Question

1. There is a small pool of oil in a remote wilderness area in a northern state. Geologists expect it to yield a net profit of $50 million at today’s prices for five years, and then fizzle out. Assume that $50 million can be taken immediately. Economists think the relative price of oil (and net profits) will rise at 4%, and the government has agreed to use a real discount rate of 3% for the oil project calculations. Environmentalists argue convincingly that if the oil is drilled, there is a risk of killing off the last remaining wolverines in the state; this would imply destruction of a specific sub-species. A careful assessment of naturalists’ enjoyment of these wolverines was provided in a contingent valuation survey. The payment card method in the survey demonstrated a mean willingness-to-pay of $5 per year per household perpetually. Environmentalists argue that since incomes in the state are increasing, these benefits will grow at 1% forever, and they accept the above discount rate. They also suggest that the population of the state is 1 million households for net benefit aggregation purposes. What are the net social benefits of the oil project, taking environmental costs into account? If the project is postponed by 1 year for more research, how will the results change? Do you think the residents of the state are the only beneficiaries of the existence of the wolverines—how would this issue change your benefits aggregation and net social benefits? [Hint: review material from Chp. 6 regarding discounting with growth formulas in perpetuity.]

2. What are 2 sources of bias in a contingent valuation survey, and what are the remedies for this bias?

3. Consider a project that would involve purchasing marginal farmland that would then be allowed to return to wetlands capable of supporting migrant birds. Researchers designed a survey to implement the dichotomous choice method. They reported the following data:

Stated Price (annual payment in dollars)	Fraction of Respondents Accepting Stated Price (percent)
0	95
5	90
10	80
15	70
20	50
25	35
30	15
35	10
40	5
45	4
50	0

What is the mean WTP for this population?

Answer 1

1)

	Computation of net social benefit
		In millions
		Now	Year 1	Year 2	Year 3	Year 4
	Net profit from pool of oil	$                  50.00	$                  52.00	$                  54.08	$                  56.24	$                  58.49
			(50*104%)	(52*104%)	(54.08*104%)	(56.24*104%)
	Discount factor @ 3%	1	0.9709	0.9426	0.9151	0.8885
	Present value of net profit	$                  50.00	$                  50.49	$                  50.98	$                  51.47	$                  51.97
	NPV of net profit	$               254.90
	Amount to be paid to villagers (PV)	=Amount to paid*(1+growth rate)/(discount rate-growth rate)
		=1 million*$5*(1+0.01)/(0.03-0.01)
		252.5
a.	Net social benefit	=$254.90-252.5
		$                    2.40
b.	Net social benefit, if project is delayed by 1 year
		In millions
		Now	Year 1	Year 2	Year 3	Year 4	Year 5
	Net profit from pool of oil	$                         -	$                  50.00	$                  52.00	$                  54.08	$                  56.24	$                  58.49
				(50*104%)	(52*104%)	(54.08*104%)	(56.24*104%)
	Discount factor @ 3%	1	0.9709	0.9426	0.9151	0.8885	0.8626
	Present value of net profit		$                  50.00	$                  50.49	$                  50.98	$                  51.47	$                  50.46
	NPV of net profit	$               253.39
	Amount to be paid to villagers (PV)	=Amount to paid*(1+growth rate)/(discount rate-growth rate)*PV @ 3%,1year
		=(1 million*$5*(1+0.01)/(0.03-0.01))*0.9709
		$               245.15
	Net social benefit	=$253.39-245.15
		$                    8.24
c.	No, there can be other beneficiaries also
	This issue can increase benefit benefit aggregation and can decrease net social benefit