1. We must first specify the objective function to be maximized—ordinarily,
net social benefit—with some measure of how different benefits (e.g., per
capita consumption, income distribution) are to be calculated and what
the trade-off between them might be.
2. To arrive at calculations of net social benefit, we need social measures of
the unit values of all project inputs and outputs. Such social measures are
often called accounting prices or shadow prices of inputs and outputs to
distinguish them from actual market prices.
14 In general, the greater the
divergence between shadow and market prices, the greater the need for
social cost-benefit analysis in arriving at public investment decision rules.
3. Finally, we need some decision criterion to reduce the stream of projected
social benefit and cost flows to an index, the value of which can then be
used to select or reject a project or to rank it relative to alternative projects.
Let us briefly examine each of these steps of project appraisal.