Benefit-Cost Ratio

Published Aug 10, 2023

Definition of Benefit-Cost Ratio

The benefit-cost ratio (BCR) is a measure of the economic efficiency of a project or policy. It is calculated by dividing the total benefits of a project or policy by its total costs. That means it is a ratio that compares the total benefits of a project or policy to its total costs.

Example

Imagine a company thinking about buying a new machine for $100,000. This machine could help them make more things and earn extra money—about $150,000 more over five years.

To make a smart choice, the company uses a method called benefit-cost analysis. It’s like balancing the good things (benefits) with the money spent (costs). They’re looking at whether the extra money they’ll make is more than what they’ll spend.

After adding up all the extra money they expect to get ($150,000) and thinking about all the costs, like buying the machine and taking care of it, they find that the benefits are 1.5 times bigger than the costs. So, for every dollar they spend on the machine, they think they’ll get $1.50 back.

This helps the company’s decision-makers decide that getting the machine is a good idea because they expect to make more money than they put in. This way of thinking helps businesses make wise choices about their money.

Why Benefit-Cost Ratio Matters

The benefit-cost ratio is an important tool for decision-makers. It allows them to compare the costs and benefits of a project or policy and decide whether it is worth investing in or not. That means it helps them to make informed decisions and allocate resources in the most efficient way.

In addition to that, the benefit-cost ratio can also be used to compare different projects or policies and decide which one is the most cost-effective.