Evaluating a Public Project 479generates no revenue. The second line makes the key point: The entire ben-
efit of the bridge takes the form of consumer surplus,the dollar benefits com-
muters enjoy above the (zero) price they pay. Consumer surplus is given by
the triangle inscribed under the demand curve and above the zero price
line. The dollar value is (.5)(4.00)(10) $20 million per year. In present-
value terms, this benefit comes to $500 million against a total cost (also in
present-value terms) of $210 million. Thus, the net benefit of the bridge
is $290 million. Since this is greater than that of the status quo (the ferry),
the bridge should be built. The advantage of the bridge relative to ferry is
290 250 $40 million.PUBLIC PRICING Here’s a point that should not be overlooked: The deci-
sion to build the bridge crucially depends on charging the “right” toll. In the
present example, no toll is charged. The right price is zero because there is a
negligible cost (no wear and tear or congestion) associated with additional cars
crossing the bridge. Thus, a zero price ensures maximum usage. Setting any
positive price would exclude some commuters and reduce net benefit. But what
if there were significant costs associated with additional use of a public good?
The general principle behind optimal pricing is simple: The optimal price should
just equal the marginal cost associated with extra usage.For instance, because large
tractor-trailer trucks cause significant road damage to highways, they should
pay a commensurate toll. In general, user fees should be set at a level that just
covers the marginal cost of the service being delivered.CHECK
STATION 3Suppose the planning authority sets a $2 toll per trip on the bridge (the same price as
the ferry). Compute the net (discounted) benefit of the bridge and compare it to that
of the ferry. In what sense is this pricing policy self-defeating?REGULATING THE FERRY Before concluding that building the bridge is war-
ranted, government decision makers should consider another option: regula-
tion of the private market. In our example, regulation means limiting the price
the ferry operator can charge. From a benefit-cost point of view, the optimal
regulated price is simply the price that would prevail in a perfectly competitive
market. With free entry of competitors into the market, the ferry’s price would
be driven down to the zero-profit point, P $1. Thus, this is the price the gov-
ernment should set for the (natural monopolist) ferry operator.
At a $1 price, the ferry delivers 7.5 million trips and makes a zero profit.
Commuters realize total consumer surplus that comes to (.5)(4.00 1.00)(7.5)
$11.25 million per year. The present value of the net benefit associated with
ferry regulation is 11.25/.04 $281.25 million. Building the bridge, with a dis-
counted net benefit of $290 million, has a slight edge over the regulatory alter-
native and continues to be the best course of action.c11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 479