VALUATION OF BENEFITS AND COSTS 1

WHEN MARKETS CLEAR

First Questions FirstFirst Questions First

• Is there a market failure that could justify government action?

• Does it matter?- What would happen without government

intervention?- What should government do?- Different answers? Which is better?

• Is there a market failure that could justify government action?

• Does it matter?- What would happen without government

intervention?- What should government do?- Different answers? Which is better?

Next Come Valuation QuestionsNext Come Valuation Questions

• Is the demand schedule linear (or can we reasonably assume it is)?

• Do we have to worry about income effects?

ASSUMING THE ANSWERS ARE YES AND NO

• Does the market clear?• Are costs constant?• Are there market imperfections?

• Is the demand schedule linear (or can we reasonably assume it is)?

• Do we have to worry about income effects?

ASSUMING THE ANSWERS ARE YES AND NO

• Does the market clear?• Are costs constant?• Are there market imperfections?

Valuation: No DistortionsValuation: No Distortions

DSS’QQ’PP’Constant Costs

Valuation: No DistortionsValuation: No Distortions

DSS’QQ’PP’Increasing Costsefabcgh

Valuation: No DistortionsValuation: No Distortions

DSS’QQ’PP’Increasing Costsefabcgh

Valuation: DistortionsValuation: Distortions

DSS’QQ’PP’Constant CostsD’abce

Valuation: DistortionsValuation: Distortions

DSS’QQ’PP’Increasing Costsefabcghji

D’

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQQ’PConstant CostsD’

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQPPerfectly Inelastic Supply

D’P’acbDWL

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQQ’PP’Increasing CostsD’abce

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQQ’PP’Increasing CostsD’abce

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQQ’PP’Increasing CostsD’abce

Cost of Resources: No DistortionsCost of Resources: No Distortions

DSQQ’PP’Increasing CostsD’abce

Cost of Resources: DistortionsCost of Resources: Distortions

DSMCQQ’PConstant CostsD’

Cost of Resources: DistortionsCost of Resources: Distortions

DSQQ’PP’Increasing CostsD’abceMCfg

Project Cost ExampleProject Cost Example

The marginal cost of supplying concrete is MC=0.01Q,Where Q=1 million cubic yards of concrete. Becausethe supplier has a local monopoly, concrete isactually sold according to the supply curve P=0.02Q.

The inverse (private) demand for concrete is P=6-0.04Q,Which implies the following demand, Q=150-25P.Solving for Q, P, CS & PS, we have:6-0.04Q = 0.02Q6 = .06Q, 100 = QP = .02(100) = $2.00CS = 100M(6-2)/2 = $200M, PS = 100M[(2+1)/2] = $150M

DS100QP246MC

Adding the projectAdding the project

The project will require 50M cubic yards of concrete,

adding 50Q to Q=150-25P, gives us Q=200-25P or an

inverse demand function of P=8 -.04Q. Once again, solving

for Q, P, private consumption, CS, and PS, we get:

8 = .06Q, 133.33M = Q, P = $2.67

Private demand = 133.33M - 50M = 83.33M

(of course 2.67 = 6 -.04Q = 83.33 = Q)

CS = .5[83.33(6-2.67)] = $138.89M, -$61.11M

PS= 133.33[(2.67+1.33)/2] $266.67M, +$116.67M

Budget cost = $2.67*50M = -$133.33M

DS100QPD’246MC2.6783.33133.33ConsumerSurplus loss

Consumer surplus loss = $61.11M

DS100QPD’246MC2.6783.33133.33ProducerSurplus gainOld producerSurplus

Producer surplus gain = $116.67M

DS100QPD’246MC2.6783.33133.33Old producerSurplusTransfer to producerfrom consumersBudgetary Costof project

Budgetary cost of project =-$133.33M

DS100QPD’246MC2.6783.33133.33ProducerSurplus gainOld producerSurplusTransfer to producerfrom consumersSocial costof project

Net cost of project = -61.11 - 133.33+116.67 = -77.77 or [(100 83.33)(2+2.67)/2]+[(133.33-100)*(1.33+1)/2] =38.88+38.89 = -77.77