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One purpose of design standards is to serve as a substitute for the need for repeated selection of optimal design parameters. For many situations this is a legitimate use of standards in roa…Full description

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**Bureau of Transport Economics, ISBN 0 642 05703 6, 9780 642 05703 7
**

Australian Government Publishing Service, 1980

ECONOMIC ANALYSIS AND OPERATIONS

RESEARCH TECHNIQUES

IN THE SELECTION OF ROAD DESIGN

PARAMETERS

Keith Linard, Director Special Studies Branch and

S. Gooneratne, Project Engineer

Bureau of Transport Economics, Canberra

(Revised & Updated May 2014)

TABLE OF CONTENTS

TABLE OF CONTENTS......................................................................................................................................................... 2

LIST OF TABLES.................................................................................................................................................................. 3

LIST OF FIGURES................................................................................................................................................................ 4

ABSTRACT.......................................................................................................................................................................... 5

Scope & Purpose............................................................................................................................................................... 5

Decision Contexts, Decision Rules & Decision Criteria in Economic Evaluation............................................................... 6

Decision Contexts.......................................................................................................................................................... 6

Perception of Funding Constraints ........................................................................................................................... 7

Decision Criteria........................................................................................................................................................ 7

The Decision Rule for Specific Contexts.................................................................................................................... 9

Choice of Discount Rate............................................................................................................................................ 9

Case Studies: Decision Contexts in relation to Road Design Standards........................................................................... 9

Selection of Optimum Geometric Road Design Parameters (Cases 1, 2 AND 3) ........................................................ 10

General Formulation............................................................................................................................................... 10

Case 1: Optimum Geometric standards under unconstrained funding.................................................................. 11

Case 2: Funding constrained both to K dollars per period and to M periods......................................................... 12

Case 3: Funding is constrained to K dollars, per period but available until program of L project units is completed

................................................................................................................................................................................. 12

Possible Relevance of Cases 2 and 3 to National Highway and Rural Arterial Programs ................................... 14

Design Standards & Mathematical programming of Highway Investments............................................................... 17

Case 4: A Programming Formulation of an Investment Program with Stage Construction, Alternative Design

Standards and Multi-Period Budget Constraints .................................................................................................... 17

Computing Costs ................................................................................................................................................. 19

Advantages of Mathematical Programming....................................................................................................... 19

Iterative Procedures............................................................................................................................................ 19

Traffic Congestion Costs and Capacity Standards – Justification for Capacity Standards .................................. 20

Case 5: Optimal timing of capacity improvements................................................................................................. 21

Case 6: Decisions Concerning Design Floods .......................................................................................................... 23

Maximising Net Present Value............................................................................................................................ 23

Expected Utility Criterion.................................................................................................................................... 23

Multiple Objective Criteria.................................................................................................................................. 24

Dealing with Risk and Uncertainty...................................................................................................................... 26

The Safety Objective Function ............................................................................................................................ 26

Case 7: Cost-effectiveness methodology................................................................................................................ 28

Overview of Cost-Effectiveness Analysis ............................................................................................................ 28

Decision Rules for Cost-Effectiveness Analysis ................................................................................................... 30

Average Cost-Effectiveness Ratio (ACER)............................................................................................................ 30

Incremental Cost-Effectiveness Ratio................................................................................................................. 30

Conclusion....................................................................................................................................................................... 34

Appendix A: Abbreviations & Subscripts Used in Figure 5............................................................................................. 35

Appendix B: Alternative Definitions of Benefit-Cost Ratio ............................................................................................ 36

Appendix C: Equations Giving Optimum Capital Outlay and Optimal Geometric Design Standard for Cases 1, 2 & 3. 37

Case 1: Optimum Geometric standards under unconstrained funding - L, N & r are constants - unconstrained

budget scenario .......................................................................................................................................................... 37

Case 2: Funding is constrained both to K dollars per period and to M periods - K, M, N & r are constants; k and

b=f(k) are variables ..................................................................................................................................................... 37

Case 3: Funding is constrained to K dollars, per period but available until program of L project units is completed -

L, K, N & r are constants; k, f(k) are variables ............................................................................................................. 38

Appendix D: Decision for Mutually Exclusive Projects with & Without Budget Constraints ......................................... 39

Graphical Derivation of Results................................................................................................................................... 39

Unconstrained Budget ................................................................................................................................................ 39

Constrained Budget with Shadow Price .................................................................................................................. 39

REFERENCES.................................................................................................................................................................... 41

LIST OF TABLES

Table 1: Decision Rules for Various Economic Optimisation Criteria & Relevance to Decision Contexts ........................ 8

Table 2: Actual Investment Benefits compared with Corresponding Community Priorities.......................................... 26

Table 3: Ranking of Road Safety Countermeasures by Decreasing Cost-Effectiveness (Present Value of

Countermeasure per Total Fatalities Forestalled over 10 Years..................................................................................... 27

Table 4: Cost-Effectiveness Ratio of Independent Safety Improvements According to Different Decision Criteria

(Maximands) ................................................................................................................................................................... 29

Table 5: Data for Cost Effectiveness Analysis of Mutually Exclusive Options (Hume Circle)......................................... 31

Table 6: Three Step Incremental Cost Analysis of Hume Circle Options ........................................................................ 33

LIST OF FIGURES

Figure 1: Variation of Capital Cost with Increasing Design Standards............................................................................ 10

Figure 2: Variation of Benefits per Period with Project Capital Cost.............................................................................. 11

Figure 3: Optimum Gradient versus Rate of Funding for Reconstruction of Twenty 1.6km Road Segments (Source

McLean 1976).................................................................................................................................................................. 13

Figure 4: NPV versus Capital Cost for a single 1.6km Road Segment ............................................................................. 14

Figure 5:Cumulative Expenditure by Benefit Cost Ratio (BCR) for All National Highways by State & Territory ............ 15

Figure 6: Cumulative Expenditure versus Benefit Cost Ratio (BCR) by State for Rural Arterials.................................... 16

Figure 7: Travel Time versus Hourly Traffic Volume....................................................................................................... 20

Figure 8: Travel Time Savings versus Hourly Traffic Volumes......................................................................................... 21

Figure 9:Net Present Value versus Commissioning Year ................................................................................................ 22

Figure 10: Present Value of Benefits versus Present Value of Costs showing - Illustrating Lower Optimum Capital

when Budget is Constrained to .................................................................................................................................... 23

Figure 11: Utility Function of Risk Averse Decision Maker ............................................................................................. 24

Figure 12: Capital Cost of Bridge versus Deck Level ....................................................................................................... 25

Figure 13: Average Annual Time of Bridge Pavement Submergence............................................................................. 25

Figure 14: Incremental Cost Effectiveness Analysis for Mutually Exclusive Options - Equivalent Annual Cost versus

Accident Reduction Benefits........................................................................................................................................... 32

Figure 15: Correctly defining the Benefit Cost Ratio ...................................................................................................... 36

Figure 16: PVB versus PVC for Mutually Exclusive Projects OA, OB, OC & OD............................................................... 40

Figure 17: NPV versus PVC for OA, OB, OC & OD........................................................................................................... 40

ECONOMIC ANALYSIS AND OPERATIONS

RESEARCH TECHNIQUES IN THE

SELECTION OF ROAD DESIGN

PARAMETERS

Keith Linard, Director Special Studies Branch and S. Gooneratne, Project Engineer,

Bureau of Transport Economics, Canberra

ABSTRACT

One purpose of design standards is to serve as a substitute for the need for repeated selection of

optimal design parameters. For many situations this is a legitimate use of standards in road design

and construction as in other fields of engineering. However, it is suggested that for certain major

projects and in extreme conditions of terrain or climate it is highly desirable that the selection of

important design parameters be assisted by economic analysis and relevant operations research

techniques.

Several classes of design standards are considered and an optimisation methodology is set out for

each class, taking into account the constraints, the decision contexts, the decision criterion and the

related decision rule. Some examples are given to illustrate the procedures, and their advantages

and limitations are discussed.

Scope & Purpose

The primary purpose of this paper is to draw attention to and provide an outline of the methodology

for economic optimisation of road design parameters. The methodology is specifically related to

some of the decision contexts in the Consolidated Set of Design Standards for National Highways in

Australia but the basic principles are applicable in most other situations.

1

This paper should not be necessary, given the many general texts on economic optimisation

techniques published in recent decades and the considerable literature on economic evaluation

disseminated by bodies such as the Commonwealth Treasury, the Bureau of Transport Economics

and the former Commonwealth Bureau of Roads.

2

Unfortunately, in all areas of public sector

investment analysis, both in Australia and overseas, the technical quality of many economic analyses

leaves much to be desired, principally because authors appear not to appreciate that different

decision contexts require different decision rules. Also, the literature is sparse on the application of

economic optimisation techniques specifically to the selection of road design parameters. Some of

the few useful contributions will be discussed later, in the appropriate contexts.

We are not arguing that economic optimisation should be the sole, or even the principal, criterion in

the selection of design standards. It is our contention, however, that it is a very important input and

should not be lightly ignored. Nor are we arguing that detailed economic evaluation of design

1

Consolidated Set of Design Standards for National Highways in Australia, Australia (1976).

