Suppose the government is trying to determine how to deal with pesticide contamination of its water supply. It wants to undertake a benefit-cost analysis of two alternative policy options for controlling pesticides: 1. Upgrade its municipal water treatment plant to remove the pesticides, or 2. Banning the use of the offending pesticides in the metropolitan area, Assume that either technique reduces pesticides to a level which does not adversely affect human health. The cost of these control options are as follows: Municipal treatment upgrades: Capital Costs $8 million. The new plant is constructed over one year. It starts operating at the beginning of year two. Once the plant begins operation, it has operating costs of $500,000 per year.
Suppose the government is trying to determine how to deal with pesticide contamination of its water supply. It wants to undertake a benefit-cost analysis of two alternative policy options for controlling pesticides: 1. Upgrade its municipal water treatment plant to remove the pesticides, or 2. Banning the use of the offending pesticides in the metropolitan area, Assume that either technique reduces pesticides to a level which does not adversely affect human health. The cost of these control options are as follows: Municipal treatment upgrades: Capital Costs $8 million. The new plant is constructed over one year. It starts operating at the beginning of year two. Once the plant begins operation, it has operating costs of $500,000 per year.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Suppose the government is trying to determine how to deal with pesticide contamination of its water supply. It wants
to undertake a benefit-cost analysis of two alternative policy options for controlling pesticides:
1. Upgrade its municipal water treatment plant to remove the pesticides, or
2. Banning the use of the offending pesticides in the metropolitan area,
Assume that either technique reduces pesticides to a level which does not adversely affect human health. The cost of
these control options are as follows:
Municipal treatment upgrades: Capital Costs $8 million. The new plant is constructed over one year. It starts
operating at the beginning of year two. Once the plant begins operation, it has operating costs of $500,000 per year.
Once constructed, the plant lasts for 5 years, then it must be replaced with a new plant. (hint: let construction year be
"year 0")
Pesticide Ban: Annual operating costs due to substitution of non-toxic methods of controlling "pests" = $4.75 million
per year. These costs would last forever.
The benefits of the pesticide control are many. But suppose the only information the government has that is related to
the benefits of controlling pesticides is the following:
Households have switched from using tap water for consumption to bottled water because of the contamination.
Before the pesticide contamination, the demand for bottles water was given by the following function:
Qt=160-10P,
Where Q is consumption per household per year of bottled water and P, is the price per bottle.
After contamination occurs, the demand curve shifts to:
Q = 200-10Pt
Assume that the price of bottled water is $4 per container and the price stays constant even after the demand shift.
There are 10,000 households in the community. Further assume that the social discount (interest) rate is 8%
1. What control option should the municipality choose? Defend your answer by computing the present value of net
benefits for each control option. Show how you obtained your results using graphs, formulas and all computational
work. No credit will be given for swers that do not show how the calculations were derived.
2. Redo (1) assuming the discount rate is 4%. What option should the municipality choose?
3. What interest rate makes the municipality indifferent between the two options?
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