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
Professor T. R. Lakshmanan
September 23, 2008
◊ User benefits (times, fares, vehicle operating costs,
◊ Investment costs
◊ Operator costs and revenues
◊ Impacts on government - taxation subsidies
◊ Externalities (environmental, congestion)
Three concepts underlying the definition of user benefit:
◊ Willingness to Pay (WTP)
◊ Consumer Surplus (CS)
◊ Generalized Cost (GC)
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)
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.
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
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).
problems. For most goods, the vertical axis indicates
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 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
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
* Public Transport users - fare plus costs of time of
* Car users - costs of time, toll charges, fuel costs plus
Differences in repeated user benefits for users of different modes (e.g. Public transport users do not have VOC benefits)
PS - TR - TC
where TR is total revenue
and TC is total costs
∆PS = ∆ TR - ∆ TC
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”
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
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
Some adjustments to Investment Costs include:
Mitigation Measures (EIS, etc.)
Disruption (effect of disruptions on traffic revenues and on
(Market prices or factor costs basis)
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).
- population subgroups and also on individual
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
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
The case of latentdemand
Amount of travel time savings overstated
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
1. travel in working time
2. travel in non-working time (e.g. shopping,
commuting, education, personal business,
3. freight travel time
Working time value is easy to analyze because there is a market (labor market) where working time is valued
Adapt the gross wage rate (wage plus employee -
related overheads) as a measure of the marginal
product of labor
minutes of travel time savings
in working time
VOT = gross wage/min X
1) The ability to work while traveling (varies by mode)
The ability to use productively any travel time saved also varies, depending upon the extent to which work tasks are divisible and flexible.
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.
- an example: UK Official Values
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.
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.
Here the private cost of travel is increased by an
external cost e.
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.
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.
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.
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
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
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.
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.
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.
of 30 Euros/person per dB per annum in year 2000 prices
This value adjusted to other countries using PPP exchange
Damage costs much higher /unit mass of pollutant emitted
in urban (US non urban areas) - 50 times as much
in London vs. rural areas.
High level of uncertainty - sensitivity testing necessary.
Inputs - modeling & forecasting all inputs (time, cost and
time). Estimates of investment costs, safety and
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.
Discounting - Discount future costs and benefits in line
with public sector conventions on discount rates.
Summary Measures - over all measure in CBA terms.
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.
Departures from perfectly competitive markets result in
wedges between interest rates faced by different economic
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%).
Present Value (NPV)
NPV = ∑
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
- Accept all projects with a positive NPV
- Accept the highest project option with the
highest NPV, when there are mutually
Accept projects based on a marginally acceptable B/C ratio.
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.
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
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.
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 World Bank experience in LDCs ($50 billion in transport
Estimated Returns from World Bank Projects
Logistics Cost Effects
Other Location Effects
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
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) ----***
(Hickling, Lewis, Brod, 1995)
Compare the high el for a high value added industry
compared to retail food.
[caution: result of a limited survey]
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
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
Transport improvements contribute to productivity
growth through mechanisms that involve the
location choice of the firm.
The Case of Agglomeration Economies
* Urbanization Economies
(scale economies in the provision of public infrastructure
in concentrated areas of public demand)
* Juxtaposition Economies
(reduction in the cost of transferring intermediate
goods among diverse firms linked together in the
* 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.
in peripheral areas.
Transportation promotes productivity both ways:
through clustering and also by spreading at the
- Different firms need different locations
- The product life-cycle model
A new project often reduces the congestion.
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.