Slide1 : Updated: Jan. 17,2007
Lecture Notes
ECON 622: ECONOMIC COST-BENEFIT ANALYSIS
Lecture Ten
Slide2 : MEASUREMENT OF COSTS AND BENEFITS OF TRANSPORTATION INVESTMENTS
Slide3 : ECONOMIC BENEFITS OF TRANSPORTATION PROJECTS 1) Improvement of existing mode
- Example of a road
2) Introducing new modes of transportation
- Example of a Buenos Aires- Colonia
bridge
Slide4 : COST - BENEFIT ANALYSIS OF TRANSPORTATION PROJECTS 1) ROAD IMPROVEMENT BENEFITS
Cost Savings for Existing Traffic
- Savings in Vehicle Operation and Maintenance Costs
- Savings of Time
Cost Savings for Newly Generated Traffic
Slide5 : Cost Savings for Existing Traffic
Cost Savings From Road Improvements : Cost Savings From Road Improvements
Traffic Volume with Project: number of vehicles by type that we expect each year to use the road over its life after improvement for the each year;
Traffic Volume without Project : the volume of vehicles by type that would travel on the road without the road improvement;
Vehicle Operating Costs with and without the Project: the costs incurred by road users in terms of:
- consumption gasoline and oil;
- The wear-and-tear on tires
- The repair expenditures for vehicles
Without Road Improvement With Road Improvement : Without Road Improvement With Road Improvement Diverted Traffic: The traffic that diverted to the upgraded road from other routes as a result of the road improvement.
Generated Traffic: The traffic that will arise from people who now made the trip more frequently due to the reduction in the cost of using the road.
Savings of Time : Savings of Time “Normal” traffic: For passengers and trucks the improved road allows their vehicles to travel at a higher speed as compared to the existing road, thus saving them time.
Example: Occupants of a vehicle value time at $20 per hour, vehicle speed is 30 kph
Time cost per km: 20/30= $ 0.66
If vehicle speed is 50 kph
Time cost per km is 20/50= $ 0.4/km
Value of Time Savings: 0.66-0.4= $ 0.26 per vehicle - km
The value of savings is tied to the value placed on occupants’ time and therefore sensitive to the level of per capita income of the country.
For Diverted and Generated passenger traffic the value of time savings is taken on average as half of the value of time savings for “normal” traffic.
Savings of Costs of Road Maintenance : Savings of Costs of Road Maintenance The annual savings in resources used for maintenance is the difference between the amount of resources spent on maintenance “without” road improvements minus the maintenance costs during the life of the road “with” the improvement.
Road improvements or new roads will affect the pattern of traffic on other roads that are complements or substitutes to the road being improved.
For complementary roads the maintenance requirements are expected to rise as the volume of traffic accessing or exiting from the improved roads increases.
The increase in maintenance costs on the complementary roads should be included as a cost associated with the road improvement project.
Substitute road maintenance expenses are expected to decrease due to the lower traffic levels.
The cost savings are a benefit to the road improvement.
Accident Reduction : Accident Reduction A road improvement can be important factor in the reduction of the number of accidents.
A road improvement may not automatically imply a substantial reduction in the rate and severity of accidents as there are other influencial aspects. Some of these factors are the geometric alignment of the road, the volume of slow traffic, effectiveness of law enforcement, vehicles mechanical conditions and drivers behavior.
Steps to assess the benefits of accidents reduction:
the rate of traffic accidents “with” and “without” the proposed improvements must be estimated. (Number of accidents per million vehicle-kilometer)
the monetary value of accident reduction should be estimated which includes the savings in damages such as property and cargo damages. It is difficult to put a monetary value on injuries and fatalities.
Slide12 : Step Two: Calculate the Average Speed
Sit=ƒ(Vt),
Where Sit is the average speed of the ith vehicle type.
Step Three: Estimate cit which is the average cost per vehicle-mile at time t for vehicle type i on the unimproved road. cit includes vehicle operating costs, depreciation, maintenance and time cost.
Step Four: Estimate c`it which is the average cost per vehicle-mile at time t for vehicle type i on the improved road.
Slide13 : Step Six: Estimate M` and M , which are the annual road maintenance costs with and without the road improvement.
Step Five: Estimate the benefits of savings in cost of travel due to road improvement in year t: and the present value of these benefits at discount rate r: (1+r) -t* (cit - c`it)*Vit t i t t
Slide14 : Step Seven: Estimate the benefits of savings in road maintenance cost due to road improvement in year t, in some cases maintenance costs may rise
Step Eight: Estimate the present value of total benefits due to improvement (when volume of traffic remains constant after improvement): (Mt - M`t) (1+r)-t* (cit - c`it)*Vit + (1+r)-t*(Mt - M`t) t i t
Slide18 : Externalities can be:
Excess of marginal social cost over marginal social benefit for traffic on roads;
Excess of marginal social benefit over marginal social cost for traffic on other modes such as railroads.
