TRANSPORT ECONOMICS

QUESTION 1
Importance of transport investment in fostering economic growth
Transport is an essential input to income generation, and to consumption and wider domestic life.
The impacts of a transport improvement are wide-ranging, particularly for large projects. To
understand their contribution to economic performance – and to have a framework for project
appraisal – it is necessary to drop to a level of detail which identifies and assesses the impacts of
particular projects. These impacts can be grouped into three types; user benefits, productivity
effects, and investment and employment effects.
User-benefits: User-benefits are the most direct effects and comprise the savings in time, vehicle
operating costs and other elements of ‘generalized travel cost’ associated with better transport.
They are calculated to include new journeys created and (for major projects) possible problems
(such as congestion) created elsewhere in the network. The term ‘user-benefit’ is perhaps
misleading; while the cost saving is best measured by its impact on users, the market economy
transfers much of the benefit to others in the economic system. Commuters who see their travel
times cut may end up transferring the benefit to their landlords in higher rent; firms whose costs
fall may pass the benefit to consumers. These benefits are the principal impacts of a transport
improvement and form the core of an economic appraisal. However, there is wide agreement that
they fail to capture the full impact of major projects.
Productivity effects: The second source of benefit is productivity gains accruing to firms and
workers, including those that are not themselves necessarily users of the transport improvement.
They arise because of the economic benefits of scale and economic density. Transport is a
necessary ingredient to securing these benefits, in several distinct ways. First, economic
interactions between firms (and between firms and consumers) are better, the better the transport
system. Firms can reach wider markets, enabling them to expand, gain scale economies and
develop specialist skills; markets are more competitive as the natural barrier of distance is
reduced and inefficiencies associated with monopoly and monopsony power are eroded. Second,
transport enables cities to specialize, developing sector specific advantages.
Investment and employment: The third causal mechanism through which transport affects
economic performance is via altering patterns of private sector investment and consequent
employment. Better transport generally makes a place more attractive for investment. There is
evidence that transport links are one factor shaping the location decisions of firms, although only
one amongst many (with availability of suitably skilled labour usually cited as the most
important.
QUESTION 2
Discuss problem of negative externalities in transport and how optimal pricing can help
address the problem
A negative externality is a cost that is suffered by a third party as a result of an economic
transaction. In a transaction, the producer and consumer are the first and second parties, and third
parties include any individual, organisation, property owner, or resource that is indirectly
affected. Externalities are also referred to as spill over effects, and a negative externality is also
referred to as an external cost.
A negative externality occurs when one individual engages in an activity that imposes costs on
another, and the victim cannot normally be compensated for them through the market
mechanism. Examples of negative externalities in transport include: air pollution, light
pollution, water pollution, noise pollution, congestion, safety hazards and community severance.
Optimal pricing maximize benefits and minimize costs by charging exactly what the market will
bear. One of the most efficient optimal pricing strategies in transport is congestion pricing.
Congestion pricing is an efficiency pricing strategy that requires the users to pay more for that
public good, thus increasing the welfare gain or net benefit for society. Congestion
pricing or congestion charges is a system of surcharging users of public goods that are subject to
congestion through excess demand such as higher peak charges for use of bus
services, electricity, metros, railways, telephones, and road pricing to reduce traffic
congestion; airlines and shipping companies may be charged higher fees for slots at airports and
through canals at busy times. This pricing strategy regulates demand, making it possible to
manage congestion without increasing supply.
According to the economic theory behind congestion pricing, the objective of this policy is the
use of the price mechanism to make users conscious of the costs that they impose upon one
another when consuming during the peak demand, and that they should pay for the additional
congestion they create, thus encouraging the redistribution of the demand in space or in time, and
forcing them to pay for the negative externalities they create, making users more aware of their
impact on the environment
QUESTION 3
a) Why is it important to appraise transport infrastructure projects?
The importance of appraising transport infrastructure projects is to identify (to society) all
advantages (social benefits) and disadvantages (social costs) of a project and its alternatives,
compared to the “without project” situation (reference alternative); and monetize, aggregate
(over all affected interest groups/stakeholders over the lifetime of the project), and compare them
to see if social benefits exceed the social costs. Finally, to identify the project alternatives which
have highest benefits compared to the costs over time.
b) How is Cost Benefit Analysis (CBA) different from Financial Analysis (FA)?
Financial Analysis compares benefits and costs to the enterprise, while the CBA
analysis compares the benefits and costs to the whole economy. CBA is concerned with the true
value a project holds for the society as a whole. It subsumes all members of society, and
measures the project’s positive and negative impacts. While financial analysis uses market prices
to check the balance of investment and the sustainability of a project, cost benefit analysis uses
economic prices that are converted from the market price by excluding tax, profit, subsidy, etc.
to measure the legitimacy of using national resources to certain projects. Financial and cost
benefit analyses also differ in their treatment of external effects (benefits and costs), such as
favourable effects on health. CBA analysis attempts to value such externalities in order to reflect
the true cost and value to the society.
c) Outline at least ten elements (5 social benefits and 5 social costs) that would be
considered in a cost benefit analysis for railway infrastructure investment.

Social benefits: travel time saved, reducing traffic congestion, reduction in cost of maintaining
roads since railway will be used, increasing property values and fostering economic
development, and providing a means of transportation for the poor

Social costs: noise pollution, air pollution, global warming, delays and part of accident costs,
and infrastructure costs where these are not fully charged for.

d) What is the decision rule for implementing or rejecting a project under cost benefit
analysis?
If the benefits of a project are more than then costs i.e when NPV is positive, accept the project
and implement. However, if the projects costs are more than the benefits i.e the NPV is negative,
reject the project.
References
 Small, Kenneth A.; José A. Gomez-Ibañez (1998). Road Pricing for Congestion Management:
The Transition from Theory to Policy. The University of California Transportation Center,
University of California at Berkeley. p. 213.

Sheldon G. Strickland & Wayne Ber (Winter 1995). "Congestion Control and Demand
Management". Public Roads Magazine. U.S. Federal Highway Administration. 58 (3).
Retrieved 2008-02-28

Vickrey, William (1992). "Principles of Efficient Congestion Pricing". Victoria Transport Policy

Institute. Retrieved 2008-02-26.

Small, Kenneth A.; Verhoef, Erik T. (2007). The Economics of Urban Transportation.

Routledge, England. p. 148. ISBN 978-0-415-28515-5.

 "Road Charging Scheme: Europe – Italy, Rome". UK Commission for Integrated Transport.
Archived from  the original  on 11 April 2008. Retrieved 16 April 2008.
 
Lindsey, Robin (May 2006). "Do Economists Reach a Conclusion on Road Pricing? The
Intellectual History of an Idea" (PDF). Econ Journal Watch. 3  (2): 292–379. Retrieved 2008-
12-09.

  Henderson, Tristan; Jon Crowcroft & Saleem Bhatti (2001). "Congestion Pricing – Paying
Your Way in Communication Networks" (PDF). IEEE INTERNET COMPUTING,
September•October 2001. Archived from the original (PDF) on 2008-06-27. Retrieved 2008-
03-01.