Question

1. Suppose a government is considering the following proposed projects (all amounts are in millions). Use the Kaldor-Hicks criterion in answering the questions. Benefits to consumers $200 $550 $450 $100 Costs to firms Government's cost Project Arm Project Bull Project Cage Project Dip $50 S60 $50 $10 $100 $400 $300 $100 (a) Which projects would you recommend be adopted if at most two projects can be constructed in the area? Explain., (b) Now suppose the constraint changes. Assume the government has $800 million to be spent on such projects. If it is possible to replicate particular projects, what would you recommend, and why? (c) If you learn that the government's cost estimate for Project Bull includes a $100 million charge for work completed two years ago, would your recommendations for (a) and (b) change? Explain. (d) If you learn that the government's cost estimate for Project Arm consists entirely of wages paid to currently unemployed workers, while the other three projects involve no such hiring, would your recommendations change? Explain!?

Answer 1

1. If at most two projects can be constructed, I would recommend building Project Bull and Project Cage. The reason for selection of these two projects is that the net benefit from these two projects is maximum which can be used to compensate the cost to firms and Government. Net benefit to consumers: Project Arm ($200-$50-$100) i.e.$50m; Project Bull ($550-$60-$400) i.e.$90m; Project Cage ($450-$50-$300) i.e. $100m; Project Dip ($100-$10-$100) i.e. loss of $10.
2. If the government has $800m to spend on these projects, I would recommend building Project Bull, Project Cage, and Project Arm, since net benefits to consumers can be maximized and excess funds generated can be used to compensate losing parties.
3. If government's cost estimate for Project Bull includes a $100m charge for work completed two years ago, my recommendations will still not change because:
   • for (a) the net benefits to consumers will still be maximized only by building Project Bull and Project Cage (if only two projects are to be built),
   • for (b) the net benefits to consumers, will be maximized by foregoing Project Dip: (If we forego Project Dip) Total benefits - Cost to firms - Cost to Government ($1200-$160-$700) i.e. $340m; (If we do not forego Project Dip) Total benefits - Cost to firms - Cost to Government ($1300-$170-$800) i.e. $330m
4. Even if the government's cost estimate for Project Arm consists entirely of wages paid to currently unemployed workers, my recommendations would not change since the net benefits to consumers will be maximized when we initially built Project Bull and Project Cage only (if only two projects can be built).