Proceedings of the Workshop on Economics of Road Design Standards

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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