These design standards were declared in September 1976 by the Minister for Transport under

provision the National Roads Act 1974.

2

Examples are Dasgupta and Pearce (1978), Mishan (1971), de Neufville and Stafford (1971),

Cassidy and Gates (1977) and Reutlinger (1970).

standards is necessary in all cases. For most purposes, professional judgement guided by design

manuals and informed through State road authority and other local and international road research

provides an appropriate basis for the selection of design parameters. We do consider, however, that

there are frequent situations where professional judgement can and should be assisted by

techniques based on economic evaluation, cost effectiveness analysis and systems analysis.

Situations where this may be desirable at the design level include major road projects such as town

by-passes, decisions concerning rural freeways and specific projects through difficult terrain and

flood-prone areas. Of course, we consider it axiomatic that the actual preparation of standards and

technical guides be guided, inter alia, by economic considerations.

3

Decision Contexts, Decision Rules & Decision Criteria in Economic Evaluation

As discussed by Taplin (1980) and Latham (1980) there are multiple objectives relevant to decisions

on road standards. In this paper we are concerned solely with the economic objective function. The

economic objective function or the economic maximand to be pursued is the expected net present

value of the available set of investment opportunities. That is, for any given decision context, the

decision rule relating to economic optimisation should be consistent with maximising the expected

net present value of the investment.

Unfortunately considerable confusion exists both in the literature and amongst practitioners when it

comes to translating this decision rule into practice. This confusion stems in part from a failure to

distinguish between the decision criterion and the decision rule, and from a failure to recognise that

different decision contexts may require different decision rules. This failure to distinguish between

the criteria and the decision rules applicable to the criteria can and does lead to confusing and

sometimes erroneous outputs.

The considerable, often conflicting, literature on the relative merits of different criteria such as net

present value (NPV), benefit-cost ratio (BCR) and internal rate of return (IRR) is largely a result of this

failure.

4

Decision Contexts

For the present purpose the broad categories of decision situations confronting public sector

analysts may be classified as follows:

5

i. Accept-Reject - No Budget Constraint: Faced with a set of independent projects and no

constraint on the number which can be undertaken, the analyst is required 'to identify all

'worthwhile' projects.

ii. Accept-Reject - Constrained Budget: Faced with the analysis of one specific project in

isolation of the total sector program, and given that sectoral budget constraints exist, the

analyst is required to determine whether an identified solution is 'worthwhile'.

iii. Choice Between Mutually Exclusive Projects: Where projects are interdependent or mutually

exclusive (e.g. alternative geometric standards or alternative alignments for a given section

of road) the analyst is required to identify the 'best' alternative, assuming either:

3

It is encouraging that the recent revision (NAASRA, 1979) to policy for Geometric Design of

Rural Roads (NAASRA, 1976) has been approached in this manner and that the current edition of

Australian Rainfall and Runoff (Institution of Engineers, Australia, 1977) provides no prescriptive

flood design standards, reversing its previous policy.

4

See for example the debate in Engineering Economist on the relative merits of IRR in

different contexts.

5

See also Dasgupta and Pearce (1978, p.160).

a) no budget constraint as in (i), or:

b) constrained budget, as in (ii)

iv. Selection of Optimal Project Size or Time Phasing (Staging): This is a special case of (iii).

v. Selection of Optimal Replacement Cycle: This is a special case of (iii).

vi. Program Composition - Single Period Rationing: Where capital is constrained for a single

period, the analyst is required to determine, from a given list of possible independent

projects, the composition of and relative priority within an investment program.

vii. Program Composition - Multi-Period Rationing: Where there are multi-period constraints on

capital or other resources, the analyst is required to determine, from a given list of possible

independent projects, the composition of and relative priority within an investment

program.

In decision contexts of type (vi) and (vii), the projects considered are often not all independent. The

treatment of program composition where some projects or groups of projects are mutually exclusive

is discussed in the text.

In carrying out an economic analysis, correct specification of the decision context is of utmost

importance. If the context of an analysis is not properly specified, then the results of subsequent

evaluations are likely to be irrelevant.

Perception of Funding Constraints

The decision contexts above refer to both constrained and unconstrained budget situations. In

practice road funding has always been constrained. However, the perception of such constraints in

relation to the standards adopted for particular situations appears to diminish with the remoteness

of the decision maker from construction and maintenance activity. It is perhaps partly a result of this

that in both Australia and the US, the design codes up to the mid-1970s evidenced little perception

of economic constraints and were based largely on considerations of engineering excellence.

Decision Criteria

A wide range of criteria are used in practice for economic evaluation: net present value (NPV), the

benefit-cost ratio (BCR), the internal rate of return (IRR), marginal present value (MPV), marginal

benefit cost ratio (MBCR), and capital efficiency ratio (CER) are the most common. Appendix A

defines each criterion.

The NPV criterion is always appropriate to use in determining the optimum economic solution. The

BCR is appropriate in certain specific circumstances, but is not synonymous with maximising net

present value in a number of common situations, especially when applied to mutually exclusive

alternatives (de Neufville and Stafford 1971; Gould 1972). The IRR criterion, even when properly

applied (and it is almost invariably used incorrectly) can and generally will result in an incorrect

economic decision

6

. Gould (1972) demonstrates that the IRR is totally irrelevant to decision making

on mutually exclusive alternatives, the context, paradoxically, where it is most often applied. The

CER is merely a variant on the benefit cost ratio (CER =BCR-1), and suffers from the defects of the

BCR. The marginal present value and marginal BCR have limited applicability, but are very valuable in

relation to choice between mutually exclusive alternatives.

6

Cassidy and Gates (1977) argue that IRR is an invalid criterion in any context. In like manner,

we contend that, while it does give the same answer as the NPV criterion in context (i), its use

should be avoided even then.

Table 1: Decision Rules for Various Economic Optimisation Criteria & Relevance to Decision Contexts

Note: λ = Shadow price of the budget, which is approximately the BCR of the most marginal (least worthwhile) project on the program.

The Decision Rule for Specific Contexts

Table 1 details the decision rules appropriate to the different contexts outlined above. A list of

definitions of abbreviations used in the table is in Appendix A. More detailed discussion is contained

in the texts referred to previously.

Choice of Discount Rate

The discount rate serves to bring project alternatives with different time streams of costs or benefits

to a common basis as present value dollars. It is beyond the scope of this paper to discuss what the

appropriate discount rate might be. However, as will be seen from some situations discussed later,

the discount rate may be a critical parameter having a significant influence on the investment

decisions being made.

Case Studies: Decision Contexts in relation to Road Design Standards

For purposes of illustration of how economic evaluation, cost effectiveness analysis and systems

analysis may be applied we have selected the following decision contexts. The choice of an optimum

standard is, by itself, always a choice between mutually exclusive alternatives. However, other

contexts arise for example in staging of standards.

Case 1: Selection of optimum geometric road design standard given an unconstrained budget. The

decision context in this case is of type (iii) in Table 1; choice is between mutually exclusive alternative

standards.

Case 2: Optimum geometric standard for progressive upgrading reconstruction of a highway system

given a multi-period budget constrained to K dollars for each of M periods. Choosing the

composition and relative priority of individual projects, or 'project units' within the program

constitutes a decision context of type (vii). For the present purpose, however, we assume that the

sequence of project units has been pre-determined or is given, and the decision required is that of

selecting the geometric standard to be adopted, such as the parameters defining the pavement

width characteristics. The decision context is again of type (iii).

Case 3: The decision context in this case is similar to the previous one, and of the same type, with

the difference, that funding at K dollars per period ceases when all project units in the program to

reconstruct the highway are completed.

Case 4: Selection of composition and relative priority of projects for stage construction of a corridor

given multi-period rationing as described in Case 2. The decision context is type (vii). It is shown that

design standards for each stage could be optimised even though staging itself is a process of

optimising a road design over the planning horizon.

Case 5: Optimal timing of road capacity improvements. The decision context is of type (iv) where the

choice is between alternative times for commissioning the improvement. As shown presently this

decision can also be stated in terms of the traffic flow at which it is optimal to upgrade.

Case 6: Hydraulic design of a road section or structure. Again this is the context, type (iii), of a choice

between mutually exclusive alternatives, but the stochastic nature of flood recurrence and the

disruptive effects of floods require different treatment from the previous examples.

Case 7: Maximising road safety. The context here is choosing the most cost-effective strategy to

maximise road safety given (a) a set of independent alternatives, and (b) a set of mutually exclusive

alternatives. This context is included because it illustrates how the introduction of non-economic

objectives might be treated.

Selection of Optimum Geometric Road Design Parameters (Cases 1, 2 AND 3)

General Formulation

We assume the progressive reconstruction of a length L equal segments of a highway is to occur by

spending a total capital of K dollars per period for Mperiods.

Although the geometric design standard of a road needs speed, width, curve radius and grade

parameters for its specification, let us denote by the variable Sa set of any one or more of these

parameters. The capital cost k

n

dollars of construction or reconstruction of a single project unit (e.g.

