Question

1. A city with 4% unemployment and no inflation is considering building a new stadium for its professional football team. The team currently plays in an old stadium owned by the city. If a new stadium were to be built, it would cost city $400M (M for million) to demolish the old one and build the new one. The new stadium would be expected to last for 40 years and the city would finance the costs of the project by borrowing at 5% annual interest and paying $25M per year for 40 years to repay the debt and other expenses. About $200M of the demolition and construction cost would be spent on labor and materials supplied by the city residents (referred to as locals). The team owner, who is not a local, would pay for maintenance of the stadium and would pay the city $1M per year rent. The owner’s company would sell the tickets to games, parking, and concessions (food, drink, souvenirs, etc.) and keep the profits from those sales. Analysts estimate that if the stadium is built, the locals’ demand curve for tickets to the games will be linear each year, with a choke price of $130, and that locals will buy 100,000 tickets per year from the team owner’s company at an average price of $70 per ticket. Analysts estimate the team owner will sell another 0.4M tickets per year to outsiders (not locals) who will spend an additional $40 on average, per game ticket, on restaurants, hotels and other goods and services provided by city residents. Assume that the average profit rate of local business and local labor is 0.2. Except in part g, below, assume that the analysts’ estimates are correct. Except in part i, assume that the football team will leave the city if the new stadium is not built.

a.[10] Assume that the locals’ marginal propensity to consume local value added is 0.3. Explain what this means. Use this information to estimate the net generated income for the locals from the construction of the stadium alone, making reasonable assumptions about any other missing information. Explain all your steps. Translate this net generated income into annualized income for the residents at 5% annual interest.

b.[7] An economic impact analysis of the stadium project estimates that the construction alone would give the locals generated income of $500M (estimated to be the $200M spent on local value added times a multiplier of 2.5). Give all the reasons why this estimate differs from the net generated income estimated in part a and why the $500M estimate is probably much higher than the net benefit the locals would get from the income generated by the construction alone (ignoring what they must pay to build the stadium and ignoring any benefit they would get from games played there after the construction is finished).

c.[6] Use the information above to estimate the locals’ annual user benefit from the stadium if it is built. Assume that the locals would have the same demand curve for the whole lifetime of the stadium. Explain all your steps.

d.[10] Using the information above, estimate the annual net generated income for locals from the game related spending by outsiders. Explain all your steps. What are the most important other costs and benefits that should be included and are not mentioned above? Leaving the costs and benefits out, estimate the annual net benefit to locals from the project. Explain all your steps.

e.[4] Business property values near the stadium are expected to rise once the construction is completed. Explain why this change in property values, in annualized form, probably should not be added to other numbers in your estimate of annual net benefit from the project.

f.[5] Which types of agents are the most likely to benefit from the project and which are most likely to lose? Consider, for example, the team owner and others associated with the football team, owners of other businesses, local and nonlocal football fans and other people. Explain your answers.

g.[3] How would a reasonable estimate of the annual net benefit from the project change if the benefits and costs listed above were uncertain and the numbers given above were only expected values of those benefits and costs? Be as specific as possible.

h.[5] How should a reasonable estimate of the annual net benefit to locals from the stadium construction project be modified if the football team would have stayed in the city and continued playing in the old stadium if the new one were not built? For each part of the estimate of annual net benefit from new stadium project in part e, explain whether it would have to be modified and, if so, how and in what direction. Be as specific as possible, making educated guesses, if necessary, with the information you have.

Answer 1