Experts in agricultural research and development (R&D) have determined that an i

Question

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.

Explanation / Answer

a. Yes, the R&D investment program will results in greater output productions. As a result it can charge lower prices resulting in greater consumptions and lower pricing. Furthermore, there will be a reduction in externalities which will reduce the environmental cost, and thus reduce society's cost in terms of health. The private sector is likely to undertake the R&D in the absence of public support, because it will reduce it's lost in output levels, and at the same time have a better image in public and it is likely to gain recognition this way further developing business.

b. It can impose a program/policy similar to the carbon footprint one, which companies can get credit in terms of tax reductions to persuade companies to be more environmentally friendly. This can be an effective way to 'subsidize' the private firm of the R&D but yet minimize the public funds used.

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