1 km section) is related to its geometric design standard Sby a curve of the form shown in Figure 1.

Since the curve is monotonically increasing, k

n

is a measure of the general design standard. If an

optimum value k

1

of k

n

could be found, the corresponding best set s

1

of geometric design parameters

is also an optimum set for all values of k.

Figure 1: Variation of Capital Cost with Increasing Design Standards

We now make the strong assumption that the annual benefits $b

n

from each project segment

remains constant over time to t = N and that $b is the same for successive project units until all L

units are completed. This implies that there is no traffic generated by the improvement and no

increasing returns to scale. Implications of this assumption and its partial relaxation are discussed

later.

As defined previously, $b includes both user benefits and changes in operating and maintenance

costs directly attributable to the project segment and is considered a function b = f ( k ) only of unit

project cost k and hence the design standard. With some encouragement from McLean (1976, Figure

13), we venture to suggest that f( k ) will mostly be of the form shown in Figure 2. It is argued that

this curve will peak and then decline because increasing per unit maintenance costs and possibly

accident costs

7

will eventually outweigh marginal increases in user benefits.

We assume a discount rate of i = ( r – 1 ), and an analysis interval of N periods fromt=0 to t=N where

N >= M. The derivation of solutions giving optimal k (and hence optimal design standards) for the

three different funding contexts of Cases 1, 2 and 3 is presented in Appendix B.

Case 1: Optimum Geometric standards under unconstrained funding

Although unconstrained funding is an inappropriate context for most road funding situations, we

present the solution because it indicates that the highest possible design standard is not the best

choice even with unlimited funds. This context may also be useful to consider the design standard

appropriate for a very low volume rural highway which has relatively large funds available for its

reconstruction due to its high functional classification; for example, National Highways in very

remote parts of Australia.

The optimum solution, derived in appendix B, is given by the equation:

F’( k ) = ln(r) / (1 - r

–N

) ≈ i (1)

The interpretation of this is surprisingly simple in that it is represented in Figure 2 by point C whose

tangent has a slope for all practical purposes equal to the discount rate i. The standard C will be

lower than the standard D, the maximum standard level, since the discount rate will not approach

zero. In other words, the optimum design standard is a function of the discount rate. Use of a lower

discount rate would result in a higher optimum design standard, as would be expected.

Figure 2: Variation of Benefits per Period with Project Capital Cost

A, B & C are solutions given optimum design standards in different decision contexts

7

There is some evidence, for example, that increasing the pavement width of a 2-lane, 2-way

rural road beyond 6.8 metres results in an increase in the accident rate. (See McLean 1980 and Dart

and Mann 1970.)

Case 2: Funding constrained both to K dollars per period and to M periods

One of the situations to which this context corresponds might be where a road funding program of

K * Mdollars in total has been announced to be made available at the rate of K dollars per period for

Mperiods. This would largely correspond to the present situation with regard to rural arterial road

programs or the Roads to Recovery Program. The context outlined previously assumes that the

backlog of works is such that there are a large number of projects which have similar benefits per

unit length - as will be discussed, this situation appears valid in a wide variety of cases.

In general, funds are known to be insufficient to reconstruct all of the L project segments (at $k per

segment) of highway), that is

L > K * M / k (2)

As shown in Appendix B, the optimum design standard set is given by

k * f’( k ) - f( k ) = 0 (3)

This is represented by point A on Figure 2, the tangent which also passes through the origin. This

solution corresponds to maximising the ratio of ( b / k ) as defined previously and, somewhat

surprisingly, it is independent of the discount rate i, the rate of funding, K dollars per period, the

number of periods of funding Mand the analysis period N.

What this solution means is that, provided the warranted or feasible project set cannot be

completed with the known or likely funding program, the optimum design standards set is that

which maximises ( b / k ), the ratio of user benefits less operating and maintenance costs per period

per project unit to capital cost per project unit. This result greatly simplifies the task of identifying

the optimum standards for a road program which satisfies our assumptions. The optimum standards

for the project unit considered in isolation correspond to the optimum program standards.

As shown in Appendix B, relaxing the assumption of constant benefits does not affect the optimality

condition in equation (3) provided that the function relating benefits to time is of the form M

b(t) = b * h(t) . This implies that the ratio of benefits less operating and maintenance costs from

different design standards remains constant over time. The possible applications of these results are

discussed after Case 3.

Case 3: Funding is constrained to K dollars, per period but available until program of L

project units is completed

This context corresponds to the situation where a funding program exists at a specified rate of K

dollars per period until the completion of a specified program, following which the funding is

assumed not to be switched to other road programs. This might correspond, for example, to a

special program for a specific set of roads to assist a developing industry, for example the ‘Roads to

Recovery’ program.

The number of periods Mfor which funding is available, for given L and K, now depends on k and

hence the design standard adopted. As shown in Appendix B, the optimum solution for k is

{ k * ( 1 – r

-pk

) - k

2

* p * ln(r) * r

-N

} * f’ ( k ) + { ( 1 – p * k *ln(r) * r

-pk

– 1 } * f( k )

- ln(r) * ( 1 – p * ln(r ) * r

-pk

) = 0 (4 )

This is admittedly difficult to interpret at first sight. It could however be readily solved for k provided

( b = f( k ) ) is known graphically. A very small computing effort is all that needed to solve equation

(4) by a process of iteration.

Despite its foreboding appearance, equation (4) does suggest some interesting points. The optimum

k depends on discount rate i, the ratio ( p = L / K ) and the analysis period N. The dependence on

( L / K ) means that as the number L of project units or the magnitude of the program task is

increased, the funding rate K must increase proportionately to maintain the same optimum design

standard.

Using equation (4), it is possible to confirm McLean's graphical demonstration (McLean 1976) that

the optimum design standard decreases as the rate of funding decreases. Taking a design grade

example where the necessary detailed data was reported by Read (1971), and using the values L =

20, i = ( r - 1 ) = 0.1 and N=30, McLean demonstrated that, with a decreasing rate of funding K and an

increasing number of years M= L * k/ K to program completion, the optimum maximum grade

increases, that is, the optimum grade standard and K decrease, as shown in Figure 3 (McLean’s

Figure 12 on p.27).

Figure 3: Optimum Gradient versus Rate of Funding for Reconstruction of Twenty 1.6km Road Segments

(Source McLean 1976)

In Figure 4 (McLean's Figure 13), McLean plots NPV versus k for a single project unit. Obtaining f( k )

graphically from this curve and iteratively solving equation (4), we could obtain an approximation of

McLean’s curve of optimum design standard versus K and Mwhich we have reproduced in Figure 3.

This example demonstrates the value of equation (4) in road investment planning situations where

f( k ) can be graphically determined.

Figure 4: NPV versus Capital Cost for a single 1.6km Road Segment

Possible Relevance of Cases 2 and 3 to National Highway and Rural Arterial Programs

The above results are applicable where the assumptions concerning the constancy of benefits

remain valid. In general, this assumption is reasonable for two lane rural roads where congestion

costs are negligible and where there remains a large backlog of warranted projects. For example,

congestion costs are negligible where traffic volumes in the design year are less than about 1800

vehicles per day and where heavy vehicles constitute less than about 10% of the traffic stream. The

traffic volume assumption is not restrictive, since at least two-thirds by length of the rural arterial

and National Highway system carries less than 1800 vpd.

A measure of the change of benefits for successive increments in investments is afforded by the

curves in Figures 5 and 6 which show plots of Cumulative Expenditure versus BCR for National

Highways and rural arterials respectively in different States.

The rate of change of benefits is least in the steepest portions of the curves. The figures suggest that

the constancy of benefits assumption in the foregoing analysis is reasonably satisfactory in the

investment range likely over the next decade in relation to National Highways in the Northern

Territory, South Australia, Tasmania and Western Australia, whereas New South Wales is a

borderline case. For rural arterials the assumptions are satisfactory in Victoria, Tasmania and South

Australia but in the case of Tasmania and Victoria the BCRs of these projects are less than 1.

Figure 5:Cumulative Expenditure by Benefit Cost Ratio (BCR) for All National Highways by State & Territory

(All Horizontal Axes – Increasing BCR from Left to Right)

Figure 6: Cumulative Expenditure versus Benefit Cost Ratio (BCR) by State for Rural Arterials

(All Horizontal Axes– Increasing BCR from Left to Right)

Design Standards & Mathematical programming of Highway Investments

Previous applications of mathematical programming to optimisation of highway investments have

been described by de Neufville and Mori (1970) and Bowyer (1976). Bowyer also gives the mixed

integer linear programming formulation of an investment program consisting of s route segments

each with L projects for implementation over T periods each of which has a constrained budget. The

former Commonwealth Bureau of Road's system for its solution with a continuous phase followed by

a branch and bound algorithm is described in detail by Bowyer.

