King Rat (gkr) wrote,
King Rat

Eco 200: canals

(individual) The Army Corps of Engineers estimates that a canal between Tussle and Big Stone would save shippers $500,000 per year. The canal would cost $200,000 per year to maintain.

  1. Is it correct to say that the canal is a good investment in the long run because it will save society a net of $300,000 per year and eventually that will sum to more than the $20 million construction cost?

    No. Because the present value of a $300,000 annuity may not reach $20 million if the life of the canal isn't long enough. Essentially, it'd only be a good deal if the going interest rate is somewhere around 1% and the life of the canal is 111 years or longer. At interest rates of even 2%, it will take hundred and hundreds of years to make that a worthwhile investment. No one will be shipping via canal by then.

  2. About how low would the interest rate have to be to make the canal a profitable investment? (The canal would not be profitable if the interest payments plus maintenance costs ate up the saving to shippers.)

    Well less than 1%.

  3. The advantage of having the government build the canal is that government can do things that are in the public interest whereas private enterprise is constrained by narrow considerations of profitability. Evaluate that argument.

    Nothing should be done if the benefit does not exceed the cost. When something is of uncertain cost or benefit or the benefit is sure but the method of monetizing it is unclear, then government may be better because it is not concerned with monetary benefits or costs to the same degree. However, in the case of the canal, unless there are some huge hidden benefits beyond the savings to shippers, I don't see how this is worthwhile for anyone to build.

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