the economics of road investment
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The Economics Of Road Investment. John Hine ETWTR. SE197. Questions and Decisions 1. Is the project justified ?- Are benefits greater than costs? Which is the best investment if we have a set of mutually exclusive alternatives? If funds are limited, how should different schemes be ranked?

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questions and decisions 1
Questions and Decisions 1.
  • Is the project justified ?- Are benefits greater than costs?
  • Which is the best investment if we have a set of mutually exclusive alternatives?
  • If funds are limited, how should different schemes be ranked?
  • When should the road be built?
questions and decisions 2
Questions and Decisions 2.
  • Are complementary investments required?
  • Should stage construction be used?
  • What standards should be applied ?
appraisal framework
Appraisal Framework
  • All appraisals need a framework or model for:

a) Forecasting changes

b) Evaluating those changes

the costs of road investment

These include:

  • Supervision
  • Management
  • Manpower
  • Machinery
  • Materials
  • Land
  • Environmental Mitigation (e.g. Resettlement)

The Costs of Road Investment


primary effects 1
Primary Effects 1.
  • Reduced vehicle operating costs

fuel and lubricants

vehicle maintenance

depreciation and interest


  • Reduced journey time

drivers, passengers and


primary effects 2
Primary Effects 2.
  • Changes in road maintenance costs
  • Changes in accident rates
  • Increased travel
  • Environmental effects
  • Change in value of goods moved
secondary effects
Secondary Effects
  • Changes in agricultural output
  • Changes in services
  • Changes in industrial output
  • Changes in consumers behaviour
  • Changes in land values
coverage and double counting
Coverage and Double Counting
  • Any economic analysis should be designed to give maximum coverage of benefits.
  • But we must avoid double counting. Do not add primary and secondary benefits (e.g changes in land values added to changes in transport costs)
  • In a competitive economy the consumers’ surplus approach (used in HDM) should be adequate.
the economic comparison
The Economic Comparison
  • An economic analysis involves a comparison of “With” and “Without” cases.
  • Traffic forecasts are made for BOTH scenarios - The analysis should not be based on “before and after”.
  • An unrealistic “Without” case can give a false result.
  • A range of “with investment” cases should be analysed to find the best solution. A minimum investment approach often gives the best economic results and should be tested.
economic and financial prices

Economic and Financial Prices

The cost to the economy of road rehabilitation and maintenance may differ from the financial cost because of :

    • taxes and duties
  • shortage of foreign exchange
  • under-employment

The Government will usually be concerned with ECONOMIC costs.

Contractors will usually be concerned with FINANCIAL costs.


use of economic prices

In an Economic Appraisal we use ECONOMIC (or SHADOW) prices NOT FINANCIAL prices

Use of Economic Prices

  • Adjust financial prices as follows:
  • Exclude all taxes and duties and subsidies
  • Use the planning discount rate not the financial market rate
  • If overvalued exchange rate then value
  • imports and exports more highly
  • Use the opportunity cost of labour
  • Standard Conversion Factors are now widely used for
  • road construction costs


benefits from road investment
Benefits From Road Investment

Changes in transport costs occur because of :

  • Lower road roughness
  • Shorter trip distance
  • Faster speeds
  • Reduced chance of impassability
  • Reduced traffickability problems
  • Change in mode
traffic categories
Traffic Categories
  • Normal traffic: Existing traffic and growth that would occur on the same road, with and without the investment
  • Diverted traffic: Traffic diverted from another road to the project road as a result of the investment
  • Generated traffic: New traffic induced by the investment
benefits from road investment15

Transport cost savings for existing (or normal ) traffic

= Traffic x Change in Transport Costs per

km x distance

Main changes in cost from:

a) change in transport MODE

b) reduced journey TIME

c) reduced VOCs

Benefits from Road Investment


generated traffic benefits
Generated Traffic Benefits

Traffic induced by the road investment are traditionally valued at:

Half the difference in transport costs

Hence total generated transport cost benefits

= Generated traffic volume x change in costs per km x distance x 1/2

estimating benefits
Estimating Benefits

Normal traffic benefits:tripsN * d1 * (VOC1- VOC2)

Diverted traffic benefits: tripsD * ((d1 * VOC1)-(d2*VOC2))