A variable increment dynamic programming approach is used by de Neufville and Mori to obtain an

optimum schedule of investments for a program of investments including stage construction options

on some projects. Detailed formulation is not given, but an example is used to illustrate the

superiority of their procedure to scheduling by benefit-cost ratios with budgetary constraints and by

a static, period by period procedure. There appear to be no cases reported of solving or even

formulating an investment scheduling problem including the choice of alternative design standards

for each project or each stage of a project. Such a formulation is given in Case 4.

Case 4: A Programming Formulation of an Investment Program with Stage Construction,

Alternative Design Standards and Multi-Period Budget Constraints

Berry (1979) and Berry and Both (1980) describe the advantages of stage development and use of

alternative design standards in investment planning for the Victorian rural arterial road system

through examples at the network, corridor and project levels.

The following is an integer linear programming formulation of this problem. The context is similar to

that described by Forbes and Womack (1976) as it applies to highway planning in California.

We consider P sections of a corridor with Q construction stages in each section, thus generating

P * Q possible projects. Each project could be built to Salternative design standards commencing

construction in any one of T periods. These sets define a set of four-dimensional variables

X( p, q, s, t ) representing the proportion of stage q of section p to be built to design standard s in

year t. If the projects are all indivisible, then:

X( p, q, s, t ) = 0 or 1, for all p, q, s, t ( 5)

From previous evaluations, the NPVs of all projects are determined and represented by V( p, q, s, t ).

Project capital costs, K( p, q, s, t }, are expressed in constant prices. The objective function then

becomes:

= ∑ ∑ ∑ ∑ , , , × , , , (6)

Subject to the constraints:

∑ ∑ ∑ , , ,

× , , , ≤ (7)

∑ ∑ ( , , , )

≤ , (8)

∑ , + , , ≤ ∑ × , , , , , = 1 − 1 (9)

And:

, + , , =

, + , , × , , , +

, + , ,

× ( − , , , ) (10)

For all p, s, t and q = 0 to Q – 1; X(p, 0, s, t ) = 0 for all p, s, t

And K

1

is defined for q = 1 to Q – 1 and K

2

for q = 0 to Q - 1

Equation (7) specifies the multi-period budget constraint. Equation (8), the mutual exclusivity

constraint, specifies that each project can be commenced only in any one period and to one design

standard. Equation (9) ensures that stage (q + 1) of a section cannot be scheduled before the

previous stage q and equation (10) selects project costs K from one of two cost matrices K

l

and K

2

depending on whether the previous stage of the same section was commenced at the same time or

before, respectively. This last condition is needed if economies of scale exist in undertaking

simultaneous construction of any two successive stages of the same section.

The above formulation assumes in equation (7) that all capital funds for each project ( p, q, s, t )

selected are allocated from the budget K(t) in the period of commencement. Alternatively, we may

wish to specify, as Bowyer (1976) has done, that allocation for each selected project may come from

more than one period.

If, for example, the project allocation comes from two periods, a project commenced in period t has

capital costs K

a

(p, q, s, t ) and K

b

( p, q, s, t+1 ) in periods t and t+1 respectively. Therefore the

budget K(t) in period t will fund K

b

type costs of projects commenced in the previous period and K

a

type costs of projects commenced in period t. Hence the new budget constraint equation to replace

equation (7) becomes:

∑ ∑ ∑ , , ,

× , , , − +

∑ ∑ ∑ , , ,

× , , , ≤ ( ) (11)

Equation (10) needs to be adjusted accordingly, so that each of K

a

and K

b

will have alternative values

depending on whether or not construction is commenced simultaneously with the previous stage.

Bowyer (1976) provides an additional condition which enables entire subsets of projects to be all

accepted or rejected. If it was desired to allow all stages of a section to be either included or

excluded we need the condition:

∑ ∑ ∑ , , ,

= × (12)

where (p) is assigned either zero (corresponding to rejection of section p) or one (corresponding to

accepting all Q stages of section P).

A Simple Example:

We consider a program of three sections (Q=3), two stages in each section (P=2) and two periods

(T=2) at a previously determined design standard (S=1). Economies of scale do not exist and costs

are expressed in constant prices. The PVC matrix implies that, in constant prices, project costs are

the same for the two periods. The NPV matrix given below shows pairs of values corresponding to

periods 1 and 2.

With budget constraints of I7 and I5 for the two respective periods, the best two solutions A

1

and A

2

,

are as shown with subscripts 1 and 2 denoting scheduling in periods 1 and 2 respectively. A

1

has a

program NPV of 25 and A

2

has 24, and both consume all funds in periods 1 and 2. If economies of

scale in simultaneous construction of section 3 exist, and will result in a capital cost reduction in

stage 2 exceeding 1, then A

2

will become the best solution.

PVC = [

5 7 5

7 10 5

] NPV( t = 1, 2 ) = [

7, 5 7, 5 5, 3

2, 1 5, 4 3, 2

]

A

[

1 1 1

− 2 2

] A

[

2 1 1

− 2 1

]

Adding different design standards to this problem simply adds another dimension of computational

complexity. A problem with larger values of P, Q, Sand T means more computations in selecting

optimal solutions. An algorithm with P = 3, Q = 20, T = 10 and S = 3 implies 1800 elements in the NPV

matrix, that is 180 for each t value. Search for the best solution is clearly a task for the computer

using solution search techniques such as those described by Bowyer (1976).

Computing Costs

Bowyer (1976) and Krosch (1980) give examples of computing resource costs for running large data

processing and computational programs. The continuing dramatic reductions in hardware costs and

the constantly increasing computational speed and versatility of systems available to users, is likely

to make such computing tasks increasingly more feasible.

Advantages of Mathematical Programming

Road planning models such as RURAL (Both and Bayley, 1976), NHUPAC (National Highways Study

Team, 1973) and NIMPAC (Bayley, 1979) are required to determine an NPV matrix of any reasonable

size, despite all the attendant difficulties. However, the extra costs and effort involved in the

programming approach could be a price well worth paying for the better quality of the analysis with

all its implications. We noted earlier that, for instance, de Neufville and Mori (1970 found their

programming solution considerably better in scheduling projects than criteria such as ranking by

benefit-cost ratio.

8

Some limited programming work by the former Commonwealth Bureau of Roads

also gives support to this (Fisher et al, 1970).

For various practical reasons, including the complexity and size of the system to be modelled, this

approach obviously has its limits. Other approaches such as sampling techniques and iterative

solutions could then become substitutes or complement mathematical programming.

Iterative Procedures

Rahmann (1976) reported the use of the NHUPAC road planning model to iteratively arrive at a set

of feasible solutions for a Queensland rural road program. Different sets of assessment and design

8

Ranking by ECR is valid for type (vi) decision contexts with single period rationing, but not for

type (vii) with multi period rationing and the requirement for an optimum time schedule of

projects.

standards were applied to the data inventories and cost matrices to generate corresponding total

program costs.

Comparing these with the available budget showed the standards which would enable an acceptable

road program. Krosch (1980) reports on an updated version of this study using the much more

versatile NIMPAC model.

Given the imperfections of the real world such as the quality of evaluation data and lack of

information for system definition, it is quite possible that judgement, based on experience and an

understanding that cannot at present be modelled, and assisted by a set of feasible solutions such as

those reported by Rahmann and Krosch, is sometimes the best method. This fact should not

however encourage abandoning research into more rigorous economic analysis and systems analysis

for optimising standards at the program level.

Traffic Congestion Costs and Capacity Standards – Justification for Capacity Standards

Travel time savings constitute the dominant component of user benefits from capacity

improvements to urban arterials and two lane rural roads with traffic volumes in excess of 2000 vpd

and significant heavy vehicle movements. As the traffic volume increases the interaction between

vehicles also increases and congestion costs increase non-linearly as shown in Figure 7 (Hutchinson,

1972a, Figure 1).

Figure 7: Travel Time versus Hourly Traffic Volume

A road improvement shifts the congestion curve downwards and the travel time benefits from it

correspond to the difference as shown in Figure 8 (Hutchinson, 1972a, Figure 2). Since the capacity

benefits increase with volume, there will be an optimum time for the improvement, its specific value

depending on the decision context.

Figure 8: Travel Time Savings versus Hourly Traffic Volumes

The use of capacity standards or capacity warrants for road improvements, taken in an economic

context, implies that a given improvement (e.g. duplication) is justified at a given traffic volume

regardless of the time profile of traffic growth.

9

Intuition may suggest that the contrary is true,

namely that the optimum time for an improvement depends not only on the traffic volume at that

time but also on the time profile of traffic growth before and after that time. However, Buckley and

Gooneratne (1974) have shown, with certain assumptions, that the solution can be expressed as an

optimum volume, so that the optimum time is merely the time at which the optimum volume is

reached, thereby providing a rationale for traffic volume based warrants or criteria for improving

road standards and capacities.

