Confederation bridge cost to build

Economic Questions (Calculation Based)

Instruction: You have to work on this assignment mostly based on the class notes, and it is economically calculation based. After take a look on the class notes, then you are good to answer these questions.

Each question only needs a paragraph or two, 2 questions a page, roughly 4 pages. please answer it by labeling the question numbers. (No repeating the question after the number)

Due Dates: 8/21/2019

Background information:

You were recently hired as a summer intern for the City of Tacoma’s Office of Environmental Policy and Sustainability. As a part of your job application, you included a copy of the report that you prepared for TECON 480, and the hiring manager thought that your expertise in cost-benefit analysis would be a useful addition to the department, as they do not have any economists on staff. The City is in the process of analyzing a new initiative that would entail spending $200 million in 2019 on “green infrastructure”. These projects include investing in charging stations for electric cars, installing solar panels on commercial buildings, improving levees to protect against rises in the sea level, and installing scrubbers on manufacturing plants to reduce emissions. The objective of this initiative is to reduce the impacts of climate change in Pierce County over the next 50 years. The department has prepared a preliminary draft of a report evaluating the impact of this initiative and has asked you to review the report.

The following 8 questions relate to the scenario outlined above.

Question 1: The draft report states that one of the benefits of the initiative is that it will create 500 new jobs in Pierce County over the life of the project. If you agree that this impact should be included as a benefit in the analysis, explain how you would quantify and monetize the benefit. If you disagree and do not think that this impact should be included as a benefit, explain why.

Question 2: Clearly explain how you would define the counterfactual for evaluating the impacts of these projects, assuming that only Pierce County has standing for the analysis.

Question 3: The draft report estimates that the annual benefits from these investments will be $5 million per year for each of the 50 years for which these infrastructure projects will be in place. Since the total benefits will be $250 million and the initial investment only costs $200 million, the analysis concludes that the net benefits are $50 million and the project should be undertaken. Explain why you agree or disagree with this statement.

Question 4: Choose one potential assumption for the project, and explain how you would conduct sensitivity analysis. Include a brief explanation as to why this is an important component of cost-benefit analysis.

Question 5: The draft report mentions that one potential benefit of the project is a reduction in the likelihood of flood damage to homes in areas within 1 mile of the Puyallup River. Without the projects, there is a 25% probability that these homes will be affected by flooding; with the projects, the probability of flood damage is predicted to decrease to 10%. Explain how you could quantify and monetize this benefit.

Question 6: The report mentions that one of the impacts of the investments would be that the slowed increase in atmospheric temperatures would regulate the local climate of Mt. Rainier and avoid excessive and early melting of the snowcap each year. Provide one example of (i) use value, (ii) option value, and (iii) existence value, associated with this impact.

Question 7: The report recommends that the projects be undertaken, because the net present value (NPV) of the projects is $482 million. The report also mentions that several potential costs and benefits were not included in this calculation, as it was not possible to quantify and monetize all of the relevant costs and benefits. Should the decision-makers focus exclusively on the impacts that can be monetized, or should the non-quantified impacts be taken into consideration? If so, how could the decision-makers account for the non-quantified impacts?

Question 8: Due to your impressive work during the summer internship, your supervisor offers you a full-time position at the end of the summer. The position would have a contract for a five year period, paying $75,000 per year for each of the five years. Your other option is to pursue a master’s degree, which would cost $20,000 per year for 2 years. This would be a full-time program, so you would be unable to work during this period. Upon graduation, you expect to be able to obtain a job that would pay $100,000 per year for years 3 to 5. Based entirely on these impacts mentioned and considering only this five year period, should you take the position or should you pursue the master’s program? Assume that your discount rate is 10%.

TECON 480 – Class 2

July 29, 2019

Part 1 - Outlining the scope of the project

• No class this Fri, Aug 2

• Assignment #1 due Aug 4 (by midnight)

• Instructions posted on Canvas

2

Announcements / Reminders

Today’s Class

• Discuss objective/framework of cost-benefit analysis

• Illustrate the 9 steps of a CBA via an example

• Begin Assignment #1

3

Outlining Scope of the Project

4

This relates to the focus of Assignment #1:

1. Specify the set of alternatives.

2. Decide whose benefits and costs count (standing).

3. Identify the impact categories, catalogue them, and select

measurement indicators.

