Problem

The marginal private costs and the marginal priva…

01:06

Problem 23 Hard Difficulty

HighFlyer Airlines wants to build new airplanes with greatly increased cabin space. This will allow HighFlyer Airlines to give passengers more comfort and sell more tickets at a higher price. However, redesigning the cabin means rethinking many other elements of the airplane as well, like engine and luggage placement, and the most efficient shape of the plane for moving through the air. HighFlyer Airlines has developed a list of possible methods to increase cabin space, along with estimates of how these approaches would affect the plane's operating costs and ticket sales. Based on these estimates, Table 13.5 shows the value of R&D projects that provide at least a certain private rate of return. Column 1 = Private Rate of Return. Column 2 = Value of R&D Projects that Return at Least the Private Rate of Return to HighFlyer Airlines. Use the data to answer the following questions.
a. If the opportunity cost of financial capital for HighFlyer Airlines is 6%, how much should the firm invest in R&D?
b. Assume that the social rate of return for R&D is an additional 2% on top of the private return; that is, an R&D investment that had a 7% private return to HighFlyer Airlines would have a 9% social return. How much investment is socially optimal at the 6% interest rate?

Answer

a) As per the given table, when the opportunity cost of financial capital is $6 \%,$ then firm would invest
$\$ 400$ in R\&D.
b) When 6$\%$ interest rate is socially optimal, then it means that private rate of return is $4 \%,$ so as
per the table the firm should invest $\$ 500$ in R\&D.

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Chapter 13

Positive Externalities and Public Goods

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Video Transcript

What you see here is basically just a rough representation of table 13.3, which is part of this question. So for letter A were asked that if the opportunity cost of financial capital is 6% how much should the firm invest in R and D? Well, that 6% which is here on the left, right. All of these are percentages at 6%. That puts us at 400 for the value of orangey. So that's letter A. For letter B. We have to assume that the social rate of return is 2% on top of the private rate of return. All right, so that means that we have to imagine that each of these numbers has an additional 2% added onto it so that it's 14 12 10 8 and six, respectively. Okay, so if the investment is still socially optimal at 6% but now it's socially not privately optimal. Now this puts us down here and again. It may look like four, but remember that you have to add 2% to everything in the left hand column so foreign to its six and now the socially optimal level of R and D is going to be 500. So while the private optimization is at 400 the socially optimal level would be 500.

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Steven A. Greenlaw, David Shapiro, Timothy Taylor

Principles of Microeconomics for AP® Courses

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Problem

The marginal private costs and the marginal priva…

Problem 23 Hard Difficulty

Answer

a) As per the given table, when the opportunity cost of financial capital is $6 \%,$ then firm would invest
$\$ 400$ in R\&D.
b) When 6$\%$ interest rate is socially optimal, then it means that private rate of return is $4 \%,$ so as
per the table the firm should invest $\$ 500$ in R\&D.

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Principles of Microeconomics for AP® Courses

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Watch More Solved Questions in Chapter 13

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Steven A. Greenlaw, David Shapiro, Timothy Taylor

Principles of Microeconomics for AP® Courses

a) As per the given table, when the opportunity cost of financial capital is $6 \%,$ then firm would invest$\$ 400$ in R\&D.b) When 6$\%$ interest rate is socially optimal, then it means that private rate of return is $4 \%,$ so asper the table the firm should invest $\$ 500$ in R\&D.

Principles of Microeconomics for AP® Courses

Steven A. Greenlaw, David Shapiro, Timothy TaylorPrinciples of Microeconomics for AP® Courses

a) As per the given table, when the opportunity cost of financial capital is $6 \%,$ then firm would invest
$\$ 400$ in R\&D.
b) When 6$\%$ interest rate is socially optimal, then it means that private rate of return is $4 \%,$ so as
per the table the firm should invest $\$ 500$ in R\&D.

Steven A. Greenlaw, David Shapiro, Timothy Taylor

Principles of Microeconomics for AP® Courses