GG 541

Professor T. R. Lakshmanan

September 23, 2008

Key Components of CBA
◊ User benefits (times, fares, vehicle operating costs,
safety etc.)

◊ Investment costs

◊ Operator costs and revenues

◊ Impacts on government - taxation subsidies

◊ Externalities (environmental, congestion)

User Benefit Estimation

Three concepts underlying the definition of user benefit:

◊ Willingness to Pay (WTP)

◊ Consumer Surplus (CS)

◊ Generalized Cost (GC)

WTP is the maximum amount of money an individual
is willing to pay for the change in his/her circumstances,
e.g to make a trip from i to j using mode m.

If the price (p) of the trip is less than or equal to WPT, the
individual is assumed to make the trip.

If P is > WTP, the traveler will find an alternative, which

may be not the travel at all.
WTP is grounded in the acceptance of Consumer
Sovereignty, so that it does not apply to goods subject to
per se social or moral judgment.

WTP can still be applied to cases of externalities

(negative spill overs).

However, if a community places extra value on social

interactions promoted by public transit, that value will
not be captured by the sum of individual willingness to
pay for transit trips (only if one could also separately
measure and include individual WTP for a better social
milieu likely to result for more social interactions)
Continued…

Note - different individuals have different levels of

WTP for the same ijm trip.

One can construct the demand function for ijm trips,

linking the price to number of trips demanded - a
downward sloping demand curve.
CBA is a comparative tool, involving a comparison of
alternative states of the world.

A do-something scenario
- Where a link or facility is included in the transport network.
these will be a separate do-something scenario for each
alternative version of the project.

A realistic do-minimum scenario

- With the project not implemented. The do-minimum
scenario will include a realistic level of maintenance and a
minimum set of minor improvements to avoid the
transport deterioration.
 D

CS
Generalized Costs

GCo S

Q Transportation
Services

The Do-Minimum Scenario

DD, the demand function represents the number of trips
that would be made at different levels of generalized costs -
a few trips with large economic benefit made at high costs,
and less beneficial trips at lower costs.

The intersection of the supply function s yields

the number of trips made. CS, consumer surplus is a
measure of the excess of willingness to pay over the
generalized cost of the trip - the area CS under the
demand curve and above a horizontal line indicating the
current price (GCo).
Operationalizing the concept in transport poses some
problems. For most goods, the vertical axis indicates
price .

In the case of transport, prices and money costs are

not only one part of the composite. Cost of transit, which
in principle incorporates travel times, access times to
public transport, discomfort, perceived safety risk and
others. Hence price is replaced by Generalized
Cost (GC).
GC represents the money equivalent of the overall
cost and inconvenience to the transport user engaged
in travel between origin (i) and destination (j) by a
particular mode (m). While in principle, it includes all
aspects of ‘quality’ factors, in practice GC is limited to
three elements.

GCC ijm = time cost ijm + user charges ijm + VOC ijm

Value of time costs vary among individuals and even for

the same individual depending upon the trip purpose and
their factors.
Price D

CS

S
A B
S'
D

Q Q’
Transportation Services
The User Benefit
1
CSijm (=CSijm – CSijm) is estimated by the rule of a half
0

(ROH) on assumption that the demand curve between

1
(Q1GC0) and (Q1GC1) is linear approximately

∆CS= 1/2 (GCo - GC1)(Q1 - Q)

This procedure repeated for transport users as well

as for freight users.
Components of GC will vary by mode
* Public Transport users - fare plus costs of time of
travel

* Car users - costs of time, toll charges, fuel costs plus

VOCs

Differences in repeated user benefits for users of

different modes (e.g. Public transport users do not have
VOC benefits)
Producer Surplus
PS - TR - TC

where TR is total revenue

and TC is total costs

∆PS = ∆ TR - ∆ TC
In the case of diagram (a) there is a rail journey time
improvement, but marginal costs and fares (which
are above marginal costs) stay constant [benefits]

The change in the producer surplus ( DPS)

is “net revenue gain”
continued…

Figure 3a is the case in which the benefits are fully passed

through to the travelers

Figure 3b – there is complete “pricing up” by the railway

operators. Thus the size of the revenue and user benefits
effects (as well as their distribution) depends upon
pricing policy.
Operating Costs

 Costs of infrastructure operation (e.g. signaling/traffic control)

 Maintenance costs (cleaning, minor repairs, winter services)

 Costs of renewals (road/rail reconstruction)

 Changes in VOCs of Public Transport Services

Investment Costs

Some adjustments to Investment Costs include:

Mitigation Measures (EIS, etc.)

