Economic Analysis Primer

Introduction

This primer begins by explaining what economic analysis is and why it is important to transportation decision making. The narrative proceeds to some of the fundamental concepts required for the economic analysis of projects (inflation and discounting) and then describes actual applications of economic analysis methodology, especially life-cycle cost analysis and benefit-cost analysis. An issue critical to accurate calculations of project net benefits - forecasting traffic growth - is addressed after the treatment of benefit-cost analysis.

Risk analysis can greatly improve the usefulness of economic analysis to decision makers. This subject is handled in a separate section, although it applies to all of the economic methods described in this primer.

Economic impact analysis is discussed at the end of the primer. It complements benefit-cost analysis by revealing how the direct transportation benefits and costs of highway projects (such as reduced travel time) manifest themselves in the form of new jobs, business growth, tourism, and income. Such information is often important for making decisions about highway projects.

Role of Economic Analysis in Highway Decision Making

Economic analysis is a critical component of a comprehensive project or program evaluation methodology that considers all key quantitative and qualitative impacts of highway investments. It allows highway agencies to identify, quantify, and value the economic benefits and costs of highway projects and programs over a multiyear timeframe. With this information, highway agencies are better able to target scarce resources to their best uses in terms of maximizing benefits to the public and to account for their decisions.

Economic analysis can inform many different phases of the transportation decision making process (see box, page 8). It can assist engineers in the development of more cost-effective designs once a decision has been made to go forward with a project. In planning, it can be applied to basic cost and performance data to screen a large number of potential project alternatives, assisting in the development of program budgets and areas of program emphasis. Similarly, economic analysis can play a critical role in screening alternatives to accomplish a specific project, providing information for the environmental assessment process.

Although economic analysis can provide valuable information for the environmental assessment of a project or program, it is neither a substitute for nor a required component of the environmental assessment process. Nothing in this primer about economic analysis should be interpreted as supplementing, overriding, or otherwise modifying Federal regulations and guidance on environmental assessments conducted under the National Environmental Policy Act of 1969, the Clean Air Act as amended in 1990, and other laws pertaining to environmental review of transportation projects.

Status of Economic Analysis

The application of economic analysis to highway investments is not a new concept. The American Association of State Highway Officials published information on road user benefit analysis in 1952, showing that economic methods and procedures for highway appraisal were well understood and described 50 years ago. Of course, significant progress has been made since that time in areas as diverse as modeling of future traffic flows; estimating the consequences of highway projects on jobs and incomes; and the application of computer technologies to support improved economic methods.

Today, many States and metropolitan planning organizations (MPOs) and some local governments use economic tools in some capacity. There is, however, much diversity in application. Most agencies will occasionally quantify the life-cycle costs or net benefits of projects or investigate their economic impacts on communities. Only a minority of agencies, however, regularly measure project net benefits in monetary terms. Also, most agencies do not consider the full range of costs and benefits when conducting their analyses. In general, there is significant potential for the broader application of economic methods to highway decision making.

Role of the Federal Highway Administration

FHWA has a long tradition of promoting the application of economic analysis to highway project planning, design, construction, preservation, and operation. FHWA has strongly encouraged the use of life-cycle cost applications as part of its pavement design and preservation initiatives, as well as in the Value Engineering program. FHWA has also developed more advanced economic tools that measure benefits and costs of highway investments, including the program-level Highway Economic Requirements System model described later in this primer.

As part of its long-term commitment to improving highway investment and management practices, FHWA will continue to develop and advance economic tools and guidance. A major new impetus for this effort is the promotion of Transportation Asset Management for use by transportation agencies. Transportation Asset Management is a strategic approach to maximize the benefits from resources used to operate, expand, and preserve the transportation infrastructure over the long term. The use of economic analysis to compare costs and benefits in dollar terms over multiyear periods provides vital information to this and other comprehensive infrastructure management strategies.