To plan the content of the report, we must first specify our objective

Outlining Scope of the Project

5

What is the objective of our analysis?

• What is the exact question we are trying to answer?

• Who is responsible for making the decision?

• What metric(s) will we use to make a recommendation?

The Confederation Bridge

6

• The Confederation Bridge that links the eastern Canadian provinces of Prince Edward Island (PEI) and New Brunswick (NB) is a good example to understand need for cost-benefit analysis

https://www.youtube.com/watch?v=DIjYQmgZhzk

The Confederation Bridge

7

• Construction period: October 1993 to May 1997

• Cost: $1.3 billion (CDN)

• Length: 8 miles

The Confederation Bridge

8

• Prior to the bridge construction, visitors of PEI had to take a

ferry to reach the island

• In the 1980s, a possible “fixed link” received the support of

the Canadian federal government

• After a long debate, the project was approved by 59.4% of PEI

residents

The Confederation Bridge

9

• Why was this decision debated?

1. Public sector project

2. Necessitated environmental review

3. Contested in court by opponent

4. Considered as economically suspect

The Confederation Bridge

10

• What was the debate at that time?

� Should we replace the ferry service?

� If yes, what is the best option: a tunnel or a bridge?

• What are the environmental impacts?

• How will it affect the local economies?

• What are the costs to maintain a bridge? To keep the ferry services?

• etc…

Cost-Benefit Analysis

11

• More generally:

What are the pros and cons of the project?

• Or:

What are the costs and benefits of the project?

Cost-Benefit Analysis

12

• Cost-Benefit Analysis (CBA): a policy assessment method that

quantifies the value of policy consequences (or impacts) in

monetary terms to all members of society

• A CBA calculates net social benefits (NSB) for each policy

alternative

• Net social benefits equal social benefits (B) minus social costs

(C):

NSB = B - C

Cost-Benefit Analysis

13

• Underlying concepts originated in Europe in 1840s

• Consumer surplus: Dupuit (1844)

• Externalities: Pigou (1920s)

• CBA in environmental applications

• Roosevelt: US Flood Control Act of 1936

Cost-Benefit Analysis

14

• Became standardized in 1950s-1970s

• President Lyndon Johnson’s planning-program-budget

system (1965)

• OECD (1969); UN (1972); World Bank (1975)

• Reagan: Executive Order 12291 (1980)

• CBA required for regulations with annual effect > $100 million

• Clinton: Executive Order 12866 (1993)

Social Perspective

15

• As individuals, we are likely to consider mostly our private

costs and benefits

• A private company would behave the same way in evaluating

various investment alternatives

• However, in CBA, we consider all the costs and benefits to

society as a whole

CBA Criticisms

16

1. Philosophical

Some dispute the fundamental assumptions of CBA:

� The sum of individual utility should be maximized and we can

trade off utility gains and losses among people

• They argue that there is no theoretical basis for making trade-

offs between one person’s benefits and another person’s costs

CBA Criticisms

17

2. Practical

Some disagree about specific issues in CBA, such as:

• What impacts will occur over time?

• How to monetize the costs and benefits of these impacts?

• How to make trade-offs between the present and the future?

4 Types of CBA

18

1. Ex ante CBA: conducted prior to the intervention � Useful to show whether resources should be used on a program or project

2. Ex post CBA: conducted at the end of the intervention � Provides information about the type of project

3. In medias res CBA: conducted during the intervention � Provides updated information: able to change decision?

4. Comparative CBA: compares the ex ante predictions to ex post results for the same project � Why do you think this is very rarely done?

CBA and Decision-Making

19

• Ex ante CBA analysis is most helpful CBA used for decision

making

• Decision-makers base the decision to allocate resources on this

type of analysis

• In medias res CBA analysis can also be used for decision

making but only to fix an ongoing project when it is still

possible

• What if the project is already half-completed?

