1 Civil Systems Planning Benefit/Cost Analysis Chapter 4 Scott Matthews Courses: and Lecture 7 - 9/22/2004

and Announcements  PS 2 will be posted this afternoon  Same Due Date  PS 1 looks good so far  Reminder: Project teams/ideas due next Wednesday

and Monopoly Analysis (cont.) MR D MC Qc Pc 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 Qm Pm

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

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

and 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’

and Distortion : p0,q0 too low Q P Q0 P0 S-v DMDM S D S: represents higher WTP for rodent control P1 Q1 What is NSB? What are CS, PS? Social WTP

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

and Nearby Residents Q P Q0 P0 S-v DMDM S DSDS P1 Q1 B P E P1+v A C Added benefits are area between demand above consumption increase What is cost voucher program? F G

and 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

and 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)

and Opportunity Cost: Land Q P D b Price 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? S Can assume quantity of land is fixed (Q)

and Opportunity Cost: Land Q P D b Price 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) S 0

and 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?? Q0 P0 D a Price Quantity D+q’ S P1 Q1

and 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? Q0 P0 D a Price Quantity D+q’ S P1 Q1 Q2

and 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 Q0 P0 D Price Quantity D+q’ S P1 Q1 Q2 E B C FA G G G

and 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 Q0 P0 D Price Quantity D+q’ S P1 Q1 Q2 E B C FA G G G

and 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

and 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

and Price Floor (e.g. Min Wage) L=num of workers P Ld Pm S D Pe Le Pr D+L’ LsLt

and Problem 4-2 from Book  Done on Board

and Monopoly Project - What is NSB? MR1D MC Q1 P1 P2 Q3Q2 Q’ D+Q’ MR2

and Monopoly Project - Agency Cost MR1D MC Q1 P1 P2 Q3Q2 Q’ D+Q’ MR2 C E A A AA A A G G G Agency Cost is A+C+G+E

and Monopoly Project - PS (2 parts) MR1D MC Q1 P1 P2 Q3Q2 Q’ D+Q’ MR2 C E A A AA A A G G G PS is price effect + Quantity effect = B+C+G+E C+G+E is transfer B

and 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

and 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

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

and Primary: Fishing Days Q1 P0 D Price 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 b a Q0 MC0 MC1 P1

and Secondary Market: Equipment P0 D0 D1 q0q1 Elastic Supply No Price Effect Do we count CS Increase or not? Consider cases of fishermen with and without equipment prior to policy.

and 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)