A state with a population of 20M (M for million) and a normal level of economic activity, with 5% unemployment and no inflation, is considering spending $200M to build a laboratory for a foreign firm. In return, the firm will bring 70 foreign researchers and technicians to the state to work in the lab during a 40 year period and will pay them a total of $7M per year. Lab construction will be financed by borrowing at a 6% annual interest rate. It will cost the state $14M per year to pay off the debt over 40 years. Out of the total cost of building the lab, $100M will be spent on local value added (LVA). The foreign firm will spend $.5M per year on LVA to maintain the lab. State residents and the foreign researchers and technicians will have the same 50% marginal propensity to consume LVA. A state agency made the following estimate of the present value of net benefits of the project. The foreign researchers brought to the state will be paid a total of $7M/yr and will spend about $3.5M/yr on state LVA and the foreign firm will spend another $.5M/yr on maintenance. The $100M spent on LVA to build the lab has an annualized value of (.06)$100M = $6M/yr. Adding these annualized expenditures and multiplying by a multiplier of 2 yields $(4 + 6)M2 = $20M/yr. The annualized cost of $14M/yr is smaller, so the state gets positive net benefit.

a.[6] The state agency estimated that a $100M income would have an annualized value of $6M/yr. What is the meaning of an annualized value in this situation? Is the procedure the state agency followed to calculate the annualized value of $100M of income appropriate? Explain.

b.[4] Explain what local value added (LVA) is and why it is relevant for a cost benefit analysis.

c.[8] Use the methods of this course to estimate the net generated income state residents would receive from the lab construction alone. (To estimate means to give a number that is your estimate.) Explain each of your steps in arriving at your estimate. Make your explanation understandable to someone who has studied principles of microeconomics, but no other economics. Explain how your steps differ from those of the state agency.

d.[7] Estimate the annual net generated income state residents would get from the spending on LVA by the foreign researchers. Compare your estimate to the state agencys estimate of the benefit state residents would get from this spending. Explain how and why they differ.

e.[4] Estimate the present value (at the beginning of the project) of the stream of annual net generated income amounts estimated in part d. You can get 3 points for part e if you explain how to get an reasonable estimate even if you did not answer part d.

f.[3] Suppose that when the agency did its cost benefit analysis the construction cost was uncertain, with an expected value of $200M. The actual cost could have been higher or lower than that. How should this uncertainty have affected the agencys estimate of the net benefit state residents get from the project? Explain.

g.[4] Business property values near the lab would be expected to rise as a result of the project. Should this property value increase be added to the net generated income from parts c and d in an estimate of the residents net benefit from the project? Explain.

h.[6] If there was exceptionally high unemployment (say 10% instead of 5%) at the location where the lab was to be built and throughout the state, how would it change your best estimate of the net benefit state residents get from the project? Explain, going through all the steps of your analysis of net benefit, being as specific as possible.