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, , , (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:
C
1
() = C
x
() + K * ln(1 +i) + M (14)
where is traffic flow, C
1
() and C
x
() 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 C() 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 and lowest MNPV (1- ) * K where is the shadow
price of the overall budget and 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 ( 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
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,
= 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,
The simplest approach is to equate to 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
We apply decision context type (ii) rules ( BCR ) and ( NPV (1) *K ) to the dependent
projects in sequence. These rules mean: accept a project if its slope (e.g., that of line OA) , in
Figure 16 or (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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