FINANCE-ECO 4504 Introduction to Public Finance

ECO 4504 Introduction to Public FinanceHomework #3Instructions: 1) return the Homework in a neatly typed Word or PDF document; scanned, handwritten pageswill not be accepted; 2) include your name, PID number, Homework number and due date; 3) include eachoriginal question and the corresponding answer; 4) include tables, if necessary, to show your work; 5) if youare making assumptions, make them explicit. Lack of clarity will result in a lower grade. No homework willbe accepted after the due date. No exceptions.Chapter 82. How does the opportunity cost of a government purchase vary depending on whether the market for thepurchased good is perfectly competitive or monopolistic?3. Two city councilors are debating whether to pursue a new project. Councilor Miles says it is only“worth it” to society if suppliers lower their costs to the city for the inputs to the project. CouncilorSqueaky disagrees, and says it doesn’t matter—society Worth Publishers, BCS, Do Not Duplicate is nobetter off with these cost concessions than it would be without the concessions. Where do you stand?Explain.5. Consider the Deacon and Sonstelie (1985) approach to valuing time described in the text on p. 214.Imagine that two cars are equivalent to one another in every way (such as gas mileage) except for gastank size, and car A’s tank has twice the gas capacity of car B’s tank. Which driver is more likely topatronize a Chevron station mandated to lower prices below those of independent stations? Explain youranswer.7. Suppose you prefer working 40 hours per week to 20 hours, and prefer working 32 hours per week toeither 20 or 40 hours. However, you are forced to work either 20 hours or 40 hours per week. Is yourhourly wage rate an accurate reflection of the value of your time? Explain.10. The city of Gruberville is considering whether to build a new public swimming pool. This pool wouldhave a capacity of 800 swimmers per day, and the proposed admission fee is $6 per swimmer per day. Theestimated cost of the swimming pool, averaged over the life of the pool, is $4 per swimmer per day.Gruberville has hired you to assess this project. Fortunately, the neighboring identical town of Figlioniaalready has a pool, and the town has randomly varied the price of that pool to find how price affectsusage. The results from their study follow:Swimming pool price per day$8$10$4$6$2Number of swimmers for day5002001,1008001,400a. If the swimming pool is built as planned, what would be the net benefit per day from the swimmingpool? What is the consumer surplus for swimmers?b. Given this information, is an 800-swimmer pool the optimally sized pool for Gruberville to build?Explain.113. You are trying to decide where to go on vacation. In country A, your risk of death is 1 in 10,000, andyou’d pay $6,000 to go on that vacation. In country B, your risk of death is 1 in 20,000, and you’d pay$9,000 to go on that vacation. Supposing that you’re indifferent between these two destinations, save forthe differential risk of death, what does your willingness to pay for these vacations tell you about howmuch you value your life?14. Jellystone National Park is located 10 minutes away from city A and 20 minutes away from city B.Cities A and B have 200,000 inhabitants each, and residents in both cities have the same income andpreferences for national parks. Assume that the cost for an individual to go to a national park isrepresented by the cost of the time it takes her to get into the park. Also assume that the cost of time forindividuals in cities A and B is $.50 per minute.You observe that each inhabitant of city A goes to Jellystone ten times a year while each inhabitant of cityB goes only five times a year. Assume the following: the only people who go to the park are the residentsof cities A and B; the cost of running Jellystone is $1,500,000 a year; and the social discount rate is 10%.Also assume that the park lasts forever.a. Compute the cost per visit to Jellystone for an inhabitant of each city.b. Assuming that those two observations (cost per visit and number of visits per inhabitant of city A, andcost per visit and number of visits per inhabitant of city B) correspond to two points of the same linearindividual demand curve for visits to Jellystone, derive that demand curve. What is the consumer surplusfor inhabitants of each city? What is the total consumer surplus?c. There is a timber developer who wants to buy Jellystone to run his business. He is offering $100million for the park. Should the park be sold?15. Imagine you are the governor of Massachusetts 25 years ago and need to decide if you should supportthe “Big Dig” highway and bridge construction project.The Big Dig is estimated to take 7 years to complete. The project will require $45 million in constructionmaterials per year and $20 million in labor costs per year. In addition, the construction will disrupttransportation within the city for the duration of the construction. The transportation disruption lengthenstransport times for 100,000 workers by 30 hours a year. All workers are paid $15 per hour (assume thatthere are no distortions and that the wage reflects each worker’s per-hour valuation of leisure).The Big Dig, when finished, will ease transportation within the city. Each of the 100,000 workers willhave their transport time reduced by 35 hours a year as compared to the preconstruction transport time. Inaddition, part of the Big Dig project involves converting the space formerly taken up by an elevatedhighway into a large park. The State of Massachusetts has determined that each worker will value thepark at $40 per year. We will assume that no one else will use the park.We also assume the government has a 5% discount rate and that the workers live forever. The benefits tothe Big Dig begin in year 7, assuming the project begins in year 0 (i.e., the project runs for 7 years, from t= 0 to t = 6).a. Should you, as the governor, proceed with the project? Formally show the cost-benefit analysis.b. It occurs to you, after completing the calculation in part a, that it is possible the cost estimates areuncertain. If the construction materials estimate is $45 million with 50% probability and $100 millionwith 50% probability, should the project proceed? Assume that the government is risk neutral.

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