4. Suppose Ontario is deciding whether to enact a new tax. If the tax is enacted

Question

4. Suppose Ontario is deciding whether to enact a new tax. If the tax is enacted, it will bring in s700 million in revenue. But it could also hurt the economy. The chance of harm to the economy is small, just 1/5. But it would cost the country s1, 200 million in lost earnings. (The s700 million in revenue would still be gained, partially offsetting this loss.) Treat gains as positive and losses as negative. a. What is the expected monetary value of enacting the new tax? The government also has the option of conducting a study before deciding whether to enact the new tax. If the study's findings are bad news, that means the chance of harm to the economy is actually double what they thought. If its 21 findings are good news, then the chance of harm to the economy is actually half of what they thought. b. Suppose the government conducts the study and its findings are good news. What will the expected monetary value of enacting the tax be then? c. Suppose the government conducts the study and its findings are bad news. What will the expected monetary value of enacting the tax be d. Suppose conducting the study would cost s5,000. Will the government conduct the study? Explain your answer. (Assume they make decisions by maximizing expected monetary value.)

Explanation / Answer

a) Expected monetory value = 4/5*700 +1/5*(700-1200) = 460 million

b) EMV = 9/10* 700 +1/10*(-500)= 580 million

c) EMV = 3/5* 700+2/5*(-500) = 220 million

Yes they should do the study

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