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What is Shadow Pricing?

Shadow pricing is the practice of allotting a dollar-value to an abstract commodity for the purpose of cost-benefit analysis.

How Does Shadow Pricing Work?

Cost-benefit analysis takes into account abstract commodities (also called intangible assets) not normally purchased or sold in a marketplace. Since cost-benefit analysis is quantitative, all variables under consideration must reflect a dollar value. By assigning a shadow price to an intangible asset, analysts can get a clear sense of how the costs of a project or investment affects the current circumstances (i.e. will this action improve or worsen the current conditions of a community/organization?).

An example of a commodity requiring shadow pricing might be the value of a park to the social well-being of a community when calculating the cost of a construction project. By assigning a numerical dollar value to the park, analysts can evaluate its value to a community with regard to the costs of new construction.

Why Does Shadow Pricing Matter?

Shadow pricing quantifies commodities for which the value would normally be viewed qualitatively. By assigning a dollar value to such commodities, the opportunity cost of certain decisions can be better understood, which can be helpful during the decision-making process.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.