04 Jun Question FULL NAME(S): (1) __________________________ (2) _____________________________ 3/30/15 ECON 345: ECONOMICS OF PUBLIC PROGRAMS
Question
FULL NAME(S): (1) __________________________ (2) _____________________________ 3/30/15
ECON 345: ECONOMICS OF PUBLIC PROGRAMS
MINI-CASE: COST-BENEFIT ANALYSIS OF PUBLIC PROJECT (Chap. 8) [10 POINTS]
Program Background:
CAFE (Corporate Average Fuel Economy) standards require that the average fuel economy of all the cars that a car manufacturer sells must meet a certain target of 30 miles per gallon (mpg) or the manufacturer must pay a penalty. CAFE standards were imposed after the oil crises in the 1970s to reduce US dependence on foreign oil. The imposition of CAFE standards has been accompanied by a rise in average fuel economy cars. Most fuel efficient cars give less protection in car accident because they are made of less strong, lightweight materials. However, they reduce gas usage and pollution. Question: Should the US raise CAFE standards to 35 mpg?
Program Input:
In order to evaluate the economic merits of CAFE standards of 35 mpg, the following data was collected by your research team:
1. On-time Research & Development R&D cost and other initial investment expenditures are estimated to be $500M, with half of that amount occurring during the first year and the other half over the second year.
2. New cars will cost $100 more, and that there will be 10M cars sold per year.
3. It is expected that there would be 100 more fatalities per year in traffic accidents. Life is valued at $3M on average.
4. Individuals will use $10 less in gas/year. Assume there are 100M cars in the US and that all cars get the same savings of $10 every year.
5. The new CAFE standards is expected to reduce pollution of the environment, which is valued at $225M/year.
6. It is also expected that the military budget will be reduced by $100M/year because the US will conduct less military actions in the Persian Gulf.
7. Assume all future payments, benefits or costs, other than the cost of R&D and the initial investment expenditures, will occur in perpetuity.
8. You are required to evaluate this program using three social discount rates (r): 5%, 7% and 10%.
Required work:
A. Clearly categorize the input above into the project costs and benefits; then, compute the Net Present Discounted Value of the project, using each social discount rate separately.
B. Based on your results in (A), which result suggests the project should be accepted or rejected.
C. Why do you believe the choice of the social discount rate (r) matter? What does a high r implies about society choice betw
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