Case 5: Optimal timing of capacity improvements

Hutchinson (l972a) describes a method for timing of investments with capacity benefits estimates

based on extreme hourly traffic volumes. He gives an expression for net present value:

= ∑ ( ∆ − ) − + (13)

Where: W(K

x

) = the net present value in the base year of a capital investment, K

x

, in a capacity

improvement in year x; V

q

= the present value factor for year q; ∆B

q

(K

x

) = the marginal benefits in

year q due to a capacity improvement in year x; M

q *

K

x

= the maintenance costs in year q of the

facility constructed in year X; a = the number of years from year x to the year in which the next

major capital expenditure is expected to occur; S= the salvage value of the capital investment, K

x

, in

the year, x+a; and V

x

and V

x+a

= the present value factors for the years, x and x+a respectively.

For the case of improving a two lane facility to a four lane facility, he computes W(K

x

) for various

values of x, the year of improvement, by estimating the marginal benefits via marginal travel time

savings, hourly volumes and average daily volumes. Figure 9 (Hutchinson's Figure 11) is his plot of

NPV versus commissioning year x for two cases with different traffic growth assumptions.

9

See for example Both and Bayley (1976) Appendix A; Both (1979) Appendix A; and NAASRA

(1976).

Figure 9:Net Present Value versus Commissioning Year

Referring to Figure 9 above, Hutchinson (1972a) says that the improvement is justified in 1976 when

NPV just becomes positive. In terms of the decision framework of Table 1, he is implicitly assuming

that the context is of type (i), namely, accept/reject with no budget constraint. Since decision

making on capacity improvements clearly constitute choice between mutually exclusive alternatives,

as we see from Table 1 the decision context appropriate to this case is that of type (iv). If the budget

is unconstrained, the decision rule becomes to maximise NPV. In the budget constrained situation

the rule is maximise (NPV − − ∗K).

Hutchinson points out that in both cases in figure 9, greater benefits could be obtained by delaying

the improvements. For the higher traffic growth case NPV continues to grow beyond the end of this

planning period, and for the lower growth case, maximum NPV is reached in about 1980 when the

curve becomes asymptotic.

While Hutchinson's method solves for optimum improvement time graphically, Buckley and

Gooneratne (1974) have suggested a maximum NPV based method for obtaining a computational

solution for optimum time via optimum volume. This method has the advantage that it makes

explicit the effect of uncertainty in traffic growth forecasts on the optimum solution. By maximising

NPV they obtain:

μ C

1

(μ) = μ C

x

(μ) + K * ln(1 +i) + M (14)

where μ is traffic flow, C

1

(μ) and C

x

(μ) are the average congestion costs per vehicle for the initial

facility and the improved one which may improve, replace or supplement the existing facility; K is

the capital cost, Mis the annual maintenance cost and i is the discount rate. This is applied to the

case of (a) replacement of an urban surface street by a motorway and (B) where it is supplemented

by the motorway. This is done by using an empirically estimated expression for μ C(μ) as a

polynomial function of the average daily traffic, the coefficients of which depend on the type of

facility. The procedure is also demonstrated for a rural road improvement. Solving equation 14 gives

optimal traffic flow for undertaking the improvement.

Once again the decision context is that of type (iv) and maximising NPV implicitly assumes no

constraint on the budget.

Hutchinson (l972b) outlines a framework for developing a regional highway investment program for

regions with relatively well developed highway infrastructures in which is included the methodology

he developed (Hutchinson, 1972a) for economic analysis of capacity improvements.

Case 6: Decisions Concerning Design Floods

Maximising Net Present Value

The selection of design flood for road and bridge projects using the economic criterion of maximising

NPV with no budget constraint constitutes a decision context of type (iiia), namely, a choice between

mutually exclusive alternatives. However, if investment in the project needs to be considered in the

context of constraints on the budget from which it is to be funded, then the context is that of type

(iiib). As shown in Table 1, two decision rules for the former case, no budget constraints, are the

lowest MBCR ≥ 1 and lowest MNPV ≥ 0. For the case of constrained budgets it can be shown that the

appropriate rules are the lowest MBCR ≥ λ and lowest MNPV ≥ (1- λ) * Δ K where λ is the shadow

price of the overall budget and Δ K is the marginal K (see Appendix C) .

Howell (1977a) graphically demonstrates the former case of unconstrained funding, as do de

Neufville and Stafford (1971). Figure 10 shows the same curve with points A and B representing

optima for unconstrained and constrained funding and having tangents with slopes of 1 and (λ – 1)

respectively.

Expected Utility Criterion

Howell (1977a) suggests that, for decision making contexts with a spread of risk such as when a state

authority has control over a large region with many flood risk situations, the monetary value

criterion or maximising expected NPV may be appropriate. In contrast, when the consequences of

flooding are large in relation to the decision maker's scale of operation, the expected utility criterion

may be more appropriate.

Figure 10: Present Value of Benefits versus Present Value of Costs showing -

Illustrating Lower Optimum Capital when Budget is Constrained to λ

Figure 11 is the plot of the utility function of a risk-averse decision maker as shown in de Neufville

and Stafford (1971) and Howell (1977a), who also suggests methods for estimating the utility

function. The rationale for this approach is clearly the need to incorporate the decision maker's risk

averseness (or any other deviations of his utility from expected value) into the decision criterion.

In a numerical example, Howell (1977a) gives the decision criterion of maximising:

=∑ ∗ ( ) (15)

Where: E(U) = Expected Utility

P(r) = Probability of r flood exceedences for r = 1,2 … 16

U(r) = Utility of r exceedences.

E(U) is computed for seven different flood frequencies and the flood selected is that corresponding

to the highest expected utility.

While the foregoing analysis, in the context of the optimum capacity of a cofferdam, considers utility

as a function of the number of exceedances per period, in the road planning context, a measure that

is sometimes considered more appropriate is flood duration per period (Vroombout 1980).

Flood duration is likely to have a non-linear cost curve. Road closure in rural areas of a day or two is

likely to impose minimal road user cost; a week's closure could be significant but a month or more is

likely to be critical. In equation (15) if r is replaced by a measure s of flood duration, then we have a

decision rule which for some situations will be preferable. In some situations it may be desirable to

consider the utility of joint events, so that P( r, s ) is the joint probability of r exceedences and a total

duration greater than s days per annum.

Multiple Objective Criteria

Vroombout (1980) expresses the view that insufficient consideration is given to flood duration

during consideration of bridge deck levels. He illustrates graphically the trade-off between the

bridge capital cost and deck level and hence the average annual time of submergence. (His curves

are reproduced in Figures 12 and 13.)

Figure 11: Utility Function of Risk Averse Decision Maker

Figure 12: Capital Cost of Bridge versus Deck Level

Figure 13: Average Annual Time of Bridge Pavement Submergence

This approach, a variant of the cost effectiveness approach, avoids the problem of subsuming the

social, political and economic cost of bridge closure into a single numeraire, the dollar. Instead the

graph makes the trade-off between these disruption costs and the dollar outlays for bridge

construction quite explicit for the decision makers and the public.

Consider a choice between accepting a four day average annual submergence and one of seven

days. Since the design flood chosen in the case cited by Vroombout required a bridge costing

$345,000 with an average annual time of submergence of seven days, instead of the $700,000

bridge necessary to reduce the annual average submergence a further three days, we conclude that

the decision makers implicitly valued at less than $355,000 the benefits accruing from a further

reduction. of three days of submergence. This process of subjective decision making, trading off one

set of objectives (e.g. economic efficiency) against another (e.g. well-being represented by

reductions in days of submergence) is the essence of the multiple objective approach. The analyst's

task is to make the necessary information as explicit as possible enabling informed decision making.

Howell (1977a) also gives an excellent example of this approach with numerical and graphical

illustration.

Howell (1977a and b) also discusses problems due to insufficient flood data causing flood frequency

estimates to be very inaccurate, and methodology for dealing with the need for arbitrary selection

due to unavailability or inaccessibility of data. Discussion directly relevant to design flood selection

for road project is contained in Howell (1980).

Dealing with Risk and Uncertainty

Many key parameters used in economic analysis of transport investments are subject to

considerable uncertainty due to their stochastic nature, due to insufficient or unreliable data or due

to the need to predict future events. In order to cope with this uncertainty conventional practice has

been to supplement the "most probable" point estimate, with an 'optimistic' and 'pessimistic'

comparison - although the implications of these are delightfully vague. Another common practice,

where the analyst felt particularly uncomfortable with the accuracy of the data (or was perhaps

more honest), has been to include a range of qualifications such that the decision maker who reads

the fine print is left in doubt concerning the value of the conclusions presented.

It is suggested that, for major projects, risk and uncertainty is best taken into account explicitly

through the use of probability analysis. Reutlinger (1970) and Pouliquen (1970) give a clear

exposition of such techniques applied to road projects.

The Safety Objective Function

Traditional evaluation of major road projects or programs subsumes the safety objective function

into the economic objective function. As a result, the implicit weighting given to different goals is

largely hidden from public scrutiny. As suggested by Table 2, there is evidence to suggest that public

ranking of the perceived importance of various benefits from road expenditure is in direct contrast

to the ranking of the monetary benefits identified in conventional cost-benefit studies, and hence to

the relative factor weightings in the evaluations. This may be a problem in quantification and

valuation of non-monetary benefits, but it could also be due to over-emphasis on the technical

engineering works as compared with community desires.

