XI. ESTIMATING SOCIAL PROFITABILITY

This chapter is oncerned with the empirical estimation of social costs and returns, the most complicated analytical task in the construction of the PAM. The information requirements for exact calcula tion of social prices of outputs and inputs are so vast that empirical estimates will never be exact, even for the best-understood economies. The policy analyst is concerned with whether approximations of social costs and returns will be sufficiently close to their true values to allow useful insights into the motivation for existing policies and the potential gains from changes in policies.

For tradable inputs and outputs, social valuation entails calculation of world price equivalents for the domestic product and requires particular attention to the effects of variations in quality and in geographic location. For domestic factors, the social valuation process begins with observed market prices and then adjusts those prices for the effects of factor market divergences. Estimates of the other influences on factor prices-the interactions between output divergences and factor prices and between input substitution and factor prices-are often no more than informed guesses. These effects usually are assumed to be small in magnitude. Because social factor price estimates necessarily are approximations of true values, sensitivity analysis of the effects of changes in social factor prices is a key element of the presentation of PAM results. By altering the quantities of inputs and outputs from the values observed under private price incentives, the analyst can also simulate producer response (if any) to the social prices for outputs and inputs.