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Bringing Social Standards into Project Evaluation Under Dynamic Uncertainty

Author

Listed:
  • Odin K. Knudsen

    (The World Bank, Washington, DC, USA)

  • Pasquale L. Scandizzo

    () (University of Rome, Tor Vergata, Italy)

Abstract

Society often sets social standards that define thresholds of damage to society or the environment above which compensation must be paid to the state or other parties. In this article, we analyze the interdependence between the use of social standards and investment evaluation under dynamic uncertainty where a negative externality above a threshold established by society requires an assessment and payment of demages. Under uncertainty, the party considering implementing a project or new technology must not only assess when the project is economically efficient to implement but when to abandon a project that could potentially exceed the social standard. Using real-option theory and simple models, we demonstrate how such a social standard can be integrated into cost benefit analysis through the use of a development option and a liability option coupled with a damage function. Uncertainty, in fact, implies that both parties interpret the social standard as a target for safety rather than an inflexible barrier that cannot be overcome. The larger is the uncertainty, in fact, the greater will be the tolerance for damages in excess of the social standard from both parties.

Suggested Citation

  • Odin K. Knudsen & Pasquale L. Scandizzo, 2006. "Bringing Social Standards into Project Evaluation Under Dynamic Uncertainty," CEIS Research Paper 87, Tor Vergata University, CEIS.
  • Handle: RePEc:rtv:ceisrp:87
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    References listed on IDEAS

    as
    1. John Cantwell (ed.), 2006. "The Economics of Patents," Books, Edward Elgar Publishing, volume 0, number 3805, December.
    2. Pasquale L. Scandizzo & Odin Knudsen, 1996. "Social Supply and the Evaluation of Food Policies," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(1), pages 137-145.
    3. Maureen McKelvey & Luigi Orsenigo (ed.), 2006. "The Economics of Biotechnology," Books, Edward Elgar Publishing, volume 0, number 3406, December.
    4. Kenneth J. Arrow & Anthony C. Fisher, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, Oxford University Press, vol. 88(2), pages 312-319.
    5. Bohm, Peter, 1975. "Option Demand and Consumer's Surplus: Comment," American Economic Review, American Economic Association, vol. 65(4), pages 733-736, September.
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    Citations

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    Cited by:

    1. Scandizzo, Pasquale L. & Ventura, Marco, 0. "Bids for the UMTS system: An empirical evaluation of the Italian case," Telecommunications Policy, Elsevier, vol. 30(10-11), pages 533-551, November.
    2. Pasquale Scandizzo & Odin Knudsen, 2012. "Risk management and regulation compliance with tradable permits under dynamic uncertainty," European Journal of Law and Economics, Springer, vol. 33(1), pages 127-157, February.
    3. Giuseppe Pennisi & Pasquale L. Scandizzo, 2006. "Economic Evaluation in the age of Uncertainty," CEIS Research Paper 86, Tor Vergata University, CEIS.

    More about this item

    Keywords

    Efficiency; Precautionary principle; Real Options; Social Standard.;

    JEL classification:

    • H1 - Public Economics - - Structure and Scope of Government
    • L5 - Industrial Organization - - Regulation and Industrial Policy
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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