lOMoARcPSD|33487588
Sample/practice exam 2015, questions and answers voorbeeld tentamen van docent.
Cost-Benefit Analysis: Theory and Applications (Technische Universiteit Delft)
Studeersnel wordt niet gesponsord of ondersteund door een hogeschool of universiteit
Gedownload door Andro Anna (androloveanna@gmail.com)
lOMoARcPSD|33487588
Final Exam: SPM9716 Cost-Benefit Analysis (CBA)
(SOLUTIONS ON PAGE 3)
PART A: THEORY
Question 1:
Regarding the conceptual foundations of cost-benefit analysis (CBA), identify and briefly
explain two types of circumstances that make the net benefits criterion of CBA an
inappropriate decision rule for public policy decision making.
Question 2:
a. Briefly define information asymmetry.
b. In the absence of government intervention, describe two effects of information asymmetry
and use a diagram to illustrate these two effects.
Question 3:
Construction of the pool would result in the citizens of Dryville purchasing
more bathing suits and sun tan lotion than they would without the pool. Do these
purchases need to be explicitly taken into account in estimating the benefits and costs
resulting from building the pool? Please explain, mentioning any factors and assumptions that
might be important in determining whether or not the purchases need to be taken into account.
Question 4:
Guardians tend to use a high social discount rate. Explain what motivates them to use this
approach.
PART B: CASE ANALYSIS
Question 5:
Due to increasing cases of residential break-ins, a city decides to add police patrol in
residential areas. The police patrol costs the city an extra €400,000 per year that will be paid
from the taxpayers money. However, as a result, the amount of break-ins falls. Specifically,
without the police patrol, the residential break-ins would cost the municipality €700,000 per
year. Next, suppose the burglars can sell the items that they got from the break-ins and cash
out €450,000 per year. What is the net social benefit/loss resulting from the police patrol
program:
a. if the burglars are given standing?
b. if the burglars are not given standing?
Question 6:
(5 points) To mitigate global warming, a project is initiated to reduce the level of greenhouse
gas. An analyst estimates that the greenhouse gas build-up imposes a net cost of $1 trillion in
400 years’ time. Compute the NPV of the net cost of the greenhouse gas at a time-constant
discount rate of 2 percent.
Question 7:
An Alaskan company has received a governmental franchise, in perpetuity, to build a pipeline
from Alaska to Southern California. The pipeline will transport fresh melted glacier water to
thirsty residents of the Golden State. The project will take nine years to complete at a cost of
$24 million per year. The first water will flow 12 months later after the project completes.
Page 1 of 5
Gedownload door Andro Anna (androloveanna@gmail.com)
lOMoARcPSD|33487588
The company assumes that it can raise water rates by 4% per year. The social discount rate is
8%. What is the minimum first year’s payment that will allow the company to just breakeven?
Question 8:
Suppose that a country’s government is evaluating seven programs that are targeted at welfare
recipients, i.e. the participation of an especially disadvantaged group. The government has
asked an analyst to conduct cost-benefit analyses for these seven programs. The findings of
the analyst are as follows:
Programs
Net social benefits
Net benefits for
disadvantaged group
Program 1
3,600
900
Program 2
2,500
-500
Program 3
-1,800
-200
Program 4
600
-1,000
Program 5
-500
100
Program 6
1,200
-300
Program 7
-800
1,000
a. Compute internal distribution weights for the programs.
b. If it is only based on the weights you found in question (a) above, indicate which project(s)
might actually be undertaken.
c. Considering a mutually exclusive project, which project should be chosen and briefly
specify the circumstances of the choice.
Question 9:
Suppose that due to the reduced use of a local highway, the local government would reduce its
purchases of concrete. As a result, there is a reduction in the quantity of concrete supplied
from 5 million to 4 million cubic meters per year. The reduction in the concrete produced
will drive the concrete price down from $4 per cubic meter to $ 3.5 per cubic meter. In
addition, the elasticity of demand in the concrete market at the new equilibrium is -0.25.
a) From the perspective of concrete producers, calculate the change in the producer surplus
and report whether it is a gain or a loss.
b) Calculate the change in the consumer surplus and report whether it is a gain or a loss.
c) Calculate the change in the social surplus and report whether it is a gain or a loss.
*** End of Exam ***
Page 2 of 5
Gedownload door Andro Anna (androloveanna@gmail.com)
lOMoARcPSD|33487588
Solutions:
1.
(1) CBA has technical limitations that may make it impossible for analysts to quantify and
monetize all relevant impacts as costs and benefits (to compute the net benefits); (2) CBA has
one goal, i.e. efficiency. However, there are policies that have goals other than efficiency (e.g.
equality of opportunity, expenditure constraints, etc.).
2.
a. Information asymmetry is when
information about a product or a job may not be
equal on both sides of a market.
b. Two effects of information asymmetry:
(1) by raising the price and the amount of the
good purchased, information asymmetry
increases producer surplus and reduces consumer
surplus, resulting in a transfer from consumers to
sellers (area PuacPi). (2) by increasing the
amount of the good sold relative to the full
information case, information asymmetry results
in deadweight loss (area abc).
3.
