Question

A city is deciding whether to pay a locally owned construction firm to build a new bridge. The city would finance the construction by borrowing. They would raise local property taxes to collect $20M more per year than they would without the new bridge. (M stands for million.) The extra $20M per year would repay the loan and pay for maintenance and all other costs of operating the bridge during its 50 year lifetime. The government expects that the demand curve for crossings over the bridge will be linear, with a choke price of $8. They plan to charge no toll and expect that there will be 10M crossings over the bridge per year and almost never any traffic congestion. They expect that only city residents will cross the bridge. Assume that the government's expectations are correct. a.[4] Estimate the total consumer surplus that drivers will get by crossing the bridge during a typical year. Show how you get your answer. b.[5] Estimate the average cost of the service provided by the bridge when no toll is charged. Show how you get your answer. c.[5] The local construction firm could have borrowed money and used it to pay its cost of building the bridge. Then it could have operated the bridge and charged a profit-maximizing toll of $4.00 per crossing. There would be 5M crossings of the bridge per year in that case. The firm would have paid $20M per year to maintain the bridge, collect the tolls, and repay the loan. Estimate the firm's annual profit from this project. d.[6] The firm's profit in part c is much bigger than the government's profit if it operates the bridge without charging a toll. Explain why the city residents (including the firm's owner) would benefit much more if the city built and operated the bridge than if the firm operated it as in part c. Why does the firm's higher profit not matter for this conclusion?  

Answer 1