Uncertain externality The health and environmental damages associated with the p
ID: 1167645 • Letter: U
Question
Uncertain externality The health and environmental damages associated with the production of GMO crops is uncertain. Without intervention agricultural producers will adopt GMO crops (whether or not it is rational to do so) . A regulator can choose to prohibit the use of GMO crops, in which case the benefits and costs would be 150 and 50, respectively. The increased yields associated with GMO production will lead to greater benefits of 200. The regulator has places a subjective probability of 0.9 that the use of GMO products will only result in a small increase of costs (cost is 60) and O. 1 probability that their use will result in a catastrophe (cost is 400). (a) What is the expected value of GMO production? What is certain value of non-GMO pro duct ion? ( b) Would a risk neutral regulator intervene? (c) Suppose that a social planner has the following utility function: U(W) =W^1/2 , where W is the total welfare experienced by society. He generates 200 units of welfare from activities not related to GMOs. What is his expected utility from GMO adoption? Prohibiting GMOs? (d) Would the risk averse planner prohibit the use of GMOs?Explanation / Answer
a.
Expected value of GMO production = 200-94 = 106
Expected cost = (0.9*60) + (0.1*400) = 94
Certain value of non GMO production = 150-50 = 50
b.
The GMO production will tend to increase benefits without increasing risk of cost. Hence, risk neutral regulator will intervene.
c.
Expected utility of GMO production = (0.9*2801/2) + (0.1* (-4001/2) = 13.06
Prohibiting GMOs = 2001/2 = 14.14
d.
Since, Expected utility of GMO production (13.06) < Prohibiting GMOs (14.14), hence risk averse planner prohibit the use of GMOs.
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