Introduction

Costs are a major concern in the decision making process of all firms. However, sometimes, those involved in the decision making process may get too concerned with only the costs of a proposal and forget that there is another side to the production, and hence the profit, equation. This is the benefit of the proposal.

In the profit equation, total costs (TC) are subtracted from total revenues (TR). Thus, P=TR-TC where P is profit. However, one has to remember that there is another equation that is directly related to profit and underlies the business structure. This is the production equation, called a production function, where inputs are combined to create an output or set of outputs.

In some cases, added costs can come from changes in the price of an input. This is an instance where there will be no change in the output levels and no additional revenue (benefit) is gained. Other added costs may occur as a result of a change in inputs or the addition of inputs. These changes are likely to have an effect on the output production and, hence, on the revenue total as well. This is where cost-benefit analysis becomes important to the firm's decision making process.

Illustrative Examples

To further illustrate this, let us examine a couple of scenarios in a cattle enterprise:

1. A producer is looking at two sources for dewormer. Once product is fifty cents cheaper than the other. They work nearly identically. On a 100 head cow herd, the difference in cost will be over $50.
2. A producer is considering her veterinarian's recommendation to adopt a managed her-health program. The program will cost her about $15 more per brood cow. If we assume the producer has 100 brood cows, the additional annual cost it $1,500. Also, let us assume that her current weaning rate is 70 percent on her herd. This weaning rate is based solely on her 100 exposed cows and heifers from the previous breeding season. The veterinarian assures her that her herd's weaning rate will improve to 80 percent and possibly 90 percent due to improved health and efficiency in her cows. This 10 percent improvement in weaning rate will also translate to an improvement in revenue. In table 1, we explore the impacts of this new program. We will make a few additional assumptions for this analysis. The producer sells her calves at 350 pounds average, and the prices used will be a steer and heifer average price.

Analysis

In Scenario 1, it is clear that a simple cost analysis would yield the same result as a cost-benefit analysis since there are no clear benefits to the more costly of the two products. Revenue is not improved in anyway while costs are increased. The net result would be to decrease profit. So, in the cost-benefit framework, there is negative benefit to the increased cost of the more expensive product.

With Scenario 2, cost-benefit analysis yields a dramatically different result than simply looking a the cost of the program. With scientific backing that healthier animals are more efficient, one could reasonably expect significant performance gains in this situation. Therefore, simply considering the cost of the program would leave out some important considerations to the bottom line of the business enterprise. In fact, a further analysis would show that any improvement in the weaning rate above four percent would make the program profit enhancing above an $87 per hundredweight average steer and heifer price given the assumptions used in this example.

Closing Remarks

These scenarios are simplified in order to clearly illustrate the principles of cost-benefit analysis. In the real world, the principles are sound, but there may be more that needs to be considered. In some cases, the time period may be longer than one year, and time value must be considered. The main point of this exercise is to demonstrate that simply asking "How much does it cost?" may not be the right question to ask in order to make the best decision for your enterprise.

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