4. Suppose Ontario is deciding whether to enact a new tax. If the tax is enacted

Question

4. Suppose Ontario is deciding whether to enact a new tax. If the tax is enacted, it will bring in s700 million in revenue. But it could also hurt the economy. The chance of harm to the economy is small, just 1/5. But it would cost the country s1, 200 million in lost earnings. (The s700 million in revenue would still be gained, partially offsetting this loss.) Treat gains as positive and losses as negative. a. What is the expected monetary value of enacting the new tax? The government also has the option of conducting a study before deciding whether to enact the new tax. If the study's findings are bad news, that means the chance of harm to the economy is actually double what they thought. If its 21 findings are good news, then the chance of harm to the economy is actually half of what they thought. b. Suppose the government conducts the study and its findings are good news. What will the expected monetary value of enacting the tax be then? c. Suppose the government conducts the study and its findings are bad news. What will the expected monetary value of enacting the tax be d. Suppose conducting the study would cost s5,000. Will the government conduct the study? Explain your answer. (Assume they make decisions by maximizing expected monetary value.)

Explanation / Answer

Question 4(a) Expecting moneary value of enacting the new tax = Tax revenue - Chane of economy harm * Value of that harm = $ 700 million - 1/5 * $ 1200 million = $ 460 million

(b) Now findings are good news,

so that means chances are half are actually haldf.

Expected monetary value of enacting the tax = $ 700 million - 1/2 * 1/5 * $ 1200 million = $ 580 million

(c) Now findings are bad news ,

Chances of economy effect are doubled.

Expected monetary value of enacting the tax = $ 700 million - 2 * 1/5 * $ 1200 million = $ 220 million

(d) Now the study would cost $ 5000. So, government shall conduct the study as the total gain by the study is

Gain by the study = $ 580 million - $ 220 million = $ 360 million which is too high than $ 5000.

So gvernemtn shoudl conduct the study.

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