Civil Systems Planning Benefit/Cost Analysis

Civil Systems PlanningBenefit/Cost Analysis Scott Matthews 12-706/19-702 / 73-359 Lecture 9

Revisiting HW 2, Question 2 (Dam) • Thanks to Ryan and Jenny.. • Their argument “should stop doing the project when the yearly PV goes negative”; year 45 instead of 66 • This is a “social cash flow” problem • Should use continuous discounting, but that’s not concern here • Part a (no concerns) show to keep adding rows until NPV (cumulative) goes to 0 • Use cumulative NPV to automate/avoid doing 25 separate NPV worksheets • But in reality, what the cumulative says is what NPV “up to year n” would have been had we done a separate worksheet • Our rule is “select project as long as NPV > 0” 12-706 and 73-359

HW 2, Q2 (cont) • Part b just has different discount rates.. (no big deal) • Still - same basic framework applies. Finding NPVs to use our “rule”, but using cumulative NPV to help see when it would have gone to zero (if had done 45-66 separate worksheets) 12-706 and 73-359

Revisiting old problem.. I changed At cash streams to be non-uniform, and decreasing Would we do this project with information above? Eg 5 years? Does the fact that PV “goes negative” in year 4 matter? 12-706 and 73-359

Last thoughts • Had we done separate worksheets to test NPV for each year 25 to 66, we would have found a positive NPV. • That is our decision rule for accepting projects. 12-706 and 73-359

Monopoly - the real game • One producer of good w/o substitute • Not example of perfect comp! • Deviation that results in DWL • There tend to be barriers to entry • Monopolist is a price setter not taker • Monopolist is only firm in market • Thus it can set prices based on output 12-706 and 73-359

Monopoly - the real game (2) • Could have shown that in perf. comp. Profit maximized where p=MR=MC (why?) • Same is true for a monopolist -> she can make the most money where additional revenue = added cost • But unlike perf comp, p not equal to MR 12-706 and 73-359

Monopoly Analysis In perfect competition, Equilibrium was at (Pc,Qc) - where S=D. But a monopolist has a Function of MR that Does not equal Demand So where does he supply? MC Pc Qc MR D 12-706 and 73-359

Monopoly Analysis (cont.) Monopolist supplies where MR=MC for quantity to max. profits (at Qm) But at Qm, consumers are willing to pay Pm! What is social surplus, Is it maximized? MC Pm Pc Qm Qc D MR 12-706 and 73-359

Monopoly Analysis (cont.) What is social surplus? Orange = CS Yellow = PS (bigger!) Grey = DWL (from not Producing at Pc,Qc) thus Soc. Surplus is not maximized Breaking monopoly Would transfer DWL to Social Surplus MC Pm Pc Qm Qc D MR 12-706 and 73-359

Natural Monopoly • Fixed costs very large relative to variable costs • Ex: public utilities (gas, power, water) • Average costs high at low output • AC usually higher than MC • One firm can provide good or service cheaper than 2+ firms • In this case, government allows monopoly but usually regulates it 12-706 and 73-359

Natural Monopoly Faced with these curves Normal monop would Produce at Qm and Charge Pm. We would have same Social surplus. But natural monopolies Are regulated. What are options? a Pm d P* AC b e MC c Qm Q* D MR 12-706 and 73-359

Natural Monopoly Forcing the price P* Means that the social surplus is increased. DWL decreases from abc to dec Society gains adeb a Pm d P* AC b e MC c D Qm Q* Q0 MR 12-706 and 73-359

Monopoly • Other options - set P = MC • But then the firm loses money • Subsidies needed to keep in business • Give away good for free (e.g. road) • Free rider problems • Also new deadweight loss from cost exceeding WTP 12-706 and 73-359

Civil Systems Planning Benefit/Cost Analysis