What It Is:
Shadow pricing is the practice of allotting a dollar-value to an abstract commodity for the purpose of cost-benefit analysis.
How It Works/Example:
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 It Matters:
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.