A policy maker decides that the government should build a dam across a river to protect downstream residents from costly floodings, even though the costs are greater than the benefits. Is the policy maker necessarily behaving irrationally? If not, why might the policy maker plan
the project?
Redwood National Park in northern California contains the tallest known redwood tree, as well as a remnant of the coastal redwood ecotype that once dominated coastal California. It does not receive many visitors: It has been estimated that no more than 5,000 visitors go each year, each spending an average of 3 days, for a total of 15,000 recreation visitor-days (RVDs) per year.
When Redwood National Park was acquired by the federal government from private timber companies (who intended to manage it for redwood lumber), it cost approximately $600 million.
(a) Assuming that the government will keep the national park forever, the initial cost can be converted into an annual cost by supposing that the government finances this purchase through the emission of a perpetuity with a present value of $600 million. What would then be the annual cost of Redwood National Park if the interest rate is 10%?
(b) What is the opportunity cost of the establishment of the park, in terms of use of the land?
(c) Why is it useful to calculate the annual cost of the park in this example? (Hint: we are about to compare benefits to costs.)
(d) What would the benefits per RVD have to be if recreational use were the only justification for Redwood National Park, and if the net present value of the park were to be nonnegative? If recreation were the only justification for the park, do you think that purchasing the park is likely to have been a good decision from a cost-benefit analysis perspective?
(e) What other justifications might exist for establishing Redwood National Park?
(f) There are approximately 100 million households in the United States. How high would average annual household willingness to pay for Redwood National Park have to be to justify the purchase?