Congestion impacts, a very important and pervasive externality.
EXTERNALITIES INVOLVING TRAFFIC ON OTHER ROADS
Slide25 : INTRODUCTION OF NEW ROADS If a new road is for developing a new mine or new tourist hotel where there are few existing inhabitants, then road is part of the investment for the mine or hotel and should not be evaluated separately.
There are other ways to estimate the benefits of a new road in an area.
Changes in Land Values
In case of agricultural areas: the present value of incremental agricultural output less the present value of incremental costs of production.
These ways of estimating the value of transportation project are mutually exclusive not an additional benefit.
Slide26 : INTRODUCING NEW MODES OF TRANSPORTATION
“Buenos Aires Colonia Bridge Project” The BAC Bridge will introduce a new mode of traffic to the Buenos Aires-Colonia area: transportation for passengers crossing the river.
There is an alternative mode of crossing the river, a ferry.
Beneficiaries of the BAC bridge consist of both passengers diverted from ferry and newly induced bridge river-crossing passengers.
Externalities Involving Railroad Traffic : Externalities Involving Railroad Traffic Major issue in North America, Europe, India and China where roads are replacing parts of an existing railway network.
Externalities Involving Railroad Traffic : Externalities Involving Railroad Traffic The problems involved in the relationships between road and rail transport can be complex, given the difficulty of isolating the relevant costs of rail transport.
Measuring Marginal Cost for Railroads:
The marginal costs of carrying additional freight on trains which are in any event running are very low
The marginal costs of running additional trains where the track and station facilities will in any event be kept in working condition are at an intermediate level
The marginal costs of providing rail service on a stretch of track as against the alternative of abandoning that stretch are higher still.
Slide31 : Railroad Road Project of Road Improvement Consequences: 1) traffic is diverted from rail to road
2) the railroad no longer has to bear the marginal cost
of carrying diverted traffic The net external effect will therefore almost certainly be negative, and will
be measured by:
- is the fare or freight rate for the type of rail traffic - is the marginal cost associated with carrying that traffic - is the change in the volume, induced by the road improvement - type of traffic on the railroad c0 c1 DROAD V0 V1 MC1 MC2 MC3 DR(C1) DR(C0)
Slide32 : Volume of traffic on road Unit
Cost of
Travel on
road M R N P - after the improvement the private unit costs of travel on the road
before the improvement G J H I O F Traffic level on railroad Fare Figure 2. the demand curve for services of the road
on the assumption that the railroad is operating
and charging the fare level OF (from Figure 2.) the demand curve for the services of the road
assuming the railroad has been abandoned the initial levels of unit costs and traffic
volume on the road the equilibrium levels after the road
has been improved and the railroad abandoned -the demand curve for services of the railroad
on the assumption that there is no improvement
on the road
- the demand curve for services of the railroad
after improvement on the road the equilibrium levels after the road has been improved but before railway abandoned Figure 1.
Slide33 : - the measure of direct benefits M N Volume of traffic on road Unit
Cost of
Travel on
road M R N P M R - the benefit perceived by traffic that would
have used the unimproved road in any event MNR -represents the net benefit perceived by those who would not have used
the road at unit cost of C1 , but who would have it a unit cost of C2. NPV2V’2 -represents cost in incurred in the road by traffic that had been involuntarily railroad because of the abandoned that railroad.
Slide34 : Volume of traffic on road Unit
Cost of
Travel on
road M R N P G J H I O F Traffic level on railroad Fare Figure 2. Figure 1. SUMMARY a) The present values of cost savings to the user
of the road (represented by area ) M N less b) The present value of those private net costs
associated with abandonment of the railroad
(represented by FD4G) less c) The present value of the excess of rail fares over
the direct marginal costs of operation
plus d) The present value of the savings stemming
lower equipment, maintenance, station operation
costs, and so forth, for the railroad
plus e) The current market value in alternative uses
of the properties to be abandoned
MC
A Case of Upgrading a Gravel Road : A Case of Upgrading a Gravel Road
Slide36 : The three expenditure decisions that need to be made by a Road Agency:
Selecting new roads for construction;
Allocating funds between road maintenance and new road construction;
Selecting the roads to be maintained, the type, and timing of treatment.
Benefits of Road Improvement : Benefits of Road Improvement Ideally, five types of benefits should be counted:
(1) reduction in resource costs on maintenance by the Roads Agency;
(2) reduction in vehicle operating costs for road users due to improved road surface;
(3) time savings for road users due to increase in the average speed of vehicles;
(4) possible reduction in the costs of accidents; and
(5) other fiscal externalities.
Economic Costs : Economic Costs Convert all financial expenditures into their corresponding economic costs.
This implies that all the taxes, subsidies, market imperfections, impact of foreign exchange premium, and labor market distortions must be removed from the financial expenditures to arrive at economic costs.
Decision Criterion : Decision Criterion If the economic NPV of the project is greater than zero, the project is potentially worthwhile to implement.
