Imagine you are the governor of Massachusetts 25 years ago and need to decide if

Question

Imagine you are the governor of Massachusetts 25 years ago and need to decide if you should support the “Big Dig” highway and bridge construction project.

The Big Dig is estimated to take 7 years to complete. The project will require $45 million in construction materials per year and $20 million in labor costs per year. In addition, the construction will disrupt transportation within the city for the duration of the construction. The transportation disruption lengthens transport times for 100,000 workers by 30 hours a year. All workers are paid $15 per hour (assume that there are no distortions and that the wage reflects each worker’s per-hour valuation of leisure).

The Big Dig, when finished, will ease transportation within the city. Each of the 100,000 workers will have their transport time reduced by 35 hours a year as compared to the preconstruction transport time. In addition, part of the Big Dig project involves converting the space formerly taken up by an elevated highway into a large park. The State of Massachusetts has determined that each worker will value the park at $40 per year. We will assume that no one else will use the park.

We also assume the government has a 5% discount rate and that the workers live forever. The benefits to the Big Dig begin in year 7, assuming the project begins in year 0 (i.e., the project runs for 7 years, from t = 0 to t = 6).

A) Should you, as the governor, proceed with the project? Formally show the cost-benefit analysis.

B) It occurs to you, after completing the calculation in part a, that it is possible the cost estimates are uncertain. If the construction materials estimate is $45 million with 50% probability and $100 million with 50% probability, should the project proceed? Assume that the government is risk n

Explanation / Answer

Answer:

A)

The governor should proceed with the project, as the net benefit is huge and positive.

B)

The revised expected cost of materials = 100m*50%+45m*50% = $72.5 million

So the revised estimates are:

The net benefit is negetive. So he should not go ahead with the project.

Particulars In$ Annual Benefit - Y=7 onwards 1 Value of transport time saved 52500000 (100000*35*15) 2 Value of the park 4000000 (100000*40) 56500000 Annual Cost for Y=0 to Y=6 1 Construction Material 450,00,000 2 Labor Cost 200,00,000 3 Cost of transport time 450,00,000 (100000*30*15) 1100,00,000

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