Table 2: Actual Investment Benefits compared with Corresponding Community Priorities

Benefits Category

Percent of Total Benefits

Community Attitudes

Relative Priorities for Road

Expenditure

Urban

Arterials

%

Rural

Arterials

%

National

Highways

%

Accident Cost Savings 16.4 4.1 3.4

Safety 100

Reliability 38

Travel Time Cost Savings (Private &

Commercial)

60.3 40.0 52.1

Speed &

Travel Time 29

Vehicle Operating Cost Savings 23.3 54.5 44.5

Vehicle

Operating Cost 21

Smoothness

of Ride 26

TOTAL BENEFITS 100 100 100

Source: Percent of Benefits – CBR (1975) Report on Roads in Australia, Tables 7.26, 8.13 & 9.9.

Community Perceptions – CBR (1974) Roads and Road Expenditure An Analysis of

Community Attitudes in Melbourne and Sydney.

Table 3 (Trilling, 1978) is interesting in this context. The table indicates the order of cost per life

saved for 37 alternative road safety counter-measures. The strategies which consume the bulk of

public road funds both in the US and Australia are precisely those which are least effective, in terms

of dollar outlay, in saving fatalities. We have certain reservations concerning methodological aspects

of the Trilling study, nevertheless the results are certainly in accord with the fact that safety benefits

form a minor component of total benefits in most road project or program evaluations.

Table 3: Ranking of Road Safety Countermeasures by Decreasing Cost-Effectiveness

(Present Value of Countermeasure per Total Fatalities Forestalled over 10 Years

Countermeasure

Fatalities

Forestalled

Cost

($ million)

Dollars per

Fatality

Forestalled

Mandatory Safety Belt Usage 89,000 45.0 506

Highway construction and Maintenance Practices 459 9.2 20,000

Upgrade Bicycle and Pedestrian Safety Curriculum Offerings 649 13.2 20,400

Nationwide 55-mph Speed Limit 31,900 676.0 21.200

Driver Improvement Schools 2,470 53.0 21,400

Regulatory and Warning Signs 3,670 125.0. 34,000

Guardrail 3,160. 10.8.0. 34,100

Pedestrian Safety Information and Education 490 18.0 36,800

Skid Resistance 3,740 158.0 42,200

Bridge Rails and Parapets 1,520 69.8 46,000

Wrong-Way Entry Avoidance Techniques 779 38.5 49,400

Driver Improvement Schools for Young Offenders 692 36.3 52,500

Motorcycle Rider Safety Helmets 1,150 61.2 53,300

Motorcycle Lights-On Practice 65 5.2 80,600

Impact-Absorbing Roadside Safety-Devices 6,780 735.0 108,000

Breakaway Signs and Lighting Supports 3,250 379.0. 116,000

Selective Traffic Enforcement 7,560 1,010.0 133,000

Combined Alcohol Safety Action Countermeasures 13,000 2,130.0 164,000

Citizen Assistance of Crash Victims 3,750 784.0 209,000

Median Barriers 529 121.0. 228,000

Pedestrian and Bicycle Visibility Enhancement 1,440 332.0 230,000

Tire and Braking System Safety Critical Inspection - Selective 4,591 1,150.0 251,000

Warning Letters to Problem Drivers Clear Roadside Recovery Area 192 50.5 263,000

Clear Roadside Recovery Area 533 151.0 284,000

Upgrade Education and Training for Beginning Drivers 3,050 1,170.0 385,000

Intersection Sight Distance 468 196.0 420,000

Combined Emergency Medical Countermeasures 8,000 4,300.0 538,000

Upgrade Traffic Signals and Systems 3,400 2,0.80.0 610,000

Roadway Lighting 759 710.0 936,000

Traffic Channelization 645 1,080.0 1,680,000

Periodic Motor Vehicle Inspection - Current Practice 1,840 3,890.0 2,120,000

Pavement Markings and Delineators 237 639.0. 2,700,000

Selective Access Control for Safety 1,300 3,780.0 2,910,000

Bridge Widening 1,330 4.600.0 3,460,000

Railroad Highway Grade Crossing Protection (Automatic gates

excluded)

276 974.0 3,530,000

Paved or Stabilised Shoulders 928 5,380.0 5,200,000

Roadway Alignment and Gradient 590 4,520.0. 7,680,000

Source: Trilling (1978), Table III

Any suggestion of lowering geometric or other road standards runs the risk of being stifled by

arguments that safety must not be impaired. However, particularly where budgets are constrained, a

lower design standard may in fact permit improved system-wide safety. The following quote from

Chansky (1975) puts the case most effectively.

"An older arterial of, say, 50 miles in length is extremely substandard in all respects. It has an

18-foot pavement, practically no shoulders, and poor alignment. On most of the route safe

operating speed is only 35 mph.

Due to funding limitations, the state can only allocate $5 million in construction funds to this

route over the next 20 years. Typically, the state uses the money to reconstruct the worst 5-

mile section to full compliance with design standards and neglects the remaining 45 miles.

I'm sure you have all experienced the type of highway I'm describing. You drive for 20 miles or

so over tortuous and dangerous highway; then hit a beautiful new 5-mile section and resume

you trip on another 25-mile death trap.

Let us suppose that we weren't restricted by the 'all or nothing' requirement for design

standards and could spend the allocated $5 million to improve the entire route in an

optimum manner. The money might permit us to resurface and widen the pavement to 24

feet for the entire 50 miles. This element would then comply with design standards. Perhaps

we could squeeze in 4-foot paved shoulders. The standard calls for 10 feet, but it would be

too costly. We could make minor alignment revisions to increase the safe operating speed to

around 50 mph.

Compare the alternative approaches described - which would result in the safest and more

cost-effective highway?"

Similar sentiments have been expressed also by Lind (1976), Kaesehagen (1977), McLean (1978) and

Berry (1979). The safety goal, however defined, can be integrated into an economic framework

without loss of identity through cost-effectiveness analysis. Another advantage of this approach is

that a full range of administrative, 'low' technology and 'high' technology alternatives is more likely

to be considered than under traditional project oriented cost-benefit analysis. Such analysis may

supplement other evaluation approaches where there are a number of goals to be met.

Case 7: Cost-effectiveness methodology

Overview of Cost-Effectiveness Analysis

Cost effectiveness analysis (CEA) is simple in concept. The aim is to identify, for given alternatives,

the degree to which the specified goal is met relative to the cost incurred. The phrase “getting the

biggest bang for the buck”, coined by the US military in the early 1950s, epitomises the aim of CEA.

In relation to a road safety investment program (for example a “black-spot” program) one might

apply CEA to identify which traffic intervention option achieves the highest accident reduction per

dollar of expenditure.

Cost-effectiveness analysis is often proposed to be better than economic evaluation because it does

not attempt to put dollar values on, for example, human life or personal injury. Rather, it presents

the decision maker with an estimate of outcome (for example expected lives saved per year) and the

cost of achieving this outcome. It thus, so it is argued, leaves the balancing of costs and outcomes to

the decision maker, rather than this being usurped bin the mathematics by the analyst.

In fact matters are not quite so simple. In relation to safety improvements, for example, the safety

goal encompasses both accident probability change and accident severity change. Any road safety

measure will have a gradation of changes in both areas. Thus measures to improve safety may

decrease the number of severe accidents but increase minor ones. Traffic lights, for example, will

reduce fatalities but increase rear end accidents. Alternative measures will, in general, reduce fatal,

injury and property damage only (PDO) accidents in different proportions.

This raises the question regarding what exactly is the maximand to be sought; reduction in fatalities

only, reduction in fatalities and other casualty accidents (which might include severe injury such as

brain damage or paraplegia); reduction in all injury to persons or reduction in all accidents. The

implications of these different decision criteria are illustrated in Table 4.

If the decision rule is to minimise $ per Casualty Accident (line 11 – the cost effectiveness of

reducing casualty accidents only), then improvements D and A rank 1 and 2 respectively. If the

decision rule chosen relates to $ per all Accidents (line 13 – the cost effectiveness of reducing all

accidents), then improvements C and D rank 1 and 2 respectively.

