Shadow prices for project evaluation under alternative macroeconomic specifications

TLDR: This article examined the shadow prices for project evaluation under alternative assumptions about how equilibrium is restored by adjusting domestic expenditures or tariff rates, except insofar as the relative shadow prices of tradeables remain their relative border prices.

Abstract: For purposes of social cost-benefit analysis, a project may be viewed as a disturbance to the economy, displacing it from some initial equilibrium to a new one. But the new configuration will depend on which particular variables adjust to restore equilibrium. This paper examines the shadow prices for project evaluation under alternative assumptions about how equilibrium is restored. When the government reacts by altering its foreign exchange reserves, the shadow prices coincide with those advocated in the manuals on social cost-benefit analysis. However, if the government adjusts its domestic expenditures or tariff rates, the shadow prices will differ from those of the manuals, except insofar as the relative shadow prices of tradeables remain their relative border prices. The paper first presents the model, followed by two cases in which domestic prices and wage rates do not vary because ad valorem tariffs are fixed and one case in which they are endogenous.