• Ex post CBA analysis cannot be used for decision making

• Objective is to learn for future decisions

CBA and Decision-Making

20

• 9 steps of CBA:

• We will look in more detail at these steps using an example:

The Coquihalla Highway in British Columbia

Coquihalla Highway Example

21

• Suppose we are back in 1986 when

this highway is being debated

• The proposed project is a highway

that links the towns of Hope,

Merritt and Kamloops, BC – the

Coquihalla Highway

• BC government asked to compare

two alternative four-lane highways:

• One with tolls

• One without

• Length of the highway = 195 km

Coquihalla Highway Example

22

Step 1: Specify the set of alternative projects

23

• There are usually a huge number of potential alternative

projects

• An n-dimension project with k possible values makes k*n

potential alternatives

• In this case, there was only n = 1 dimension with k = 2

possible values

• With (i) an $8 toll or (ii) with no toll

24

• Can we think of other dimensions and alternatives?

• Example of calculating the # of alternatives to analyze:

� Analysts generally analyze no more than six scenarios

Step 1: Specify the set of alternative projects

25

• CBA compares the NSB of a project with the NSB of the

“counterfactual”

• Counterfactual: a hypothetical outcome that would arise if the

project does not proceed

• It is usually the status quo

• In our example: No highway built

• Sometimes the Status quo is not always a viable alternative

• In that case, have to evaluate relative to a displaced alternative

• For example: Highway project vs. Railway project in a case where

the government has already decided to build one or the other

Step 1: Specify the set of alternative projects

26

• What are the counterfactuals in the following decisions?

1. You are deciding whether or not to attend UWT.

2. You are deciding whether to invest $5000 in Amazon stock.

3. You are deciding whether to withdraw your country from the

Paris Agreement.

Step 1: Specify the set of alternative projects

Step 2: Decide whose benefits and costs count (standing)

27

• Next step: determine the “standing”

� which benefits and which costs should be included in the CBA

• Standing usually most appropriately specified at the level of

relevance for the government

• In our example, there are two standings:

1. Provincial perspective: costs and benefits for BC residents and

BC government

2. Global perspective: costs and benefits for everyone, irrespective

of where they reside. (i.e. Albertans, Americans, Europeans, etc.)

28

• Federal government usually chooses the national level as the

standing

• Some critics argue that many issues should be analyzed with a

global perspective, especially those that affect people abroad

• For example: many environmental issues

• Municipal/local governments tend to choose their municipality

• Even if part of the costs are supported by a higher level of

government

Step 2: Decide whose benefits and costs count (standing)

29

• Who do you think has standing in the following scenarios:

1. You are deciding whether or not to attend UWT.

2. You are deciding whether to go ahead with ST3 and construct

62 miles of light rail from Everett to Tacoma.

3. You are deciding whether to withdraw your country from the

Paris Agreement.

Step 2: Decide whose benefits and costs count (standing)

Step 3: Identify impact categories, catalogue them and

select measurement indicators

30

• Identify the physical impact categories for the proposed

alternatives

• The term impact is used for inputs (required resources) as well

as outputs

� Catalogue them as benefits or costs

� Specify the measurement indicator for each impact category

(i.e. the appropriate units)

31

For our Highway example:

• The anticipated benefit impact categories are:

1. Time saved and reduced vehicle operating costs for travelers

using the new highway - “Time and Operating Cost Savings”

2. The value of the Highway at the end of the discounting period –

“Horizon Value of Highway”

3. Accidents avoided and lives saved due to the shorter and safer

new highway – “Safety Benefits”

4. Reduced congestion on the alternative/old road – “Alternative

Routes Benefits”

5. Revenues collected from tolls – “Toll Revenues”

6. Benefits accruing to new travelers – “New Users”

Step 3: Identify impact categories, catalogue them and

select measurement indicators

32

• The anticipated cost impact categories are:

• Construction costs – “Construction”

• Additional maintenance and snow removal – “Maintenance”

• Toll collection – “Toll Collection”

• Toll booth construction and maintenance – “Toll Booth

Construction”

Step 3: Identify impact categories, catalogue them and

select measurement indicators

33

• Can you think of any impacts that haven’t been included here?

