(10pts.) Consider a low-wage labor market. Workers in this market are not presently covered by the minimum wage, but the government is considering implementing such legislation. If implemented, this law would require employers in the market to pay workers a $5 hourly wage. Suppose all workers in the market are equally productive, the current market clearing wage rate is $4 per hour, and that at this market-clearing wage there are 600 employed workers. Further, suppose that under the minimum wage legislation, only 500 workers would be employed and 300 workers would be unemployed.
Finally, assume that the market demand and supply schedules are linear and that the market reservation wage, the lowest wage at which any worker in the market would be willing to work, is $1.
Compute the dollar value of the impact of the policy on
c. Society as a whole.
4. (10pts.) Suppose the government is considering an increase in the toll on a certain stretch of highway from $.40 to $.50. At present, 50,000 cars per week use that highway stretch; after the toll is imposed, it is projected that only 40,000 cars per week will use the highway stretch.
Assuming that the marginal cost of highway use is constant (i.e., the supply schedule is horizontal) and equal to $.40 per car, what is the net cost to society attributable to the increase in the toll? (Hint: The toll increase will cause the supply schedule, not the demand schedule, to shift.)
Because of the reduced use of the highway, the government would reduce its purchases of concrete from 20,000 tons per year to 19,000 tons per year. Thus, if the price of concrete were $25 per ton, the government’s cost savings would be $25,000. However, the government’s reduced demand for concrete causes its market price to fall from $25 per ton to $24.50 per ton. Moreover, because of this reduction in price, the purchases of concrete by non-government buyers increase by 300 tons per year. Assuming that the factor market for concrete is competitive, can the government’s savings of $25,000 be appropriately used as the measure of the social value of the cost savings that result from the government purchasing less concrete? Or would shadow pricing be necessary?
Section II: Problem Solving (60 pts.)
“The state of Connecticut announced last week that it would build nine “microgrids” to deliver more reliable power, including at the police station in Bridgeport, the naval submarine base in Groton, the St. Francis Hospital in Hartford, and the campus of Wesleyan University. The cost to taxpayers: $18 million.
Some readers might say: $18 million? For, what, some backup generators? And what is a microgrid anyway?
It is no coincidence that Connecticut is pushing the envelope of power innovation. Last October, Hurricane Sandy knocked power out to 625,000 homes and businesses, revealing how inadequate the the power system is in the face of superstorms. “Today marks another step forward for how we handle extreme weather,” said Connecticut Governor Dan Malloy.
Sounds great, but it won’t be cheap. The $18 million price tag for Connecticut’s new microgrids doesn’t even include the new sources of power they will require. The networked power system of the 21st Century is mind-bogglingly complicated, and is still being invented.
Source: Ferris, David. “Microgrids: Very Expensive, Seriously Necessary.” Forbes. Accessed November 30, 2018.https://www.forbes.com/sites/davidferris/2013/07/31/microgrids-very-expensive-seriously-necessary/.
The proposed nine microgrids will be built in 2019 and satisfy the need for increased coastal resilience if the project passes the NPV test in a Benefit Cost Analysis. The microgrids have a construction cost of $18 million, 70% of which will be spent in year 0 and 30% in the next year. The project will cost the state $ 250,000 to
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EEC 440|Take-Home Exam 2 Due: Tuesday, December 8 by 11:00am submitted to Brightspace-Assignments
maintain and operate each year starting with year 1. The benefits of the project are estimated at $3 million each year starting with year 1. The microgrids are losing efficiency with increased use and that makes the benefits decline at a constant rate of 3% each year. However, the rate of decline can be higher (5.5%) or lower (1.5%) depending on the assumption of the number of extreme weather events that will take place during the life time of the microgrids. The system is expected to last 15 years before major components need to be replaced. State regulations require the use of a nominal interest rate of 7%. The average inflation rate has been estimated at 2.5% but it may be low as 1% or as high as 3%. The state expects to incur a cost of disposing safely of the microgrids’ components in year 15. Many of these components contain elements that are hazardous to human health and the environment. The safe disposal cost was estimated at $300,000 but this estimate comes from a range of $150,000 and $1 million.
a. (30pts) Compute NPV1 for the nine-microgrid project and make a recommendation to the governor of CT.
b. (10pts) Conduct a Best and Worst Case Sensitivity Analysis. How, if at all, will NPV and recommendation change due to this uncertainty? (Computations needed)
c. (2pts) Find the IRR of this project.
d. (18pts)The NPV estimated above was based on the assumption that the annual benefits are certain.
However, consider that the benefits of the microgrids are based on whether or not an extreme weather event occurs and the state uses the microgrids as a way to deal with power outages in the affected areas. The state does not trust this annual benefit estimate and wants to perform an analysis and find the NPV based on an expected value of annual benefits. The state already estimated that when there is an extreme whether event such as a Category 4 super storm, the benefits from the microgrids will be $2million annually, for a Category 3 storm, benefits will be $1.2 million annually, and for a Category 2 or less storm the benefits will be of $500,000 each year. Probabilities of the three event categories are presented below. Further, assume that there is no rate of decline in benefits but all other parameters and assumptions stay the same as described above. How does the NPV change?
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