Table 4: Cost-Effectiveness Ratio of Independent Safety Improvements According to Different Decision

Criteria (Maximands)

Improvement (Project) A B C D

Cost Related Data Estimated Costs ($’000)

1 Initial Cost 150 225 300 600

2 Operating Cost per Annum 3 0 6 12

3 Terminal / Salvage Value 0 0 30 60

4 Service Life (years) 10 10 15 20

5 Equivalent Uniform Annual Cost

1

27.45 36.30 44.55 81.45

Accident Types

Estimated Reduction in Number of

Accidents per Annum

6 Casualty Accident (Fatal & Serious Injury) 1.0 1.0 1.5 3.5

7 Personal Injury (not involving hospitalisation) 5.0 7.0 13.5 22.5

8 Casualty Accidents and Personal Injury ( = 6+7) 6 8 15 26

9 Property Damage Only 22 36 48 70

10 All Accidents ( = 8 + 9) 28 44 63 96

Decision Criterion (Goal to be Maximised or Maximand) Cost-Effectiveness Ratio

11 $ per Casualty Accident ( = 5/6) 27,500 36,000 29,700 23,300

12 $ per all Casualty & Personal Injury ( = 5/8) 4,580 4,540 2.970 3,130

13 $ per all Accidents (casualty, injury & property) ( = 5/10) 980 825 707 848

Ranking by Criterion Ranking of Improvements

14 $ per Casualty Accident 2 4 3 1

15 $ per all Casualty & Personal Injury 4 3 1 2

16 $ per all Accidents (casualty, injury & property) 4 2 1 2

Note 1: Based on data in rows 1 to 4, using 10% discount rate

The decision maker is therefore required to make a judgement as to the relative merits of these two

criteria. If arbitrary weightings are assigned to the respective benefits in forestalling accidents of the

three different types criteria 11, 12 and 13 could be combined to a single criterion dependent on the

relative values assigned to the different accident types. Such a measure has the advantage of putting

the information on a common basis and the disadvantage of concealing the relative values being

assigned. If the weightings reflect estimates of the costs associated with the different accident

types, we are back to benefit-cost evaluation

10

.

10

For typical values used in Australia see Both and Bayley (1976) and for typical US values see

Jorgensen Associates.

Decision Rules for Cost-Effectiveness Analysis

As with Cost-Benefit evaluation, the decision rules for Cost-Effectiveness Analysis (CEA) also vary

according to the decision context. Users of CEA can allocate limited resources and make decisions

more efficiently if certain decision rules or guidelines are followed.

When Assessing Independent Programs – Use Average Cost-Effectiveness Ration (ACER)

Order the programs from least to most effective.

Eliminate the strongly dominated programs.

Calculate ACERs.

Implement programs in order of increasing ACER until either resources are exhausted or the

ACER is equal in value to one unit of effectiveness.

When Assessing Mutually Exclusive Options – Use The Incremental Cost Effectiveness

Ratio (ICER)

Form groups of mutually exclusive programs.

Order programs within each group from least to most effective.

Within Each Group

Calculate the ICER.

Eliminate both strongly and weakly dominated programs.

Rank all programs in order of increasing ratio.

Implement programs in order of increasing ICER until either resources are exhausted or the

ratio is equal in value to one unit of effectiveness.

Average Cost-Effectiveness Ratio (ACER)

The hypothetical example in Table 4 illustrates the average cost-effectiveness ratio (ACER) concept,

assuming each of the road safety options are independent, not mutually exclusive. Using different

safety criteria or different units of effectiveness will result in different rankings of the four

independent alternative safety improvements A, B, C and D.

Incremental Cost-Effectiveness Ratio

Use of the average cost-effectiveness ratio (ACER) should parallel that of benefit cost ratio

suggested in Table 1 and is appropriate for use in ranking independent alternatives. However, for

mutually exclusive alternatives (type (iii) in Table 1), incremental cost-effectiveness ratio (ICER) is

the appropriate criterion. In the context of analysis of measures to reduce accidents, the

incremental cost effectiveness ratio may be defined as the marginal cost per additional accident

forestalled.

This is illustrated in Tables 5 and 6 and Figure 14 by an analysis of alternative measures for

upgrading an accident-prone intersection. The example is based on accident reduction data for

various options in Department of Construction (1976) for the Hume Circle, Canberra, rehabilitation

project. That project reviewed a Canberra intersection which averaged 80 casualty accidents per

year. The review considered a simple line marking and channelization improvement, two

roundabout upgrades, three signalisation and three grade separation options.

The review undertook a traditional Cost-Benefit Analysis, based on mutually exclusive alternatives,

following the decision rules in Table 1. In that analysis, dollar values were ascribed to the various

social benefits, including casualties forestalled. However, noting that casualty accident numbers

were the primary rationale for the improvement project, the analysis also undertook a Cost-

Effectiveness Analysis, that is, it identified the primary objective to be number of accidents

forestalled, and assessed the efficacy of the various options in addressing that objective.

Table 5: Data for Cost Effectiveness Analysis of Mutually Exclusive Options (Hume Circle)

Mutually Exclusive

Improvement

Projects

Option Details

Cost

$’000

Benefits

(Expected Annual

Accident Reduction)

Do Nothing Do Nothing 0 0

A

Line marking &

Channelisation

100 10

B Roundabout 600 17

C Roundabout 700 29

D Signalisation 2,400 12

E Signalisation 2,900 19

F Signalisation 3,000 31

G Overpass 8,000 37

H Overpass 10,000 19

J Overpass 20,000 29

Table 6 details the calculations for the 3 step Incremental Cost Effectiveness Ratio procedure.

In Step 1, options are sorted by increasing benefit, then by increasing cost. ‘Strongly

dominated’ options are identified and eliminated.

We see that options D, E, H and J are “strongly dominated” by other options. That

is, other options can produce improved benefits at lower cost. Thus, for example,

Option D achieves a reduction of 12 accidents per year at a cost of $2,400,000 whilst

option C, at less than a third the cost, achieves more than double the accident

reduction.

In Step 2, remaining options are again sorted by increasing benefit, then by increasing cost.

‘Weakly dominated’ options are identified and eliminated.

In Step 3, remaining options are again sorted by increasing benefit, then by increasing cost.

For each option, the incremental cost per benefit achieved is inspected both against the

available budget and against the decision makers’ “willingness to pay” for the additional

benefits.

Referring to Table 5 and the associated Figure 14, Option A has the lowest cost and lowest average

cost effectiveness ratio of $10 per accident forestalled. However, it only achieves 10 accident

reductions per annum, and the residual accident rate of 70 per year presumably remained

unacceptable.

Referring to Figure 14, the line joining 0 – A – C – G is referred to as the ‘efficient frontier. The

optimal alternatives lie on the efficient frontier. Which is selected depends on the available budget

and how much the decision maker is prepared to pay to achieve the incremental benefits from

choosing a more rather than less expensive option. Thus option C is expected to lead to a further 19

accident reduction per year, compared with A, but the cost of each accident forestalled is $34,000.

Implementing option G, rather than C, is expected to result in a total reduction of 37 accidents per

year, or 8 more than option C. The marginal cost of each of these 8 additional accidents forestalled

is over $900,000 per accident. Which of these is optimal depends on the decision makers’

assessment of the social cost of accidents. If the situation relates to casualty accidents forestalled,

the incremental cost per accident of $34,000 for option C is most likely to be considered very

worthwhile. When we come to consider moving from option C to option G the likelihood is that

decision makers would consider the extra funds could be applied to other accident hot spots and

reduce far more accidents.

The reality is that, even in cost effectiveness analysis, the decision maker ultimately has to put a

valuation on life and human suffering.

Figure 14: Incremental Cost Effectiveness Analysis for Mutually Exclusive Options - Equivalent Annual Cost

versus Accident Reduction Benefits

Table 6: Three Step Incremental Cost Analysis of Hume Circle Options

Mutually

Exclusive

Improvement

Projects

Option Details

Cost

$’000

Incremental

Cost

(Additional

Cost c.f.

Previous

Option)

$’000

Benefits

(Expected

Annual

Accident

Reduction)

Incremental

Benefits

(Additional

Accidents

Reduced c.f.

Previous

Option)

Average Cost-

Effectiveness

Ratio

( = Annual Cost /

Benefits)

Incremental Cost-

Effectiveness

Ratio

( = Incremental

Cost /

Incremental

Benefits)

Exclusion Criteria

STEP 1: Sort by Increasing Benefits & Identify 'Strongly Dominated' Options

Do Nothing Do Nothing 0 0 n/a

A

Linemarking &

Channelisation

100 100 10 10 10,000 10,000 n/a

D Signalisation 2,400 2,300 12 Strongly Dominated Option

B Roundabout 600 500 17 7 35,000 71,000

E Signalisation 2,900 2300 19 Strongly Dominated Option

H Overpass 10,000 7100 19 Strongly Dominated Option

C Roundabout 700 100 29 12 24,000 8,000

J Overpass 20,000 19300 29 Strongly Dominated Option

F Signalisation 3,000 2,300 31 2 97,000 1,150,000

G Overpass 8,000 5000 37 6 216,000 833,000

STEP 2: Remove 'Strongly Dominated' Options; Recalculate ICER; Identify 'Weakly Dominated' Options

Do Nothing 0 0

A 100 100 10 10 10,000 10,000

B 600 500 17 7 35,000 71,000 Weakly Dominated Option

C 700 100 29 12 24,000 8,000

F 3000 2300 31 2 97,000 1,150,000 Weakly Dominated Option

G 8,000 5000 37 6 216,000 833,000

STEP 3: Remove 'Weakly Dominated' Options; Recalculate ICER; Determine Preferred Option based on ICER & Benefits

Do Nothing 0 0

A 100 100 10 10 10,000 10,000

C 700 600 29 19 24,000 32,000

G 8,000 7300 37 8 216,000 913,000

Conclusion

Several examples have been discussed illustrating the application of economic optimisation

methodology. They were selected for their variety in decision contexts as well as in design

parameter types.