Disruption (effect of disruptions on traffic revenues and on

service quality)

Consistent Account
(Market prices or factor costs basis)
Travel Time Savings
- Dominant item of benefits, especially for air travel,
urban community and surface freight shipping

- Big time savings occur when there is

 A new high speed rail service

 A new highway through previously underdeveloped land
 Congestion relief from expanding capacity
 Improved rail switching facilities
 Upgrade a line haul facility to permit higher speeds
An extensive literature based on demand models
suggests that people and firms make reasonably
predictable trade-offs between travel time and other
factors when they make travel choices. From these
studies, attempts to estimate WTP for travel time
savings, a quantity known as the ‘Value of Time’
(VOT).
VOT Varies Across

- population subgroups and also on individual

circumstances

e.g. people WTP more on average

to avoid time walking to a bus stop or waiting there
than they are willing to pay to avoid the same amount of
time riding on the bus.

Also willing to pay more to avoid driving in congested

conditions.
These variations not surprising as time is not fungible:
time saved in one circumstance cannot be automatically
used in another – examples:

These variations must be considered:

Predicting travel time savings often complicated by

offsetting behavioral shifts as a result of unpriced
congestion.

The case of latent demand

Amount of travel time savings overstated

The Case of Land Use Distortions
Failure to price highway congestion leads to the city
being inefficiently decentralized. New highways
exacerbate this effect by creating housing locations
which create longer trips and more traffic. So
congestion will be reduced by a project less than
predicted.
In estimating VOT, distinction is made between:

1. travel in working time

2. travel in non-working time (e.g. shopping,

commuting, education, personal business,
leisure)

3. freight travel time

Working time value is easy to analyze because
there is a market (labor market) where working
time is valued

Two approaches

Adapt the gross wage rate (wage plus employee -

related overheads) as a measure of the marginal
product of labor
minutes of travel
time savings
VOT = gross wage/min X in working time
Second approach by Hensher qualifies the previous
approach in two ways:

1) The ability to work while traveling (varies by

mode)
2) The ability to use productively any travel time
saved also varies, depending upon the extent to
which work tasks are divisible and flexible.
Non-working Time Savings Value

No market exists
A WTP value based on market research
Both revealed preference (RP) and stated
preference (SP methods used for VOT in different
situations - including route choice, mode choice
etc.
Value of Non-working Time Varies with
Disposable Income
- Disposable income

- Employment status

- Type of activity (walk and wait higher than in

vehicle time, congestion) and with mode (comfort,
privacy)

- Journey purpose and journey lengths

- Pragmatic use of standard values

Freight Travel Time Savings

 Most important savings in drivers time

 Not only VOC savings but those resulting from trip

rescheduling which leads to total labor cost reduction

 Also the ability to adapt more efficient logistics - the

process and service innovations and the resulting
productivity in access.
Appraisal Values for Travel Time Savings
- an example: UK Official Values
Trip Purpose Value ($ per minu te) (a)

Working time
Road
Car driver 0.44
Car passeng er 0.36
Ligh t goods vehicle driver 0.34
Other good v ehicle driver (b) 0.32
PSV driver © 0.33
PSV passenge r 0.36
Rail 0.55
All modes 0.43

Non-working time
Standard appraisal value 0.11
Notes: (a) all values have been converted to 1999 US$, (b) Other goods vehicles include
heavy goods vehicles. c) PSVs are public service vehicles, principally buses. (d)Walking,
waiting and, cycling in non-working time are given double this value.
CBA with Externalities

Transport provision often leads to a variety of

negative or positive external effects (e.g. Air
pollution, congestion, accidents and fatalities and
airport noises are negative externalities. External
economies of agglomeration is an example of
positive externalities.
CBA with Externalities

Price S+e
D
S'+e

S
E
S'
D

Q Q'
Transportation
Services

Here the private cost of travel is increased by an

external cost e.
Because of the upward sloping nature of the
s + e functions, the estimated benefit (a social benefit here) will
be lower than the user benefit (in the simple user benefit case)
by the amount E, which represents the extra external cost
imposed by the increase in trips. If one wants to reduce
pollution, a positive adjustment is needed.

To implement this adjustment, it must be possible to

calculate the net change in external cost in monetary terms and
subtract it from the calculated user benefits.
Congestion Effects

Price
D
S
S'

P'

Q Q' Transportation Services

Congestion is a reciprocal externality. When the
traffic exceeds design capacity, all vehicles experience
congestion. As congestion increases, travel time is
an increasing function of the number of users of the
transport link. As a consequence, the horizontal supply
function is to be replaced by an upward sloping segment.