• Omitted benefits:

• Omitted costs:

Step 3: Identify impact categories, catalogue them and

select measurement indicators

34

• Current critics might argue that some relevant impacts have

been omitted:

• Health impacts from car emissions

• Improved reliability of travel times in the winter

• Impacts on wildlife (elk, etc.)

• Changes in the scenic beauty

• Cost of the land

� This CBA was conducted in 1986; quality of CBA has improved

since then

Step 3: Identify impact categories, catalogue them and

select measurement indicators

35

• CBA analysts should be interested only in impacts that affect

the utility of individuals

� Impacts without value for human beings should be excluded

• To be included in a CBA, a cause and effect relationship

between project outcome and the individual’s utility is required

� these costs and benefits must be incremental to the project

� i.e. they would NOT arise in the counterfactual

Step 3: Identify impact categories, catalogue them and

select measurement indicators

36

• Individuals can have opposite views on impact categories

� Some individuals view the impact as a cost while others view it

as a benefit

• In such circumstances, you should create two separate impact

categories

• Example: the impact of “global warming”

Step 3: Identify impact categories, catalogue them and

select measurement indicators

Step 4: Predict impacts quantitatively over life of project

37

• Goal is to quantify all impacts in each time period

• This prediction is one of the most difficult aspects of CBA

• Difficulty is increased by:

• Unique projects

• Long time horizons

• Complex relationship among variables

38

• When analyzing the highway impacts, we must estimate:

• The no-tolls and the with-tolls alternatives

• Each category of driver:

• Trucks, passenger cars on business/vacation, etc.

• About:

• The number of vehicle-trips on the new highway

• The number of vehicle-trips on the old road

• The proportion of travelers from BC.

Step 4: Predict impacts quantitatively over life of project

39

• With those estimates, we can then estimate:

• The total vehicle operating costs that users save

• The number of accidents avoided

• The number of lives saved

� Consider the example of the number of lives saved

Step 4: Predict impacts quantitatively over life of project

40

• Lives would be saved for two reasons:

1. The new highway is shorter

• It will avoid 130 million vehicle kilometers (vkm) of driving each year

• Evidence shows that there are 0.027 deaths per million vkm on average

• 130 vkm x 0.027 lives per vkm = 3.5 lives/year

2. The new highway is safer

• It is expected to have 313 million vehicle kilometers (vkm) driven each year on the new highway

• Evidence shows that the new highway would lower the death rate by one-third

• 313 vkm x 0.027 lives per vkm x 0.33 = 3.0 lives a year

� The new highway is expected to save 6.5 lives a year

Step 4: Predict impacts quantitatively over life of project

Step 5: Monetize (attach dollar values to) all impacts

41

• The dollar value is measured in terms of “willingness to pay”

� This can be derived from demand curves

• Many impacts are difficult to associate with a dollar value because there are no markets

• Life

• Environment

• etc.

� If no individual is willing to pay for an impact, we consider it to have 0 value

42

• In our example we need to monetize each unit of:

• Time saved

• Lives saved

• Accidents avoided

• Here are some of the values used in 1986:

• Truck drivers’ time saved per vehicle = $14 per vehicle-hour

• Value of life saved = $500,000 per life

� These estimates were based on studies conducted prior to 1986

Step 5: Monetize (attach dollar values to) all impacts

Step 6: Discount benefits and costs to obtain present values

43

• If the project has impacts over different years, we must

discount for the time period in order to be able to aggregate

costs and benefits over time

• Discounting is necessary for two main reasons:

1. Most people prefer to receive a benefit today than in the

future, and to pay a cost in the future than today

2. There is an opportunity cost to the resources used

• Must compute the present value of the costs and the benefits

44

• A cost � �

or a benefit � �

in year � is converted to its prevent

value when divided by (1 + r)�, where r is the social discount

rate

• Often, r is mandated by a government agency

• In the Highway example, they used r =7.5%

• Suppose a project has a life of � years

• Often, the costs are incurred up front, and the benefits are

enjoyed in later years

Step 6: Discount benefits and costs to obtain present values

45

• The present value of the benefits is:

• The present value of the costs is:

( )0 ( )