On the other hand, if the NPV is less than zero, the project should be rejected on the ground that the resources invested could be put to better use if they were left to be allocated by the capital market.
When selecting among several alternatives, the economic NPV criterion makes it possible to choose the best combination of roads.
Alternative road projects with the highest NPV’s should be selected first in order to maximize the net economic benefits over time.
Roads Management System : Roads Management System All existing roads are catalogued in a database that contains a detailed description of roads, their condition, and user traffic.
Graphical interface and allows the analyst to examine the whole network.
The location of a particular road link is referenced relative to other roads.
A total count of annual average daily traffic (AADT) is recorded and proportion of heavy vehicles traffic.
Condition of a road link is assessed through a number of criteria: cracks, poth, patching, rutting.
Two summary measures of physical condition are stated: international roughness index (IRI), and visual condition index (VCI).
Example of Gravel Road Upgrading : Example of Gravel Road Upgrading There are a few potential sources of such forecasts: a) a study by specialized consultants; b) a traffic flow movement software system for the province (no such system exist at the RAL as of now); or c) building own traffic forecast by using all of the available information.
Traffic count suggests that in 2005 there will be an annual average of 600 vehicles a day (AADT), with 10% being heavy vehicles.
Suppose that a 20 km existing gravel road is being considered for tarring.
It is expected that “normal” traffic will grow at a rate of 2.0% per annum and share of heavy traffic will not change over time.
It is expected that due to lower user costs some “additional” traffic will appear on the road in year 2006 with an AADT of 40 vehicles and 5% of heavy vehicles.
This new traffic flow consisting from “diverted” and newly “generated” users is assumed to grow at 2.0% per annum.
Traffic Forecast “With” and “Without” Project (2005-2025) : Traffic Forecast “With” and “Without” Project (2005-2025)
Project Costs : Project Costs
Financial Cashflow Profile (R2005, million) : Financial Cashflow Profile (R2005, million)
Financial Expenditures : Financial Expenditures The incremental financial PV criterion could wrongly suggest that it is better to continue with the existing gravel road than to upgrade it to a tarred surface.
A decision based on undiscounted sum of the budget expenditures over a number of years may be incorrect, because it does not account for the time value of money.
Project Benefits : Project Benefits Economic Maintenance Resource Savings. The estimated present value of economic resource maintenance savings due to road improvement amounts to R2005 23.1 million.
Vehicle Operating Costs (VOC) Savings. The present value of economic VOC resource savings is estimated to be R2005 70.6 million.
Time Savings. The total PV of time savings to all road users is estimated as R2005 15.1 million.
Economic Resource Flow Statement (R2005, million) : Economic Resource Flow Statement (R2005, million) Incremental Statement (= “With Project” – “Without Project”)
Financial flows have been converted into economic equivalents by using economic conversion factors.
Economic Assessment : Economic Assessment The proposed project appears to be economically feasible as it generates a positive NPV of R2005 71.4 million.
In order to compare this particular road upgrading investment to other alternative road improvement alternatives, the Roads Agency must conduct their assessment and estimate what NPV each other project will generate.
A relative ranking of all projects then could be done by the size of their estimated NPV’s.
Distributive Analysis : Distributive Analysis The relative distribution of benefits among the three stakeholder groups is such that the owners of light vehicles stand to benefit the most from the proposed road improvement.
The owners of heavy vehicles are the second main beneficiary group.
For the RAL, the R2005 23.1 million amount of total maintenance resource costs savings is overwhelmed by the investment costs of road upgrading, R2005 37.3 million, and the net impact on RAL is net economic cost with a PV of R2005 14.2 million.
Sensitivity Analysis : Sensitivity Analysis 1. Construction Costs Overruns. This test measures the response of the economic NPV due to unexpected escalation of the tar road construction costs, keeping all other project parameters constant.
2. Traffic Growth Rate. This test measures the project’s performance under various traffic volume levels, resulting from the assumption of the future growth rate.
3. Maintenance Costs Savings Factor. This factor adjusts all the maintenance resource savings over a range from -50% to 0% in order to assess the sensitivity of the NPV to the overall value of the maintenance savings.
4. VOC Savings Factor. A range of -50% to 0% for this factor has been tested. 5. Time Savings Factor. This test examines the elasticity of the NPV to changes in the total value of time savings in a range of -50% to 0%.
Case Study Conclusions : Case Study Conclusions Road upgrading and construction activities should be subject to cost-benefit analysis.
Cost-benefit analysis should attempt to incorporate not only Roads Agency’s costs and savings but also the costs and benefits accruing to the road users and other stakeholders.
The relevant project selection criterion is the economic net present value, discounted by the economic opportunity cost of capital for South Africa.
From the results of the sensitivity analysis it is apparent that the outcome of the project is very dependent on the amount of initial construction costs, reliability of the initial traffic counts and future traffic volume growth.