Infrastructure improvement leads to an increase in design

capacity, thus shifting the upward sloping segment to the
right as in previous figure.
continued…

Calculation of congestion costs must not be on a link

basis but on a transport network basis.

Please note that trips induced by the transport

improvement may negate much of the benefit that
might otherwise have accrued to freight users.
 Value of Safety Impacts
Some of the safety projects are market driven, while
some safety proposals are government mandated.

Changes in the risk of injuries, fatal or otherwise can be

assessed based on WTP.

Decisions are made implicitly placing values on additional

risks incurred.

A reliable method to value risk of death appears to be

comparing wages for jobs that are similar in all respects
except occupational risk.
Review of such studies suggest that on average people
in affluent industrialized countries are willing to pay
(early 1990s) $3 - $7 for each reduction of one in a
million in the risk of death.

Take $5, and a million people, their aggregate WTP

for saving one life is $5 million.

- “value of life” (VOL) 5 million

Most government agencies use a value of VOL of much
less than $5 million.

Canada $1.4 million (Canadian) (1991).

[Even this amount is higher than those the average person’s

personal wealth or the discounted sum of future earnings]

No one is paying to avoid a sure death; rather people are

paying to lower the probabilities slightly.
Risk of serious injuries or illnesses evaluated in a similar
fashion.

WTP to reduce the risk of typical serious (but non fatal)

traffic injury is 10% of WTP (for traffic fatality).

Note that the government borne costs of medical

treatment must be added.
Some Countries Public Official Values for
CBA Purposes
Environmental Impacts of Transport

The challenge for CBA is to find ways to bring these

impacts (air pollution, noise, or regional long run
problems such as acid rain and global warming) into the
CBA framework in a consistent way, given the greater
uncertainty associated with environmental problems.

Noise: Hedonic analysis of rental property to get the

impact of noise.
Values generated by the approach are typically of the order
of 30 Euros/person per dB per annum in year 2000 prices
(Grant-Muller).

This value adjusted to other countries using PPP exchange

rates
Particulates most Significant Air Pollutant

Damage costs much higher /unit mass of pollutant emitted

in urban (US non urban areas) - 50 times as much
in London vs. rural areas.

46-740 Euros/kgm.
High level of uncertainty - sensitivity testing necessary.
The CBA Process
 CBA Process

Inputs - modeling & forecasting all inputs (time, cost and

time). Estimates of investment costs, safety and
environmental impacts.

Consistent Benefit Estimation - Use ROH for user benefits and

simple do-minimum vs. do-something comparison for other
cost and benefit items initially for one or two years.

Interpolation and Extrapolation - using growth rates for

quantities and unit values, to arrive at cost and benefit
streams over the entire appraisal period.
continued…..

Discounting - Discount future costs and benefits in line

with public sector conventions on discount rates.

Summary Measures - over all measure in CBA terms.

 Discounting the Future

Valuing future benefits less because of

* People’s impatience or

* The productive possibilities for investing their money

Discount rate related to the interest rate on financial assets.

continued…

Departures from perfectly competitive markets result in

wedges between interest rates faced by different economic
factors.

Take a risk-free government bond with real after-tax-

interest rate rc (usually 4%).

Investment earns a real net social rate of return

(marginal product of capital) ri (9.6% in 1989).

How about a weighted average of rc and ri.

In US, OMB (Office of Management & Budget) uses since
1993, a social discount rate of 7% (Australia 7%, Canada 10%).
Main summary measure of net social benefit is the Net
Present Value (NPV)

t=n
Bt-Ct-Kt
NPV = ∑
t=0 l-r

Where Bt are the benefits in year t

Cb the recurring costs in year t
kt the investment costs in year t
r the social discount rate
[reflecting the social opportunity cost of capital]
n number of years in the appraisal period
Decision Rules

- Accept all projects with a positive NPV

- Accept the highest project option with the

highest NPV, when there are mutually
exclusive alternatives
Under budget constraints use B/C ratio.

t=n
Bt-Ct t=n Kt
BCR= ∑ (l+r)t ∑
t=0 t=0
(l+r)t

Accept projects based on a marginally acceptable B/C

ratio.
Presentation format of CBA analysis
The previous table shows the aggregate social costs and
benefits as well as the benefits accruing to
different incidence groups - identifying gainers and
losers.

Discuss the case.

Issues in CBA

Projections of Capital Costs & Travel Demand

Projected estimates are required of:

 up front capital costs

 the future operating costs

 the future demand for travel on the facility

Record on these projections very choppy.

