End of Chapter Exercises: Solutions
Chapter 12
1. Manufacturers in an urban environment are currently producing 25,000 widgets
per annum. Their gross revenue is $300 per widget and their variable costs are
$125 per widget. Air quality in the city has fallen to a level of 20 points measured
on a 0 to 100 point indicator. Three proposals are being considered to improve
the city’s air quality. Option 1 involves annual direct costs of $100,000 which
raises the index of air quality to 32; option 2 costs $130,000 per annum which
raises the air quality index to 42; and option 3 costs $150,000 per annum and
raises the air quality index to 50. In addition, producers are required to reduce
their output of widgets by: 5% under option 1, 10% under option 2, and 15%
under option 3. Three questions are posed:
(i) Which option has the lowest total opportunity cost?
(ii) Which option has lowest cost per unit of air quality improvement?
(iii)Why might neither of these represent the most efficient option?
Answer:
(i)
(ii)
(iii)
Option 1 has lowest total opportunity cost of $150,000
Option 2 results in the lowest cost per unit of water quality
improvement ($9,200)
We do not know how the value of ecosystem services and other
benefits respond to changes in water quality. Without that information
we cannot say which option maximizes net benefit. Adopting the
precautionary principle we would probably choose option 3.
2. Individuals A and B have the same money income, have the same tastes, and
face the same set of prices of all goods and services except that of access to a
National Park. Individual A lives further away from the Park than Individual B and
hence incurs a higher travel cost per visit. There is no admission charge to enter
the Park. The following data summarize their annual use of the Park:
Individual
A
B
(i)
(ii)
(iii)
(iv)
Answer:
(i)$25
(ii)$100
Travel Cost per Visit
$20
$10
Number of Visits p.a.
5
10
approximately how much consumer surplus does Individual A receive
per annum from her use of the Park?
approximately how much consumer surplus does Individual B receive
per annum from his use of the Park?
what is the approximate measure of the annual benefits to A and B
from their use of the Park?
why are the measures in (i), (ii) and (iii) “approximate”?
(iii) $125
(iv) assumption of a linear demand curve
3. A contingent valuation study was used to value improvements to a coral reef,
where, at present, the reef quality, measured in terms of percentage of reef
cover, is so poor that the local residents can no longer rely on the reef for their
supply of fish. The study sample, which included users (one-third) and non-users,
found the following estimates of average WTP.
Mean WTP ($ per annum)*
Scenario
Whole sample
Local users
Others
1. Increase reef $25
$45
$15
cover to 50%
2. increase reef $40
$70
$25
cover to 75%
3. increase reef $53.5
$95
$33
cover to 100%
* NOTE: In the textbook the column headings for this table are misaligned, one
column to the left.
(i)
(ii)
construct a demand curve for reef quality for: users; others; and
the whole sample and discuss the forms of these curves;
explain how this information could be used in a BCA to compare
management options to improve the quality of the reef.
Answer:
(i)
$50
$40
WTP
($)
Local users
$30
`
$20
$10
Whole sample
Others
25%
50%
75%
Percentage Cover
100%
(ii) Alternative management options (projects) to increase reef cover could be costed,
and, when assembled in ascending order in terms of marginal cost, and resulting
improvement in reef cover, a corresponding supply curve could be constructed,
showing the marginal cost of improvements to reef cover. The optimal management
option would then be identified as that combination of projects at which marginal cost
and marginal benefit are equal; ie. where the supply curve intersects the demand
curve for the whole sample. If its assumed that ‘others’ are non-users, the difference
between the users and non-users WTP could be used as a basis for setting a users’
entrance fee for the marine park.
4. Using the data provided in Example 12.4, calculate the net benefits of an
alternative road proposal that results in increased noise levels in Areas A and B
of 5 and 10 decibels respectively, and decreased noise levels in Areas C and D
of 2 and 8 decibels respectively.
Answer:
Area
A
B
C
D
Mean
Price
$250,000
$125,000
$400,000
$100,000
No.
houses
Change
in
Noise
level
% price
per unit
76
5
0.45
124
10
0.18
64
-2
0.92
60
-8
0.08
Net cost of change in noise levels
Cost ($ thous)
427.5
279.0
-471.0
-38.4
$197.1
Note that under this scenario there is a net increase in the cost of noise to the
community in comparison with the original example where there was a decrease in
noise cost of $18.4 thousand. To calculate the net benefits of the project, the
benefits/costs of changed noise levels would need to be added to other project
benefits and then compared with the cost of constructing the ring road, within a BCA
framework. That additional information has not been provided.