1. 1 Civil Systems Planning Benefit/Cost Analysis Scott Matthews 12-706/19-606 and 73-359 Lecture 1 - 8/30/2004

2. Lecture 1: 8/30/0412-706/19-606 and 73-3592 Scott Matthews  Asst. Prof., CEE/EPP  Research Director and Faculty  Green Design Institute  B.S. ECE/Engineering & Public Policy, M.S. Economics, PhD. Economics  Research  Sustainable infrastructure and green product/system design  Make sure corporations understand all private and social costs of decisions.

3. Lecture 1: 8/30/0412-706/19-606 and 73-3593 Scott Matthews  Office: Porter Hall 118-L  Email: hsm@cmu.edu  Best way to reach me  Mailbox: In main CEE office - PH 119  Phone: 268-6218

4. Lecture 1: 8/30/0412-706/19-606 and 73-3594 Course Web Page  Lecture notes, problem sets and schedule will be on the course web page: http://www.ce.cmu.edu/~hsm/bca2004/

5. Lecture 1: 8/30/0412-706/19-606 and 73-3595 Merged Course – Economists and Engineers  Seemed to work well during the past 7 years.  Instructors realized courses overlapped in content - need for practical decision making aids.  Engineers need economic perspective; economists need an engineering (practical problem solving) perspective.

6. Lecture 1: 8/30/0412-706/19-606 and 73-3596 Course Requirements  Five Problem Sets  Midterm Quiz  Final Examination  Course Project for the grad students - (12-706: 25%, 73-359: 0%)  Participation: Borderline cases  (I will learn all names)

7. Lecture 1: 8/30/0412-706/19-606 and 73-3597 Text and Handouts  Boardman, Greenberg, Vining, and Weimer, Cost-Benefit Analysis: Concepts and Practice, Prentice Hall, Second Edition, 2001.  Lecture notes- available on web page.  Application cases.  Miscellaneous: articles, problems, etc.

8. Lecture 1: 8/30/0412-706/19-606 and 73-3598 Two Courses  Engineering - 12 units including project report (oral and written).  Economics - 9 units, no project requirement. (independent study option available to do project).

9. Lecture 1: 8/30/0412-706/19-606 and 73-3599 Objectives  Prepare you to conduct project planning studies and benefit/cost analyses.  Understand issues of estimation, uncertainty, coping with multiple parties and objectives in decision making.  Understand basics of project finance, analysis, and pricing decisions.

10. Lecture 1: 8/30/0412-706/19-606 and 73-35910 Benefit/Cost Analysis  Framework to systematically identify major benefits and costs associated with a particular investment or policy.  Often controversial, with different analysts coming to different conclusions or not agreeing on objectives.  BCA is a framework, not a recipe.

11. Lecture 1: 8/30/0412-706/19-606 and 73-35911 Application Areas  Methods and techniques are general.  Emphasize environmental / civil systems investment and pricing applications as examples.  Ports, roadways, transit systems.  Telecommunication networks.  Water and wastewater systems.  Public, private and mixed investment/finance decisions (e.g. Stadium construction).

12. Lecture 1: 8/30/0412-706/19-606 and 73-35912 Planning Process versus Analysis  Benefit-Cost Analysis and Design support planning processes, often performed by consultants or staff.  Planning processes tend to involve many different parties (current terminology - “stakeholders”), all with their own agendas.

13. Lecture 1: 8/30/0412-706/19-606 and 73-35913 Example Planning Process: New Plant  Initiated by Owner or Developer  Projected benefits/costs reviewed by financiers.  Local government and public often involved in planning for land acquisition.  Local government, utilities, regulatory agencies and public participate in permitting process.

14. Lecture 1: 8/30/0412-706/19-606 and 73-35914 Steps in Benefit Cost Analysis  Setting objectives and impact measures.  Defining alternatives (including do- nothing).  Quantifying benefits.  Quantifying costs.  Sensitivity and uncertainty analysis.  Selection.

15. 15 Cost Benefit Analysis zWhat is it? zWhy do we use it? zWho uses it? zWhat are its limitations? zWhen is it appropriate to use it? zHow do we use it?

16. Lecture 1: 8/30/0412-706/19-606 and 73-35916 What is CBA?  Decision making tool for agent(s) and society(s).  Allocation of (scarce) resources.  Systematic analysis:  Ex ante.  In medias res.  Ex post.  Allows for updating.  Allows for comparisons.

17. Lecture 1: 8/30/0412-706/19-606 and 73-35917 What is CBA?  Ex ante. High level of uncertainty. 1st. approx. as to whether resources should be allocated to a specific project.  In medias res. Updating as information is gathered.  Ex post. Useful but after the fact. Time frame concerns.  Accuracy (ex post) ≥ Accuracy (in medias res) ≥ Accuracy (ex ante)

18. Lecture 1: 8/30/0412-706/19-606 and 73-35918 Why do we use it?  Required: Exec Order 12291 (Reagan) ex-ante  Perform RIA for federal programs over $100 M  Note typical federal BCA costs ~$1 million  Market failure (when used by government).  Comparison of projects/alternative policies (contribution to improved quality of information).  Explain divergence between expected and actual outcomes.

19. Lecture 1: 8/30/0412-706/19-606 and 73-35919 Who uses it?  Everyone in the political/business process.  Government  Individuals  Consultants  Industries  NGOs  Citizen groups

20. Lecture 1: 8/30/0412-706/19-606 and 73-35920 What are its limitations?  Philosophical: Aggregation across individuals.  Information gathering costs/burden.  Benefits are difficult to quantify.  Costs are difficult to quantify.  Difficulty in monetizing benefits and costs.  Costs and benefits may not be spread across the same groups.  Predicting future behavior is not easy.

21. Lecture 1: 8/30/0412-706/19-606 and 73-35921 Steps in a CBA (from Table 1.2 in Boardman) CBA of new highway between 2 cities in Canada 1. Determine standing (whose benefits/costs count) Canadians, Americans, tourists,.. (state vs. global) 2. Select portfolio of alternatives. a) Status quo b) Toll road (pay for use) c) Free road 3a Catalogue potential (physical) impacts Positive: Time saved, reduced operating costs, less accidents, less congestion, toll revenues, new traffic revenues Negative: Road/toll construction and maintenance

22. Lecture 1: 8/30/0412-706/19-606 and 73-35922 3b Select measurement indicators. Lives saved per year, person-hours of travel, dollars 4. Predict quantitative impacts of the life of the project Number of trips on old and new highways, safety 5. Monetize - convert impact categories into dollars Leisure wages / Business wages / Values of lives 6. Timeframe and money. Convert dollar values in future to present dollars 7. Sum. NPV = NPB - NPC > 0 For multiple projects, select one with highest NPV 8. Sensitivity Analysis Use varying ranges of the inputs to see if NPV changes 9. Recommendation - highest NPV ITERATE AT EACH STEP !!!! Steps in a CBA (from Table 1.2 in Boardman)

23. Lecture 1: 8/30/0412-706/19-606 and 73-35923 Graphic interpretation of CBA

24. Lecture 1: 8/30/0412-706/19-606 and 73-35924 The Policy World  Normative vs. Positive theories  N - based on ‘norms’ - ‘should be done’  P - based on ‘reality’ - ‘actually done’  This reinforces the idea of perspective  See Guardian vs. Spender mentality in chapter  Guardians bottom-line oriented, see only tolls  Tend to underestimate costs  Spenders see everything (inc. costs) as benefits  Tend to overestimate benefits