CAFE (Corporate Average Fuel Economy) standards require that the average fuel economy of all the cars that a car manufacturer sells must meet a certain target of 30 miles per gallon (mpg) or the manufacturer must pay a penalty. CAFE standards were imposed after the oil crises in the 1970s to reduce US dependence on foreign oil. The imposition of CAFE standards has been accompanied by a rise in average fuel economy cars. Most fuel-efficient cars give less protection in a car accidents because they are made of less strong, lightweight materials. However, they reduce gas usage and pollution. Question: Should the US raise CAFE standards to 35 mpg?

Program Input:

In order to evaluate the economic merits of CAFE standards of 35 mpg, the following data was collected by your research team:

1. On-time Research & Development R&D cost and other initial investment expenditures are estimated to be $500 Million (M), with half of that amount occurring during the first year and the other half over the second year.
2. New cars will cost $100 more, and that there will be 10M cars sold per year.
3. It is expected that there would be 100 more fatalities per year in traffic accidents. Life is valued at $3M on average.
4. Individuals will use $10 less in gas/year. Assume there are 100M cars in the US and that all cars get the same savings of $10 every year.
5. The new CAFE standards is expected to reduce pollution of the environment, which is valued at $225M/year.
6. It is also expected that the military budget will be reduced by $100M/year because the US will conduct less military actions in the Persian Gulf.
7. Assume that all future payments, benefits or costs, other than the cost of R&D and the initial investment expenditures, will occur in perpetuity, starting in year 3.
8. You are required to evaluate this program using a social discount rate (r) of 10%.

Required work:

1. Clearly categorize the input above into the program’s costs and benefits. Then, compute Net Present Discounted Value (i.e., PDV of social net marginal benefit) of the program.
2. Based on your results in (A), should the program be accepted or rejected? Why?
3. Suppose that the city of Buffalo added a new subway station in a neighborhood between two existing stations. After the station was built, the average house price increased by $10,000 and the average commute time fell by 15 minutes per day. Suppose that there is one commuter per household, that the average commuter works 5 days a week, 50 weeks a year, and that the benefits of reduced commuting time apply to current and future residents forever. Assume an social discount rate of 5%. Produce an estimate of the average value of time for commuters, based on this information.