Generated traffic benefits: tripsG * d2 * (VOC1- VOC2)/2

d1 = existing road length d2 new road length

VOC1 = vehicle operating costs per km “without”investment

VOC2 = vehicle operating costs per km “with” investment

VOC data relates to each road section and its condition at the time

the consumers surplus approach

The Consumers’ Surplus Approach

Transport Cost Savings to existing

traffic and normal growth






Additional benefits from new

traffic and production induced

by new investment



T1 T2 Traffic


development benefits

Development Benefits

  • Development benefits arise from a combination of increased traffic and reduced transport costs.
  • Benefits may also include :
  • Increased agricultural production
  • Increased service provision
  • Increased industrial activity


illustration of benefits
Illustration of Benefits













different types of benefit
Different Types of Benefit
  • Normal traffic benefits

= traffic x change in transport costs

  • Development benefits

- A function of (change in transport costs)2

  • Social benefits

- A function of population x change in transport costs

consumer s surplus approach
Consumer’s Surplus Approach:
  • Advantages: Simple, cost based, traffic approach dependent on predicting changes in traffic
  • Disadvantages: May not address critical factors promoting either rural development or social access
producers surplus approach
Producers Surplus Approach
  • Advantages: Draws attention to changes in agricultural output (key economic activity in rural areas)
  • Disadvantages: No reliable way of predicting response

- impact studies give widely different answers

–it could be based on agricultural supply price

elasticities but this is almost never done; it requires

very careful examination to use.

    • For most projects benefits are just invented !
producers surplus
Producers’ Surplus

Price & Costs per unit

Of output


farmgate price


lower input costs

O1 O2


indicies and ranking
Indicies and Ranking
  • Widely used for feeder road planning; there are many different approaches

e.g. i) cost of improvement / population

ii) estimated trips / cost

Adavantages: Speed , simplicity, transparency, many factors can be incorporated

Disadvantages: How do we value widely different factors ? (adding up apples and pears); weightings are not stable ; cannot easily address questions of road standards, timing etc, ; possible double counting

community priorities
Community Priorities
  • Community priorities now often form an important part of feeder road appraisal. It is possible just to ask communities to rank the investments they prefer- both within the road sector or between roads and other investments.
  • Advantages: Community acceptability, use of community knowledge
  • Disadvantages: Sectional interest groups may dominate voting, community knowledge of area or road impact may be poor

1. Net Present Value:NPV = (B1- C1) + (B2- C2) + ….. (Bn- Cn) (1 + r) (1 + r)2 (1 + r )n2. Internal Rate of Return : solve for i, (IRR) 0 = (B1- C1) + (B2- C2) + ….. (Bn- Cn) (1 + i) (1 + i)2 (1 + i )n B1, B2 … Bn : Benefits in years 1, 2 … n C1 C2 Cn : Costs in years 1, 2 …. n r : Planning discount rate , n : planning time horizon


3. Net Present Value/ Investment Cost


4. First Year Rate of Return

FYRR = (B1- C1)


B1, C1 : Benefits and Costs in year 1.

Ci : Road investment costs

economic comparison of alternatives
Economic Comparison of Alternatives
  • When comparing project-alternatives, the Net Present Value (NPV) is used to select the optimal project-alternative (alternative with highest NPV)
  • The Internal Rate of Return (IRR) or the B/C ratio are not recommended to compare alternatives of a given project

Alternatives NPV0.

Optimal Alternative:Highest NPV


ranking projects by economic priority
Ranking Projects by Economic Priority
  • When comparing the economic priority of different projects, a recommended economic indicator is the NPV per Investment ratio


Selected Alternative OverlayReseal


NPV/Investment 8.45.2



economic decision criteria
Economic Decision Criteria


Economic validity v. good v. good v. good poor

Mutually exclusive v. good poor good# poor


Project timing fair## poor poor good

Project screening poor v. good good poor


Use with budget fair ## poor v. good poor


# Need incremental analysis

## Needs continuous recalculations

appraisals post evaluations 1
Appraisals & Post Evaluations 1.
  • An Appraisal is carried out before an investment is made. Everything is uncertain.
  • A Post evaluation may be made say 5 years after the investment. The investment is known and 5yrs of with case are known.

The without case is unknown as is the remainder of the with case.

appraisals post evaluations 2
Appraisals & Post Evaluations 2
  • In Both Cases forecasting and evaluation models are required to come to an answer.
  • Hence we can never be certain about the viability of an investment !