If the increased demand for bathing suits and sun tan lotion doesn't drive up their prices,
which seems likely, these purchases do not have to be taken into account in estimating the
benefits and cost resulting from building the pool. This also presumes that the production and
purchases of bathing suits and sun tan lotion are not associated with any important market
distortions. Given an absence of price increases and market distortions, impacts in secondary
markets, such as those for bathing suits and sun tan lotion, will be fully captured by the
demand curve in the primary market.
4.
Answer: Because guardians know that using a high discount rate will make it more difficult to
justify most projects because costs usually occur before benefits. Thus, they can limit
spenders, who, in their view, overestimate benefits, underestimate costs, and generally use
money less efficiently than the private sector.
5.
Answer:
As a result of the police patrol program, the insurance companies (or the citizens) save
€700,000 (benefits), taxpayers incur costs of €400,000 and the burglars incur costs of
€450,000.
a. If the burglars are given standing, society suffers a €150,000 net loss:
€700,000 - €400,000 - €450,000 = -€150,000.
b. If the robbers are not given standing, society enjoys a €300,000 net benefit from the police
patrol program:
€700,000 - $400,000 = $300,000.
Page 3 of 5
Gedownload door Andro Anna (androloveanna@gmail.com)
lOMoARcPSD|33487588
6.
Answer:
NPV = $1,000,000,000,000 x e-(0.02 x400) = $335,462,628.
Note: If you do not give the final number ($335,462,628) due to the limitation of your
calculator function but do show the computation ($1 trillion x e-(0.02 x400)), you will still get the
full points. Naturally, if you show both the computation and the final number, you will also
get the full points.
7.
Answer:
This problem involves a nine-year annuity, a growing perpetuity, and a perpetuity. To break
even, the PV of the benefits (i.e. revenues) must equal the PV of the costs. The PV of the
project’s cost is: PV (Costs) = $24M (1/0.8) [1-1/(1.08)9] = $150M.
If revenues start in year 10 and grow at 4% per year, the PV today (year = 0) is: PV
(Revenues) = [C/(0.08-0.04)][1/(1.08)9]
Note that the first term in square brackets finds the PV in year 9 of a growing perpetuity
starting in year 10, while the second term in square brackets discounts this value back nine
years to the present. Setting this equal to $150M and solving for C find:
$150M = [C/0.04][0.500] C = $12M
Thus, the firm should charge $12 M the first year and 4% higher each subsequent year.
8.
Answer: a. To compute internal distribution weights, we first need to calculate the net benefits
for advantaged (nonparticipant) group which is equal to: net social benefits – net benefits for
disadvantaged group. We then look for programs that result in a trade-off between efficiency
and distribution (that is, when net benefits for disadvantaged group and net social benefits
are of the opposite sign). For programs that have the trade-offs, their internal distribution
weights are simply net benefits for advantaged (nonparticipant) group divided by net benefits
for disadvantaged (participant) group.
Programs Net benefits for
Net benefits for
Net Social
Internal
disadvantaged
advantaged
Benefits
Distribution
(participant) group (nonparticipant)
Weights
group
Program 1
900
2,700
3,600
n.a.
Program 2
-500
3,000
2,500
6.0
Program 3
-200
-1,600
-1,800
n.a.
Program 4
-1,000
1,600
600
1.6
Program 5
100
-600
-500
6.0
Program 6
-300
1,500
1,200
5.0
Program 7
1,000
-1,800
-800
1.8
b. If it is only based on the weights, program 4 and program 7 should be considered (note as
mentioned in the theory, the distributional weights should be between 1.5 and 2.0).
c. Between these two programs, if it is based on pure/standard CBA (K-H criterion), program
4 would be undertaken as it delivers a higher net social benefit than program 7 (600>-800);
while if it is based on the highest net benefits for the disadvantaged group, program 7 should
be selected.
Note: If you answer project1 based on the highest NSB, you will also get the full point.
Page 4 of 5
Gedownload door Andro Anna (androloveanna@gmail.com)
lOMoARcPSD|33487588
9.
a. Answer: Since there is a decrease in the concrete price and in the quantity of concrete
produced, the concrete manufacturers will experience a loss in their producer surplus.
The reduction in producer surplus can be measured as follows:
(.5)($4-$3.5)(1 million) + ($4-$3.5)(4 million) = $2.25 million/year
b. Answer: Since consumers will now have to pay less for each cubic meter of concrete,
they will experience a gain in their consumer surplus.
To measure the gain in consumer surplus, we must first estimate the change in quantity
demanded due to the reduction in price once the demand schedule shifts:
-.25 = (∆q/∆p)(p/q)
∆q = (-.25)(∆p)(q/p)
∆q = (-.25)(-$0.5)[(4 million)/($3.5)]
∆q = .14 million/year
The gain in consumer surplus is thus:
(.5)($4-$3.5)(.14 million)+($4-$3.5)(4 million-.14 million) = $1.965 million/year.
c. Answer: Since the loss in producer surplus exceeds the gain in consumer surplus, this
will create a loss in social surplus. The loss in social surplus in this secondary market
is $2.25 million - $1.965 million = $0.285 million/year.
Page 5 of 5
Gedownload door Andro Anna (androloveanna@gmail.com)