Cost-Benefit Analysis I. True or False. Please explain whether the following statements are true or false.
1) If a public construction project hires workers from a labor market with higher than usual
unemployment, then a CBA analyst should count the benefits of hiring those workers in their
calculation. 2) In a CBA, an analyst should monetize the benefits in nominal dollars, the costs in real dollars
and discount only the benefits using a nominal discount rate. 3) Suppose the Navy is buying 100 new computers to replace older and slower computers
across a few bases. A reasonable estimate of the opportunity cost of these computers in a CBA
is the budgetary outlay i.e., price of the computer times 100. 4) Suppose the Army Corps of Engineers has proposals for retrofitting five bridges with the
present value of the benefits (B) and costs (C) listed below.
Bridge
A
B
C
D
E Benefits
($millions)
40
25
30
10
15 Costs ($millions) Net Benefits B-C ratio 20
10
20
20
10 If the Army has a total budget of $50 million and can retrofit multiple bridges using that budget,
it should retrofit bridges A, B and C to maximize social welfare. [2 points] II. Theory of Consumer Choice
The city of San Francisco is concerned about security. It currently uses a combination of
security personnel and hi-definition surveillance cameras located across the city to monitor
threats. The price of security personnel is $50,000 each and the price of a camera is $2,000
each. Suppose San Francisco’s security budget is $100 Million.
1) Please write an equation describing NPS’s budget constraint pertaining to security on
campus and illustrate this budget constraint on the graph below. [2 points] 2) The preferences of SF’s mayor for buying personnel and cameras are represented by
indifference curves. The mayor’s preferences have the same properties as a consumer’s
preferences. On the graph above, identify the optimum consumption of personnel and cameras
given SF’s security budget and a representative set of preferences for SF’s mayor. [1 point] 3) Suppose the price of cameras falls to $1000 each. How does this change the budget
constraint? Write the equation and draw it on the graph below. [2 points] 4) Suppose after the price decrease in (3) the mayor’s consumption of cameras increases and
her consumption of personnel decreases (i.e., fewer personnel are hired at the new optimum).
Show the new optimum, using indifference curves above. [2 points]
5) Please describe in words the effects of the income and substitution effects on the
consumption of personnel and cameras following the decrease in the price of cameras. [3
points] III. Seaside Bike Trail
Seaside has decided to build a new bike trail for city residents if the present value of the
benefits exceeds the present value of the costs. The city has also decided to charge a user fee for
using the bike trail. LC recommends Seaside hire you to determine if the bike trail should be
built To help you with the CBA, LC calculates the following costs and benefits associated with the
project. Construction and maintenance costs
Environmental costs
Revenue from nonresidents
Revenue from residents
Monetized value of benefits to nonresidents
Monetized value of benefits to city residents Present Value (millions of
dollars)
13
5
2
12
3
18 1. Assuming you take a national perspective and the information made available by Dr. C,
would you recommend Seaside build the bike trail? [2 points] 2. Assuming you take a local city perspective and the information made available by Dr. C,
would you recommend Seaside build the bike trail? [2 points] 3. How does a local perspective, i.e., giving standing to Seaside’s residents, compared to a
national perspective change the calculation of costs and benefits? [1 points] 4. The mayor of Seaside is delighted with the project. He says: “This park is going to bring new
jobs to our city, increase tourism and generate significant benefits for our local workers.”
What is wrong with the mayor’s assessment of jobs created by the project? [2 points] 5. Please describe one method of calculating the willingness-to-pay for the benefits offered by
the bike trail? What is the major advantage and disadvantage of the method you selected? [3
points] IV. Cost Benefit Analysis
A landslide in Big Sur has closed a section of Highway 1 south of Monterey. Caltrans is
considering two policies to fix that section of Highway 1. The first cheaper proposal involves a
complete retrofit of the Pfeiffer Canyon Bridge that was damaged earlier this year and cleaning
up the debris from the road. The second proposal involves a complete retrofit of the Pfeiffer
Canyon Bridge, cleaning up the debris and widening that section of the highway to add one
more lane that would improve traffic and reduce fatal accidents along the Highway. Residents and tourists heavily use Highway 1 so there are many people who could potentially
benefit from these projects. Imagine the California Department of Transportation has asked you
to carry out a Cost Benefit Analysis of the two proposals to help them with the decision-making
process. You are told you should use only the following information:
PROPOSAL 1 The proposed bridge retrofit and debris cleanup will take 2 years to complete. It will
require $30 million in construction costs and $15 million in labor costs (assume that the
markets for labor and materials are competitive). When finished, the retrofitted bridge will decrease travel time for both tourists and
residents. Assume there are 20,000 residents that will have their transport time reduced by
10 hours per year and 200,000 tourists that will have their transport time reduced by 2
hours per year as compared to the pre-retrofit transport time. Both residents and tourists
value their time at $15 per hour. PROPOSAL 2 The proposed bridge retrofit and debris cleanup will take 2 years to complete. It will
require $30 million in construction costs and $15 million in labor costs (assume that the
markets for labor and materials are competitive). The proposed widening of the highway will take 4 years to complete. Caltran will begin
work on the widening of the highway at the same time as the bridge retrofit. The widening
of the highway will require $50 million per year in construction costs and $25 million per
year in labor costs (assume that the markets for labor and materials are competitive). When finished, the retrofitted bridge and widened highway will decrease travel time for
both tourists and residents. Assume there are 20,000 residents that will have their
transport time reduced by 20 hours per year and 200,000 tourists that will have their
transport time reduced by 4 hours per year as compared to the pre-retrofit transport time.
Both residents and tourists value their time at $15 per hour. The improved highway is also
estimated to lead to a reduction of 20 fatalities per year. You are instructed to assume the government has a 4% discount rate. Assume both projects
begin in year 0 and run for 30 years, from t = 0 to t = 29. Furthermore, all costs and benefits
described above are in real, year t=0 dollars. Under Proposal 1, the benefits begin in year 2 and
accrue till the end of the project. Under Proposal 2, the benefits begin in year 4 and accrue till the
end of the project. You can use Excel for the calculations.
1. What are the two courses of action you are tasked to consider? 2. List in words the cost and benefits that you are asked to consider for both proposals. 3. Find the net present value of Proposal 1 assuming you take a national perspective. You may
use excel for your calculations and attach the spreadsheet to the solutions. 4. You realize that the value of a life saved is not given to monetize the benefits of Proposal 2.
Briefly describe in words (not numbers) one way you may estimate the value of these lives. 5. Find the net present value of Proposal 2, assuming that the value of a life is $5 million and
you take a national perspective. You may use excel for your calculations and attach the
spreadsheet to the solutions. 6. Which proposal maximizes economic efficiency?

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