Question

A town council is considering building a new bridge over a small river that runs through the town to
reduce congestion on the existing bridge and reduce commuting times. Each of 1,000 commuters who
must cross the bridge would experience a benefit of $20 per day from saving commuting time. The
bridge would be financed through increased property taxes that amount to $1 per day for each of the
40,000 households in the town.

a. Would the bridge pass a cost-benefit test?

b.Would building the bridge be a Pareto improvement (relative to not building the bridge)?

c. Could using tolls instead of taxes to finance the bridge yield a Pareto improvement?

d. Would using tolls be Pareto efficient? (Assume that the marginal cost of using the new bridge for an
extra trip is zero and assume the demand for trips across the bridge is downward-sloping.)

Answer 1

a)

Benefit =1000*20=$20000

Cost=1*40000=$40000.

As Benefit is greater than the cost so the bridge pass a cost-benefit test.

b)Yes, building the bridge is a Pareto improvement as everyone get more benefit from this than cost.

c) Toll is a charge for using the bridge.

The cost would be levied from the commuters only and not all 40,000 people will pay these taxes.

Now if govt. will charge them and these cost only benefit these commuters it might be possible that the cost outweigh the benefit. But in case of property tax government can collect tax from every single individual. So using tolls to finance the bridge does not yield a pareto improvement

d) If a car consist of 4 people and crosses the bridge. Toll will charge on this car only not on 4 people in this car individually. As MC=0 so if 1 person pay the toll the other 3 will be free rider. It is not a pareto efficient as there is market failure for presence of free rider. Again demand downword sloping means if toll increase then demand for crossing this bridge will decrease. Government can not finance the cost of building the bridge.