1

n

t

t

t

B PV B

r=

= +

∑

( )0 ( )

1

n

t

t

t

C PV C

r=

= +

∑

Step 6: Discount benefits and costs to obtain present values

We will discuss these calculations later in the course

Step 7: Compute net present value of each alternative

46

• The net present value (���) equals the present value of benefits minus the present value of costs:

��� = ��(�) − ��(�)

• Decision-maker should select the project with the highest ���

• Assuming that (at least) one project has a positive ��� and that projects are mutually exclusive:

• The project with the largest NPV represents a more efficient allocation of resources

• Note: this is not necessarily the most efficient allocation

• Not all possible alternatives are analyzed and the most efficient option may not be included

Step 8: Perform sensitivity analysis

47

• To deal with the uncertainty on (i) the different impacts and (ii) monetary valuation, an analyst should perform a sensitivity analysis

� Shows how uncertainty affects the results of the analysis

• In the highway example, a sensitivity analysis has been performed on the standing by computing the NPV with a global and a provincial perspective

• Sensitivity analysis is possible on every variable, but time and resource constraints necessitate focusing on the “important” variables

Coquihalla Highway Example

48

Step 9: Make a recommendation

49

• Generally, you should recommend the project with the largest ���

• In our highway example, we should recommend the “no tolls” highway because ���s are larger than those of the “with tolls” highway and larger than 0

• Question: what would you recommend if all NPVs < 0?

• Note: ���s are estimated values

� Sometimes sensitivity analyses may suggest that the project with the largest ��� is not always the best alternative

Step 9: Make a recommendation

50

• Politicians decided to build the Coquihalla Highway with tolls

• Tolls were eliminated in 2008

• $845 million in tolls collected over 22 years

• Original cost = $848 million (over three phases)

Our Project for the Class

• Video of Pacific Avenue BRT project

https://www.youtube.com/watch?v=6cQl76sf0Ek

• Background information on the project:

https://www.piercetransit.org/brt/

https://www.piercetransit.org/brt-virtual-open-house/ 51

52

Our Project for the Class

53

Assignment #1

• While you are welcome to discuss the assignment with

classmates and incorporate our classroom discussions, each

student must submit their own assignment

• Assignments are due by midnight on the date indicated (they

may be submitted via email or uploaded to Canvas)

54

Assignment #1

• In this assignment, we will begin our analysis of Pierce Transit’s

potential investment in bus rapid transit (BRT) along the Pacific

Avenue corridor

• This assignment covers Steps 1-3 of the cost-benefit analysis

framework

55

Assignment #1

• Please provide a separate heading/section for each of the three

steps

• These sections will subsequently be used as part of the final

report, after you incorporate the feedback that I provide and as

your thoughts develop throughout the course

• Note that there is no minimum/maximum length of the various

sections at this point 56

Assignment #1

Step 1: Specify the set of alternatives

• In this section, discuss the potential alternatives available to the

decision-maker and explain/justify which alternatives you will

choose to analyze. Be sure to specify the status quo (or the

counterfactual) that will be used.

57

Assignment #1

Step 2: Decide whose benefits and costs count (standing)

• In this section, discuss who the decision-maker is in your

analysis, the objective of the analysis that will be undertaken,

and whose benefits and costs should count in the analysis given

the context.

58

Assignment #1

Step 3: Identify the impact categories, catalogue them, and select measurement indicators

• In this section, discuss the potential impacts of the project and classify them as costs or benefits (or undetermined, if it is potentially the case that the impact could be either a cost or a benefit). For each impact, suggest the “physical” units that you would ideally use to measure these impacts; note that at this point, these impacts should just be identified qualitatively, and you do not have to discuss how you would quantify/monetize these impacts.

• As an example, suppose the project was an investment in a new recycling facility. You may think that one of the impacts would be a reduction in plastic waste in the landfill, that this would be a benefit to society, and that you would measure it by the number of tons of plastic “saved” from the landfill over the course of a year.

59

Our Project for the Class

• In groups of 2-3, try to brainstorm the following:

I. 5+ potential benefits of the BRT project

II. 5+ potential costs of the BRT project