Valuation of Nontradable Goods and Services

Domestic distortions drive a wedge between economic and financial prices

of nontradable goods. Consequently, it is necessary to adjust financial

prices to reflect economic opportunity costs. The calculation of shadow

prices for nontradables, however, can be extremely time-consuming, and

project analysts must determine whether the refinement is worth the additional

effort. For example, domestic sales taxes are a common distortion;

the prices consumers pay for the good (demand price) will differ

from the price suppliers receive (supply price) by the amount of the tax.

As discussed in the technical appendix, the economic opportunity cost of

this good would depend on the elasticities of supply of and demand for

the good. Because gathering information about elasticities can be timeconsuming,

it is advisable to proceed cautiously. If the NPV of a project is

not sensitive to variations in the economic price of the input, estimating

its economic price with great accuracy is not worth the cost and an educated

guess will suffice.

Material Inputs

The first step in valuing nontradable material inputs is assessing whether

there are serious distortions in the market for the good or service. The

second step is to estimate upper and lower bounds for the economic price of the good. The final step is to decide whether to estimate the economic

opportunity cost of the good in question with a great degree of accuracy,

or simply use an educated guess.

Suppose that a project uses quarry stones that are subject to a 15

percent excise tax and that each quarry stone costs one U.S. dollar. The

project unit, therefore, pays US$1.15 for each stone, producers receive

US$1.00, and the government receives US$0.15. As shown in the technical

appendix, the economic opportunity cost of quarry stones will lie

between US$1.00 and US$1.15. As a first approximation, analysts can

estimate the project’s NPV using the two extreme values. If the project’s

NPV does not change materially as a function of the economic price of

quarry stones, it would not be worthwhile conducting time-consuming

studies to calculate the elasticities of supply and demand. A rough, educated

guess will suffice.

If, however, the project’s NPV changes from positive to negative, depending

on whether the economic price is US$1.15 or US$1.00, then it behooves

the analyst to estimate the elasticities as thoroughly as the budget

allows. These considerations are applicable to all nontradable material inputs,

and the technical appendix provides further guidance on estimating

the shadow prices of such goods.

Land

Land is a prime example of a nontradable good. In this respect its valuation

is, in principle, no different from that of any other nontradable good.

Land differs from other tradable goods, however, in that its supply is completely

inelastic: any land diverted to the project is necessarily taken away

from some other use, even if that use is speculation. Therefore, the valuation

of land for project use may have to rely on indirect methods, rather

than on straightforward use of market prices, adjusted for distortions.

If an active land market exists, land purchased specifically for project use

may be costed as a capital value using the price paid adjusted for distortions.

This is so if the analyst thinks that the market is sufficiently representative of

alternative use values for the land. If a capital value is used in costing the

land in the project accounts, then a residual value should be included at the

end of the project life. If the annual rental or lease charge is used in costing

the land, then no residual value should be shown for the land at the end of

the project life. If a lessor rents the land, then the rental value adjusted for

distortions should be considered in the project analysis.