Assignment 5
Part I (10 Points each)
1.
What is the major
criticism of the Hicks-Kaldor criterion for
acceptance of a project?
2.
We’ve discussed
the fact that although government has the power to requisition people’s labor,
making the on-budget costs negligible. However,
the true social costs are not 0. For
people who are employed a common practice is to use their wage rate as a proxy
for the opportunity cost of their time.
For those that do not participate in the market for paid work we need to
develop shadow prices. Assume a project will take a homemaker, who takes care
of two children under 5 years old, away from home (such as to be sequestered
for a jury) for 7 days. How much do you
think you should use as a shadow price for this person’s time in your benefit
cost analysis? You can get some idea of
the value of many different paid jobs from the bureau of labor statistics http://www.bls.gov/bls/blswage.htm. In particular if you assume your project is
in
3.
How should you
choose an appropriate discount rate for your analysis?
4.
You know most
people when asked feel their lives have an infinitely high value. However, you
still need to make decisions such as how wide to make the highway. Based on
people’s behavior how do we estimate how much they value a "statistical
life"?
5.
Enhancing the
local park will benefit the 1,000 residents of a particular area by about $300
every year. Property values are expected to increase in that area by about
$10,000,000. How would you include this information in your benefit cost
analysis? (Hint: Beware of double counting.)
6.
The multiplier
concept is a well-accepted principle based on Keynesian economics, so why is it
also considered a common potential pitfall of benefit cost analysis? (Hint:
What if we’re already at full employment?)
7.
Suppose a
proposed project has some risk so it’s exact costs are
unknown, but we expect there is a 50% chance it will cost $100 million and a
50% chance it will cost $500 million. In including this cost data in your
analysis does it matter if the costs will fall on millions of people or just 100
middle class people? Briefly explain. (Hint:
Be sure to think about why certainty equivalence estimates are sometimes used.)
8.
A proposal for a sports stadium points out
that sports teams, owners and fans will not be the only beneficiaries of the
stadium. Area restaurants, gas stations, souvenir vendors will also benefit and
they in turn will buy more from local suppliers of other goods and services,
who will in turn buy more goods and services locally too. What is the
"Chain-Reaction Game" critique of this type of argument?
Part II (20 points)
1. The city you work for is
considering installing a pond with a fountain that will add beauty to the
community and also reduce the probability of flood waters getting into local
residences and businesses. The pond with
fountain will cost $10 million to install and $10,000 a year for
maintenance. Fortunately, with proper
maintenance the pond and fountain are expected to last forever. For each of the 1,000 large businesses in the
area the expected value of the flood reductions will be approximately $25 per
year. About 100,000 residents will each
benefit from the beauty and reduced likelihood of flooding by approximately $10
each per year. The interest rate is 10%.
A)
What is the
approximate present value of the project’s costs? What is the approximate
present value of the project’s benefits? What is the approximate net present
value of the project based on the data you have? Is the project admissible?
B)
Suppose the
maintenance cost estimates and benefit estimates were in current dollars and
the interest rate of 10% was in nominal terms.
Your analysis suggests expected inflation is 6%. How would your estimates of the approximate
present value of the project’s costs, benefits, and net present value change?
C)
If the pond and
fountain would only last for three years even with the maintenance, what would
be the approximate present value of the project’s costs?
D)
There is another
project that would provide a net benefit of $20 each to a different group of
200,000 people immediately, but is unlikely to be provided in the absence of
government intervention. Unfortunately,
due to insufficient budget and political will you can only do one of the
projects. Comparing the project
described in “A)” and this project, in the absence of any other information
about the people involved, which project should be preferred and why?
E)
What
"distributional weight" would make you indifferent between the
original project in part “A)” and this new project?