In affluent countries record is not very encouraging.

- For ten rail transit systems recently built in the US.

Capital costs underestimated (up to 1/3) in nine cases
(Don Pickrell); in eight cases ridership was
overestimated (by a factor of 3).

- Even for toll highways (bond financed) 10 out of 14 had

less toll revenues well below projections.

- Similar experience for 7 large Danish highway bridges.

 continued….

Case of toll road near Vancouver, BC. Ex post CBA

showed that ex ante CBA drastically underestimated both
actual construction costs and actual traffic - offsetting
errors but still humbling.

Is there a strategic bias in these ex ante CBAs?

 The Case of CBA in LDCs - quite different

The World Bank experience in LDCs ($50 billion in transport

projects).

Estimated Returns from World Bank Projects

Type o f Project Number of Projects Annua l Rate of Return
Air ports 8 21%
Highway s 306 26%
Rail 72 14%
Ports 96 20%
All Transport Projects 482 22%
All Sectors n.a. 15%
-------------------------------------------------------------------------------------
Sour ce: Eno , 1997, p.24
Extensions of CBA

 Logistics Cost Effects

 Facilities Consolidation

 Other Location Effects

Total Logistics Costs

Total Logistics Costs (TLC) = PC + C + TC

Where PC = Procurement Costs

C = Carrying Costs
TC= Transport costs

PC and TC (Unit Costs) will be lower , the larger the shipment

C, which includes storage cots, interest on inventory and

Insurance, will be proportional to shipment size
Total Logistics Costs
Costs T LC

T LC'
C

P +T

P +T '

B' B Shipment Size

P+T and C are grouped against the average shipment

size B, optimal B is where TLC (T+P+C) is a minimum.

Given the tradeoff between TP and C. Logistical systems

such as Just-in-time (JIT) ----***
Measures of Travel Time Reduction
Impacts on Costs
(Hickling, Lewis, Brod, 1995)

Industry Logistics cost /

travel tim e Logistics cost savings as % of sales
elasticity 20% reduction in 45% reduction in travel
travel time time
Retail Food .055 .04% N/A
Automotive Parts .234 .20% .45%
Telecommunication .103 .02% .05%
Equipment
Medical / Surgical .548 .88% 1.98%
Instruments
Elasticity of logistics costs el with respect to travel
time reduction.

Compare the high el for a high value added industry

compared to retail food.

[caution: result of a limited survey]

Provision of Infrastructure & Industry
Levels
Shirly and Winston (2001) using the Census Bureau’s
Logitational Research Database find support for the
view that lower transportation costs and higher
reliability allow firms to maintain
lower inventories.
Facility Consolidation

Reduced freight costs allow a multifacility firm to

concentrate its production and distribution facility
locations in fewer locations to take advantage of
scale economies.

Substantial savings in logistical costs

Case study of a firm in medical surgical products

with $1.8 billion sales in 1990.
Logistics Cost Savings due to Facilities
Consolidation, Medical and Surgical
Products Case Study
Before After Savings
Consolidation Consolidation
Distribution Faciliti es 16 6
Costs ($Mil lions)
Transpo rtation 22 18 18.2%
Warehous ing 9 7 22.2%
Inven tory Carrying 11 9 18.2%
Total Logistics Costs 42 34 19.0%

Hickling (1995)
Location Effects

Transport improvements contribute to productivity

growth through mechanisms that involve the
location choice of the firm.

The Case of Agglomeration Economies

several types:
* Urbanization Economies
(scale economies in the provision of public infrastructure
in concentrated areas of public demand)
 continued….

* Juxtaposition Economies
(reduction in the cost of transferring intermediate
goods among diverse firms linked together in the
production chain)

* Localized Economies
(spillovers of knowledge and labor skills that occur
when firms in the same industry cluster together)

Significant productivity benefits to economic

agglomeration promoted by lowered transport costs.
Interstate System and the “greenfield” production sites
in peripheral areas.

Transportation promotes productivity both ways:

through clustering and also by spreading at the
urban periphery.

- Different firms need different locations

- The product life-cycle model

Benefits of agglomeration offset at some point by
congestion.

A new project often reduces the congestion.

Transport and Value Added

Adding value to the output of either the freight using firms

or the transportation service provider.

The case of fresh fish with transport improvements.

It is possible to get fish from Maine to St. Louis in less than
a day after catch. Fish can be produced only in a few places
& has a scarcity value elsewhere. Now the fish producing
firm expands its market, and reaches markets where its
output has a higher value than its local market.