PS 04.Key - ANSWERS TO PROBLEM SET 4 Economics 335 J...

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ANSWERS TO PROBLEM SET 4 - Economics 335 J. Wissink - Cornell University 1. Answer True, False, or Uncertain. Explain. a) False. The increased benefits to the tackle shop owner represent pecuniary gains and therefore should not be included unless you want to include losses from, say, tackle shop owners that are not located by the new reservoir and now loose business. The benefits referred to are just a transfer of income and not new real increases in benefits. b) False. Higher interest rates mean less would have to be put in the bank today to yield a dollar tomorrow. Therefore the PDV of a dollar benefit received tomorrow is smaller the higher the interest rate. c) False. The project with the higher NPDV is not always the project with the higher benefit/cost ratio - refer back to lecture notes for an example. d) Not necessarily. A positive NPDV just indicates that there is a potential Pareto improvement; not an actual one. If we assume dollars are a comparable measure of benefits and costs across different people, then a project with a positive NPDV is just one in which the "winners" win enough so they could compensate the "losers" and still come out ahead. However, unless such compensations are carried out there will, in fact, be winners and losers, so we can't say that acceptance of the project is an actual Pareto improvement. e) False. Recall the numerical example presented in class with trees. In that case, the project with the higher NPDV was not always the project with the higher internal rate of return. The ranking of the tree project depended on the market interest rate. f) False. It depends on who really bears the economic price incidence of the cost of pollution control devices. The market will determine this and not the government. It will depend on the own price elasticity of demand relative to the own price elasticity of supply.
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