It has been shown that different decision contexts require different decision rules even when using

the same decision criterion. In particular, constrained funding situations require different rules from

corresponding unconstrained situations and lead to different optimum design parameter values. It is

stressed that our aim has been to demonstrate that economic evaluation techniques can be applied

in a wide variety of circumstances. We have not endeavoured to provide a handbook for

practitioners, but rather to illustrate how such evaluation can be adapted to different circumstances.

One significant by-product of this exercise has been to demonstrate that, in the case of constrained

funding, the optimal design standard is lower than in the case of unconstrained funding.

Some situations, such as programming the improvements to a road network, require relatively more

complex methodology including various operations research techniques. These cases usually involve

very large investments and the relative difficulty of analysis need not be an excuse for abandoning

systems analysis within the appropriate economic framework.

Appendix A: Abbreviations & Subscripts Used in Figure 5

B = expected present value of benefits to the government agency responsible for the project,

to the clients/users & to society as a whole MINUS the expected net present value of

recurrent operating and maintenance costs.

{B = Bs – Cu – Cs – (Ca – K) }

C = expected present value of all recurrent costs associated with the project.

{C = Cu + Cs + (Ca – K)}

K = expected present value of all capital costs associated with the project. (Presumed to be

incurred by the government agency responsible for the project.) K is a sub-set of Ca (all

agency costs). Agency recurrent costs = (Ca – K).

BCA = Benefit Cost Analysis (sometimes referred to as Cost Benefit Analysis)

CEA = Cost Effectiveness Analysis

NPV = Expected Net present Value

= [B – C - K]

BCR = (Net) Benefit Cost Ratio

= { [B – Cs – Cu – (Ca – K)] / K}

Note: other definitions are often used, but are invalid. See Appendix B.

IRR = Internal Rate of Return and is defined such that:

∑ − ×[ + ] =

MNPV= Marginal Net Present Value

= [ Change in B ] – [ Change in C ] for a small change in investment,

λ = Shadow price of the Budget. This is roughly equal to the BCR of the least ‘worthwhile’

project in the sectoral budget (i.e., the last program to make it onto the project schedule).

ACER = Average Cost Effectiveness Ratio

ICER = Incremental Cost-Effectiveness Ratio

i,n = possible projects out of a schedule of [ 1 to n] project alternatives, where Project is the ‘ith’

project in the schedule..

x = integer variable with value [1] if a project is accepted, and [0] if not.

a, u, s = the group (Project agency, direct users or society at large) which benefits or suffers costs as

a result of the project.

t, T = the year ( t ) in the range [ 1 to T ] in which a project is initiated or in which a benefit or a

cost is produced.

Estimating Budget Shadow Price, λ

The simplest approach is to equate λto the BCR of the least attractive project included in the

program funded in the last budgeting period. A more rigorous method is described in Feldstein

(1964).

_____________________________________________

Appendix B: Alternative Definitions of Benefit-Cost Ratio

Much of the literature on BCR is ambiguous if not incorrect when it comes to defining the B/C ratio.

The problem arises because cost reductions may be defined as a positive benefit and cost increases

may be defined as a negative benefit. How does one decide whether a particular ‘cost’ or ‘cost

saving’ should be included in the numerator or the denominator of the ratio. . It can readily be

shown that only those costs, which are under the control of the agency funding the project, and

which are subject to budget constraints, should be included in the denominator. Figure 15 gives a

clear definition of the BCR in various circumstances.

Figure 15: Correctly defining the Benefit Cost Ratio

Appendix C: Equations Giving Optimum Capital Outlay and Optimal Geometric Design

Standard for Cases 1, 2 & 3

Following from the problem formulation and definition of parameters preceding Case I, these results

could be derived by adopting either periodic or continuous discounting. For reasons of clarity and

mathematical convenience we use the latter approach.

Case 1: Optimum Geometric standards under unconstrained funding - L, N & r are

constants - unconstrained budget scenario

Selection of optimum geometric road design standard given an unconstrained budget. The decision

context in this case is of type (iii) in Table 1; choice is between mutually exclusive alternative

standards.

Given unlimited funds and no other resource constraints (e.g., labour), the program budget K = L * k

is sufficient to construct all L project units at t=0.

PVC = L * k

PVB = L * B * dt = ( L * B / n*r ) / ( 1 - )

NPV = PVB - PVC

Setting ( d(NPV) / dK ) = 0 gives:

f’(K) = ( 1 - )

It can readily be shown that, for typical values of r ( = 1 + i) and N

( 1 - )≈ i

(For example, for I = 10% and N = 30 years, ( 1 - r ) = 0.101 ≈10%.

Case 2: Funding is constrained both to K dollars per period and to M periods - K, M, N & r

are constants; k and b=f(k) are variables

No. of project units L > K*M/k

For Period t = 0 to t = M:

Present value of capital cost incurred in (t, t+dt) is (K * r dt). Since (K / k) project units would be

completed in time t, present value of benefits in (t, t+dt) is (K * b / k) * t * r dt.`

For period from t=M to t=N:

By definition, no capital costs are incurred.

Present value of benefits in (t, t+dt) is ( K / k ) * M * r dt.

Present Value PVB of Capital Costs:

PVC = K * = (K / ln(r) * ( 1 - ) (17)

Present Value PVB of Benefits:

PVB = ( / k ) * ( . dt + M * . dt (18)

Net Present Value:

NPV = PVB - PVC

To determine optimum k, we set d(NPV) / dk = 0, corresponding to maximum NPV. We obtain:

k f' (k) - f(k) = 0 (19)

where f' (k) = d (f(k)) / dk

For N = ∞, BCR = b / (k *ln(r) )

Case 3: Funding is constrained to K dollars, per period but available until program of L

project units is completed - L, K, N & r are constants; k, f(k) are variables

Let p = L/K, then, given L = K*M / k, we have M = p* k

Due to the additional variable M, d(NPV)/dk=0 gives a less convenient result:

{ k( 1 - ) - * p * ln(r) * } f’(k) + { ( 1 – p * k * ln(r) * – 1 } f(k)

- ln(r) * ( 1 – p * ln(r) * ) = 0 (20)

Relaxing the Assumption of Constant b with Respect to Time

We define b(t) as the average rate of benefits per period per project at time t, over all projects

completed at time t. While traffic growth would tend to increase b(t) over time, any tendency for

decreasing returns from successive projects would tend to decrease b(t) with respect to time.

Defining b(0}=b=f(k}, a very general expression for b(t) would be b(t)=b * h(b, t) , h(b, 0) = 1.

However we make the less general assumption that:

b (t) = b * h(t), where h(0) = 1 (21)

which has the implication b (t) / b (t) = b / b

which means that ratios of benefits from different design standards remain constant over time. It

can be shown that incorporating equation (21) in derivation of PVB modifies equation (18) to

PBV = Kb ( 1 - - M * ln(r) * + g ( h(t) , r , M , N) ) ) / ( k * r ) (22)

Where g denotes a function, which does not contain variables k and b = f(k). Consequently, in Case

2, it is evident that the solution given by equation (19) will be unchanged. In Cases 1 and 3, the

solutions will be different but their form will be similar to equations (16) and (20).

Appendix D: Decision for Mutually Exclusive Projects with & Without Budget Constraints

Graphical Derivation of Results

In Figures 16 and 17, OA, OB, OC, OD represent four mutually exclusive projects with PVCs and PVBs

as shown in Figure 16 and NPVs as shown in Figure 17.

However, the choice between these four mutually exclusive projects is equivalent to the choice

between four dependent projects OA, AB, BC and CD. The dependency is obvious. In the given

sequence, any one project is dependent on all those preceding it.

Unconstrained Budget

We apply the decision context type (i) rules for BCR and NPV from Table 1 to the dependent projects

in the given sequence starting with OA. We find that OA, AB and BC satisfy the respective rules ( BCR

≥1 ) and ( NPV ≥0 ), but CD does not. Selecting OA+AB+BC is equivalent to choosing OC. The

appropriate decision rules can be inferred from Figures 16 and 17 and they are:

choose project that maximises NPV (Figure 17)

choose project that has least MBCR ≥1, (Figure 16)

choose project that has least MNPV ≥O, (Figure 17)

Constrained Budget with Shadow Price λ

We apply decision context type (ii) rules ( BCR ≥λ) and ( NPV ≥(λ−1) *K ) to the dependent

projects in sequence. These rules mean: accept a project if its slope (e.g., that of line OA) ≥λ, in

Figure 16 or (λ−1), in Figure 17. We find that OA and AB satisfy the rules and BC does not. The

corresponding best mutually exclusive alternative is OB, and from Figures 16 and 17 we infer the

decision rules contained in Table 1 for this context:

choose project that maximises NPV − − ∗ , (Figure 17)

choose project that has least MBCR ≥ , (Figure 16)

choose project that has least MNPV ≥( − ) * ( , ) , (Figure 17)

Figure 16: PVB versus PVC for Mutually Exclusive Projects OA, OB, OC & OD

Figure 17: NPV versus PVC for OA, OB, OC & OD

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