Reference no: EM131933216
Question: Anne rides the subway at a cost of $1 per trip, but would switch if the price were any higher. Her only alternative is a bus that takes five minutes longer, but costs only 50 cents. She makes 10 trips per year. The city is considering renovations of the subway system that would reduce the trip by 10 minutes, but subway fares would rise by 50 cents per trip to cover the costs. The fare increase and reduced travel time both take effect in one year and last forever. The interest rate is 25%.
(a) As far as Anne is concerned, what are the present values of the project's benefits and costs? [Hint: If the perpetual annual benefit is B and the interest rate r, then the present value is B/r]. The city's population consists of 20,000 middle-class people, all of whom are identical to Anne, and 5,000 poor people. Poor people are either unemployed or have jobs close to their homes, so they do not use any form of public transportation. What is the net present value of the subway project for the city as a whole?
(b) Some members of the city council propose an alternative project that consists of an immediate tax of $1 per middle-class person to provide "free" legal services for the poor in both of the following two years. The legal services are valued at a total of $100,000 per year (Assume that this amount is received at the end of each of the two years). What is the net present value of the legal services project? If the city must choose between the subway project and the legal services project, which should it select?
(c) What is the "distributional weight" of each dollar received by a poor person that would make the present values of the two projects equal? Interpret your answer.
(d) What is the "distributional weight" of each dollar received by a poor person that would make the present value of the two projects equal if the legal services are made available to middle-income individuals and you are told that they are used by both poor and middleincome people in proportion to their population shares (but still financed exclusively by middle-income people)?
(e) Discuss the use of distributional weights in cost-benefit analysis.
For part a, the answer I got was $0.00 for net benefits, therefore my answers after I'm not really sure if I have done them right. Could someone help me with these questions so i can check with mine?
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