it as much. This is declining utility for the user and one of the foundations of cost-benefit analysis.
Alfred Marshall
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British economist Alfred Marshall, considered to be the father of neo-classical economics, developed economic principles that further what ultimately became cost-benefit analysis theory. Marshall's book, "The Principles of Economics," is still in use today.
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Army Corps of Engineers
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The Army Corps of Engineers' historical practice was that the benefits of a project should not exceed the costs. The corps was not staffed by economists and did not develop economic theory, it just proceed on a common sense basis. The corps had a history of neutrality in congressional fights over water rights and projects. The Flood Control Act of 1936 stated that projects approved by the Army Corps of Engineers would be the only projects approved by Congress, which allowed the introduction of practical application of cost-benefit analysis.
Kaldor-Hicks
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Kaldor-Hicks is the current standard for cost-benefit analysis. This criterion developed in the late 1930's by Sir John Hicks, a future Nobel Prize winner, and Nicholas Kaldor. The methodology behind the Kaldor-Hicks criterion of cost-benefit analysis is extensive, but the basic premise is that Kaldor-Hicks efficiency occurs if the allocation of resources produces more benefit than cost in an overall capacity. While there are problems with the theory, it is the underlying concept of today's cost-benefit analysis methodology.
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