COST-BENEFIT ANALYSIS ECON CLASS

Reference - Boardman et al., Cost-benefit Analysis: Concepts and Practice. 4th Ed.

Exercise 2: Option Price and Option Value ' Consider the project of constructing a dam. The only person affected by this project is a farmer, with utility U (I ) where 95] is his income. There are two possible contingencies: it rains a lot (wet) or it does not rain a lot (dry). With the dam, his income is $200 if wet and $180 if dry. Without the dam, his income is $150 if Wet and $50 if dry. The probability of raining a lot is 50%. (a) What is the expected surplus of the farmer? (b) What is the standard deviation of income with the dam and Without it? (0) Assume U(I) : In I. What is his expected utility in case the dam is not constructed? What is his option price? Compare its option price to its expected surplus. (d) Assume U (I ) : I 2. What is his expected utility in case the Dam is not constructed? What is his option price? Compare its option price to its expected surplus. (e) 7 Calculate the option value for each case above. Compare them. How would you explain their difference