Reference no: EM133416310
Problem 1.
Suppose you are an economist at the US Army Corps of Engineers. The Corps is considering whether to build a dam (such as the Kinzua Dam) to prevent flooding on a major river. The Corps asks you to conduct a cost benefit analysis of the project. The dam is expected to be in service for over 100 years, so you can assume the time horizon is essentially infinite. You have the following information:
Estimated costs:
• $1 billion in construction costs in the first year
• $10 million in maintenance costs every year, forever
Estimated benefits:
• $20 million in property damage avoided every year, forever
• 3 flooding deaths prevented every year, forever
a. Assume r=3% and the value of a statistical life is $10 million. Calculate the present value of net benefits for the dam. Do you recommend that the project be approved?
b. Assume the VSL is still $10 million. How big would the discount rate have to be to change your recommendation of the dam's approval? (In other words, find r such that the present value of net benefits is zero)
c. Assume r=5%. How big would VSL have to be to justify the dam's construction based only on the benefits in terms of flooding deaths prevented?
d. In your opinion, should the dam be constructed? Explain your answer with reference to the discount rate and the value of a statistical life.
Problem 2.
Consider the East Palestine derailment of the Norfolk Southern train. After the train derailed, it released toxic pollutants into the community of East Palestine. One major concern for the residents of East Palestine is the decline in their home values.
a. Explain using the hedonic price theory why residents in East Palestine would be rightfully concerned about a potential decline in property values after the spill.
b. Assume a new renter moves to East Palestine after the train derailment. Using hedonic price theory, explain why cleaning up the pollution may not make the renter any better off.