Experts in agricultural research and development (R&D) have determined that an investment program to develop an alternative pesticide technology that would achieve the productivity gains without causing the negative externalities would cost $50 million dollars and result in social benefits of $10 million dollars annually in perpetuity. The $50 million R&D investment program would be performed by a consortium of private firms. However, because of spillovers, the private benefits appropriated by the consortium would be only $3 million annually in perpetuity. The private and social required rates of return (hurdle rates) are the same and equal 10%.
a. Is the R&D investment program socially beneficial? Explain. Will the private sector undertake the R&D in the absence of public support? Explain.
b. Explain the design of a public policy that would subsidize the private performance of the R&D (to ensure that the research is done by the private sector) yet would minimize the public funds used.
Experts in agricultural research and development (R&D) have determined that an investment program to develop an alternative pesticide technology that would achieve the productivity gains without causing the negative externalities would cost $50 million dollars and result in social benefits of $10 million dollars annually in perpetuity. The $50 million R&D investment program would be performed by a consortium of private firms. However, because of spillovers, the private benefits appropriated by the consortium would be only $3 million annually in perpetuity. The private and social required rates of return (hurdle rates) are the same and equal 10%.
a. Is the R&D investment program socially beneficial? Explain. Will the private sector undertake the R&D in the absence of public support? Explain.
b. Explain the design of a public policy that would subsidize the private performance of the R&D (to ensure that the research is done by the private sector) yet would minimize the public funds used.
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1. The Sit N Sip Tearoom has an outdoor deck where customers can sit outside on nice days and sip their tea. Next door to the tearoom is the Flowerchild Nursery, which grows flowers for sale to florists. Using the ideas of social and private benefits, which company seems more likely to provide positive externalities for the other? Briefly explain.
2. The Gizmo Company is looking at plans for developing many new household gadgets. The table below shows the company's demand for financial capital for research and development of these gadgets, based on its expected rates of return from selling them. However, say that every investment would have an additional 5% social return: that is, an investment that pays at least a 6% return to the Gizmo Company will pay at least an 11% return for society as a whole, an investment that pays at least 7% for the Gizmo Company will pay at least 12% for society as a whole, and so on.
Value of R&D Projects That Provide at Least This High a Private Rate of Return
| Estimated Rate to the Gizmo Company | of Return (measured in millions of dollars) |
| 10 | 100 |
| 9 | 102 |
| 8 | 108 |
| 7 | 118 |
| 6 | 133 |
| 5 | 153 |
| 4 | 183 |
| 3 | 223 |
a. If the opportunity cost of financial capital for the Gizmo Company is 9%, how much will it invest in R&D if it receives only the private benefits of this investment?
b. In the table, the numbers in the second column are rising as the numbers in the first column are falling. What's the economic reasoning behind this pattern?
c. How much will the firm invest if it also receives the social benefits of its investment?
