There are also intangible costs and benefits of

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: its decision it will impact some people negatively (by taxation) and others positively by investment. This kind of decisions are not “Prato Optimal”. – The counter argument is that if the net gain is greater than the net lose, the gainers can compensate losers and the society is left with a net positive result. – However, since valuation of gain and loses by individuals in the society is difficult (and different), it would be difficult to determine net gain/lose through distributive impact of project on the society. (This is why some argue for a fee based approach, such as toll road, to be superior to public financed) – The concept of Prato optimality is used in terms of distributive impact of government decisions Social Choice • “Prato Optimality” condition argues that if a decision makes one individual better off with out making any one worth off, then that decision is Prato optimal – Implication for infrastructure is that taxing and investing in infrastructure is not “Prato Optimal”, while privatize development of infrastructure is, since those use the facility pay for it and are better off, while we are not taxing others Social Choice • Alternatively it is argued that if the decision improves the over all social benefit, even if it make some worst off it is still acceptable decision. – Government involvement in infrastructure through tax money, which makes some tax payers worst off but increases benefit to the society is acceptable if social benefits exceeds social cost. • Privatized infrastructure development reduces dead weight of tax. – Consumer surplus will not be impacted by taxes Budgetary Constraint • Government has limited budget, therefore it must allocate its resources among various uses. The issues therefore include – Does the project provide net benefit (benefit over cost) – Does it provide the highest net benefit among various projects government can under take. – For whom does it create benefit (allocation issue) Shadow Price • One way to evaluate the value of public investment is through what is called shadow prices. It is an imputed value • If our objective is to maximize economic growth, and the economy faces a number of constraint such as water, energy, telecommunication, road, how would we decide in what sector investment should go? Obviously to the sector that create the highest growth. The value that it contributes is called the shadow price of this investment. • What if the objective is to maximize social welfare, (which is not necessary equivalent of maximizing GNP growth)? In this case it may be marginal contribution to social welfare that is the shadow price (solving a constraint optimization model). This can also be determine by the revealed preference. • Note that with this definition, a resources that is in excess supply may even have a zero shadow price Shadow Prices and Market Prices • If there is no externalities and market is perfectly competitive then market price and shadow prices are equal. But there are a number of factors contribute to market failure: – Monopoly – Indirect tax – Unemployment – Property right (market can only operate if it is clear who owns what) – Pricing of non market item (externalities) – Time related choices (exhaustible resources) Example • To illustrate how CBA might be applied to a project, let us consider a simple highway improvement and extension. The improvement in highway leads to more capacity resulting in time saving. Data indicates that for rush hour the time cost is of a trip is $5 without project and $3 with project. It is assumed that operating cost of vehicle is unaffected by the project ($4). The project lowers the cost of trip leading to increase in number of trips. For rush hour cost saving is $2 and for non rush hour it is $0.8. Also, project is expected to reduce fatalities from 12 per year to 6.We assume value of time to be $0.1 per minute during rush hour and 0.08 during non-rush hour. Table below shows relevant data. • Assume cost of right of way is $100 mill that can be recover at the end of the project and construction cost $200 mill during four years ($50 mill a year) and maintenance $1 mill per year. Calculate whether this project make sense if the life of project is 30 years and that bond rate is 4% with 2% inflation rate (2% real interest). Data for Expansion of Highway Trip No Extension Extension Saving per trip Rush hour Passenger Trips Difference 3000 4000 1000 Trip time (minutes) 50 30 20 Value of time per minute 0.1 0.1 0.1 5 3 $2 500 555.5 55.5 35 25 10 0.08 0.08 0.08 2.8 2 $0.80 Cost per trip Non Rush Hour Passenger Trips Trip time (minutes) Value of time per minute Cost of rip Social benefit Annual Basis (Consumer Surplus) Rush Hour $7,000 $10,920,000.00 Non rush Hour $ 422.20 $ 3,039,840.00 Total benefit $13,959,840.00 consumer surplus in Rush Hour= ((3000+4000)/2)*$2 Consumer surplus non-Rush Hour= ((500+555.5)/2)*$0.8 To annulaize Rush hour we muliply by 6 hour a day...
View Full Document

This note was uploaded on 07/25/2012 for the course ECON 111 taught by Professor King during the Spring '12 term at CSU Bakersfield.

Ask a homework question - tutors are online