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Civil Systems Planning Benefit/Cost Analysis

Civil Systems Planning Benefit/Cost Analysis. Chapter 4 Scott Matthews Courses: 12-706 and 73-359 Lecture 7 - 9/22/2004. Announcements. PS 2 will be posted this afternoon Same Due Date PS 1 looks good so far Reminder: Project teams/ideas due next Wednesday. Monopoly Analysis (cont.).

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Civil Systems Planning Benefit/Cost Analysis

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  1. Civil Systems PlanningBenefit/Cost Analysis Chapter 4 Scott Matthews Courses: 12-706 and 73-359 Lecture 7 - 9/22/2004

  2. Announcements • PS 2 will be posted this afternoon • Same Due Date • PS 1 looks good so far • Reminder: Project teams/ideas due next Wednesday 12-706 and 73-359

  3. 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

  4. 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

  5. Pollution (Air or Water) Third parties: (gain) B+C+F (avoided quantity between S curves) Govt revenue: A+E Total: gain of C P S#:marginal Social costs S*: marginal Private costs P# t C A B C is reduced DWL of pollution eliminated by tax** P* F E P# - t D Q Q# Q* **This cannot be a perfect reduction in practice - need to consider administrative costs of program 12-706 and 73-359

  6. Distorted Market - Vouchers • Example: rodent control vouchers • Give residents vouchers worth $v of cost • Producers subtract $v - and gov’t pays them • Likely have spillover effects • Neighbors receive benefits since less rodents nearby means less for them too • Thus ‘social demand’ for rodent control is higher than ‘market demand’ 12-706 and 73-359

  7. Distortion : p0,q0 too low What is NSB? What are CS, PS? S Social WTP P S-v P0 P1 DS: represents higher WTP for rodent control DM Q Q0 Q1 12-706 and 73-359

  8. Social Surplus - locals Make decisions based on S-v, Dm What about others in society, e.g. neighbors? P P S S-v P1+v C A P0 B E P1 DS Because of vouchers, Residents buy Q1 DM Q Q0 Q1 12-706 and 73-359

  9. Nearby Residents Added benefits are area between demand above consumption increase What is cost voucher program? P P S S-v F P1+v C A G P0 B E P1 DS DM Q Q0 Q1 12-706 and 73-359

  10. Voucher Market Benefits • Program cost (vouchers):A+B+C+G+E ---- • Gain (CS) from target pop: B+E • Gain (CS) in nearby: C+G+F • Producers (PS): A+C • --------- • Net: C+F 12-706 and 73-359

  11. Notes about Public Spending • Resource allocation to one project always comes at a ‘cost’ to other projects • E.g. Pittsburgh stadium projects • “Use it or Lose it” • There is never enough money to go around • Thus opportunity costs exist • Ideally represented by areas under supply curves • Do not consider ‘sunk costs’ • Three cases (we will do 2, see book for all 3) 12-706 and 73-359

  12. Opportunity Cost: Land • Case of inelastic supply (elastic supply in book, trivial) • Government decides to buy Q acres of land, pays P per acre • Alternative is parceling of land to private homebuyers • What is total cost of project? Price Can assume quantity of land is fixed (Q) S b P D Q 12-706 and 73-359

  13. Opportunity Cost: Land Government pays PbQ0, but society ‘loses’ CS that they would have had if government had not bought land. This lost CS is the ‘opportunity cost’ of other people using/buying land. • Total cost is entire area under demand up to Q (colored) Price S b P D 0 Q 12-706 and 73-359

  14. Example: Change in Demand for Concrete Dam Project • If Q high enough, could effect market • Shifts demand -> price higher for all buyers • Moves from (P0,Q0) to (P1,Q1).. Then?? Price D+q’ D S P1 P0 a Q1 Q0 Quantity 12-706 and 73-359

  15. Another Example: Change in Demand • Original buyers: look at D(p1), buy Q2 • Total purchases still increase by q’ • What is net cost/benefit to society? Price D+q’ D S P1 P0 a Q1 Q2 Q0 Quantity 12-706 and 73-359

  16. Another Example: Change in Demand • Project spends B+C+E+F+G on q’ units • Project causes change in social surplus! • Rule: consider expenditure and social surplus change Price D D+q’ S P1 C A F B P0 G E G G Q1 Q2 Q0 Quantity 12-706 and 73-359

  17. Dam Example: Change in Demand • Decrease in CS: A+B (negative) • Increase in PS: A+B+C (positive) • Net social benefit of project is B+G+E+F Price D D+q’ S P1 C A F B P0 G E G G Q1 Q2 Q0 Quantity 12-706 and 73-359

  18. Final Thoughts: Change in Demand • When prices change, budgetary outlay does not equal the total social cost • Unless rise in prices high, C negligible • So project outlays ~ social cost usually • Opp. Cost equals direct expenditures adjusted by social surplus changes Quantity 12-706 and 73-359

  19. Price Floors (e.g. Min. Wage) • Labor market example (tricky) • Supply and demand ‘reversed’ - ideas of ‘consumer’, ‘producer’ switched • In labor market, workers are ‘producers’ • Companies are ‘consumers’ of labor • A ‘price floor’ is a guaranteed wage rate level that must be kept • Good for some workers, bad for others 12-706 and 73-359

  20. Price Floor (e.g. Min Wage) P S Pm Pe D+L’ D Pr L=num of workers Ld Lt Le Ls <- L’ -> 12-706 and 73-359

  21. Problem 4-2 from Book • Done on Board 12-706 and 73-359

  22. Monopoly Project - What is NSB? MC P2 P1 D+Q’ MR2 MR1 D Q3 Q1 Q2 12-706 and 73-359 Q’

  23. Monopoly Project - Agency Cost MC P2 G E C G P1 A G A A D+Q’ A MR2 A A MR1 D Q3 Q1 Q2 Agency Cost is A+C+G+E 12-706 and 73-359 Q’

  24. Monopoly Project - PS (2 parts) PS is price effect + Quantity effect = B+C+G+E C+G+E is transfer MC P2 G E B C G P1 A G A A D+Q’ A MR2 A A MR1 D Q3 Q1 Q2 12-706 and 73-359 Q’

  25. Monopoly • Easy to see loss in CS is B+C. Thus: • Original Buyers lose B+C • Monopolist gains B+C+G+E • Project Costs A+C+G+E • -- • NSB = (loss) A+C • Budgetary outlays larger than Social costs 12-706 and 73-359

  26. Secondary Markets • There are always secondary effects • When secondary markets affected • Can and should ignore impacts as long as primary effects measured and undistorted secondary market prices unchanged 12-706 and 73-359

  27. Primary: Fishing Days Government decides to buy Q acres of land, pays P per acre What is total cost of project? Price a MC0 b MC1 P D Q0 Q1 12-706 and 73-359

  28. Primary: Fishing Days Government puts more fish in lake for fishermen Makes local lake more attractive, lowers travel/access costs Number of fishing days increases in quantity Change in CS is trapezoid P0-a-b-P1 Price a P0 MC0 b MC1 P1 D Q0 Q1 12-706 and 73-359

  29. Secondary Market: Equipment Elastic Supply No Price Effect Do we count CS Increase or not? Consider cases of fishermen with and without equipment prior to policy. P0 D1 D0 q0 q1 12-706 and 73-359

  30. When to Consider Secondary Markets • We should ignore impacts in undistorted secondary markets as long as: • We measure change in social surplus in primary market • Secondary prices do not change… OR • OR When we measure benefits in primary market with demand schedules that do not hold secondary market prices constant • Measuring both usually leads to double counting (since primary markets tend to show all effects) 12-706 and 73-359

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