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Course: EC 3545, Fall 2009
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Key Answer Part I Text Page 67 Questions #2 LCF = .06 (1 + .06) 20 (1 + .06) 20 - 1 = 0.087 The annual payment would be \$1,000,000 x 0.087 = \$87,000 #3 Benefit/Cost Ratio = \$70,000/\$87,000 = 0.80 What if the interest rate were 2%? LCF = .02 (1 + .02) 20 (1 + .02) 20 - 1 = 0.061 The annual payment would be \$1,000,000 x 0.061 = \$61,000 The new Benefit/Cost Ratio would be \$70,000/\$61,000 = 1.15 Net Benefits:...

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Key Answer Part I Text Page 67 Questions #2 LCF = .06 (1 + .06) 20 (1 + .06) 20 - 1 = 0.087 The annual payment would be \$1,000,000 x 0.087 = \$87,000 #3 Benefit/Cost Ratio = \$70,000/\$87,000 = 0.80 What if the interest rate were 2%? LCF = .02 (1 + .02) 20 (1 + .02) 20 - 1 = 0.061 The annual payment would be \$1,000,000 x 0.061 = \$61,000 The new Benefit/Cost Ratio would be \$70,000/\$61,000 = 1.15 Net Benefits: (at 6%) \$70,000-\$87,000 = -\$17,000 (at 2%) \$70,000-\$61,000 = \$9,000 #5 At 6%: PVB = 1 - (1 + .06) .06 -20 \$70,000 \$805,000 1 - (1 + .06) \$87,000 \$1,000,000 .06 Benefit/cost ratio = \$805,000/\$1,000,000 = .81 -20 PVC = At 2%: PVB = 1 - (1 + .02 ) .02 1 - (1 + .02 ) .02 -20 \$70,000 \$1,155,000 -20 PVC = \$61,000 \$1,000,000 Benefit/Cost ratio = \$1,155,000/\$1,000,000 = 1.155 #6 Make your case either way but explain how it affects the benefit/cost ratio. Part II Majority Voting There will be smoking (2 to 1 vote for smoking) Pareto-Criteria No smoking (allowing smoking would make the non-smoker worse Kaldor-Hicks Criteria No Smoking (the amount smokers are willing to pay is less than the damage to the non-smoker) With the Air Filter: Majority Voting There will be smoking with a filter (2 to 1 vote for smoking) Pareto-Criteria There will be no smoking (Everybody is worse off having to pay for the filter and the non-smoker still incurs damages from the smoking). Kaldor-Hicks Criterion There will be smoking with a filter (the smokers are able to compensate the non-smoker for her damages even after they all pitch in for the filter). Part III Total Cost = 5Q2 Marginal = Cost 10Q Marginal Benefit = 40 Total Benefits = 40Q a.) Optimal Quantity is where MC=MB. That is, where 10Q=40 or Q=4. b.) Cost per resident would be 5(4)2/15 = 5.33 c.) Majority Vote NO Pareto-Criteria NO Kaldor-Hicks -- NO (the flarenostrils would have to compensate the plugnoses 10x4.33=\$43.30 in order to get them to accept the reduction, but the flarenostrils are only willing to pay \$3.35). d.) Part IV a.) Explain and defend your thoughts either way. b.) If Smith is not liable for noise and there are no negotiation costs, he will install the soundproofing. The difference in gains for Smith between no soundproofing and soundproofing is \$150-\$34 = \$116/wk. Jones is willing to pay up to \$125-\$6 = \$119/wk to have Smith install the soundproofing. Jones can pay Smith \$116/wk to install the soundproofing and still be \$3/wk better off. c.) If the negotiation costs of maintaining an agreement are \$4/wk then Smith would not maintain the soundproofing....

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