This paper extends the case for shadow pricing traded commodities at their relative international prices in benefit-cost analysis. This result is shown to hold (a) when there are nontraded commodities whose (possibly distorted) prices are indirectly affected by public production of traded commodities, and (b) when there is a government budgetary constraint. Contrary to arguments found in the literature, neither of these cases in itself provides an argument for shadow pricing traded commodities at values other than their relative international prices.

I. Introduction, 95. — II. Notation and assumptions, 96. — III. Necessary conditions for a second-best optimum, 98. — IV. Informational requirements, 100. — V. Stability, 103. — VI. Some alternative solutions, 109. — VII. Summary and conclusions, 112. — Appendix A: Proof of Proposition 1,113. — Appendix B: Proof of Proposition 3,115.

This paper extends the case for shadow pricing traded commodities at their relative international prices in benefit-cost analysis. This result is shown to hold (a) when there are nontraded commodities whose (possibly distorted) prices are indirectly affected by public production of traded commodities, and (b) when there is a government budgetary constraint. Contrary to arguments found in the literature, neither of these cases in itself provides an argument for shadow pricing traded commodities at values other than their relative international prices.

Brian D. Wright, Peter G. Warr; The Isolation Paradox, the Social Discount Rate, and Neutrality: Further Thoughts, The Quarterly Journal of Economics, Volume 10

One argument used to justify a rate of discount for benefit-cost analysis below the market rate is based on a divergence of private and collective behavior known as the “isolation paradox.” In this paper we reexamine this argument using a three-period general equilibrium model incorporating the intergenerational structure of benevolence assumed by earlier writers. We show that in this model the appropriate rate of discount is the market rate, regardless of the existence of the isolation paradox. In the absence of other market distortions, no shadow pricing of capital inputs is necessary in the calculation of net present value.