Cost and Benefit Analysis - Essay Example

This paper will make an analysis for the HS2 project in U.K. This is a project that relates to the railway sector of U.K. The HS2 project will build high speed rail connections between important locations of U.K., like, Manchester, Crewe, Liverpool, Glasgow and Preston. It will connect a wide range of places in U.K. in the most efficient manner, starting form Euston to North of Birmingham. Apart from these, the project would improve railway connectivity of more places and also, involve in the construction of many new railway stations. The project requires a sum of £ 40 billion, which is huge and demanded for a severe cost benefit analysis (Depart of Transport, 2013). However, Lord Heseltine claimed in public forum on 12th November 2013 that though the money to be invested in the project high, but the investors should not take account of it. He further indicated that the project was lucrative as it was ‘really imaginative’ and its nominal investment requirement is worth the benefits. Nonetheless, other ministers claimed that if this project would be indeed funded, then it would substantially increase incidence of taxation on the general taxpayers in Britain. So, they requested to cut down the investment fund of the project by at least 10 billion. They also recommended that the government of the country should try to increase contributions of private sector in the project. On the contrary, Heseltine claimed that the money invested through huge in the project would bring greater economic growth in the country, as it would augment the overall wellbeing of the northern and southern regions of the nation. He also claimed that with great risks comes great opportunities and thus, it is highly economic to invest in the concerned project. Economics behind Cost and Benefit Analysis of HS2 Project It was stated by Lord Heseltine that though monetary investment value for the HS2 project was high, it was highly rational to invest such huge amounts in the project; as it was productive and imaginative and could generate large returns in the long run. Even so, the economists always considered monetary benefit and cost analysis to estimate the worth of making an investment. This is because; in the real world, the business operates are subjected to different fluctuations in market conditions generated by internal and external externalities. Figure 1: Cost Benefit and Action Approach (Source: Authors Creation) Figure 2: Three Major Steps (Source: Pindyck and Rubinfeld, 2012) Figure 3: Components of Cost and Benefit Analysis (Source: Shaughnessy, 2013) The economists regard the three above factors to examine cost benefit analysis of a government project. However, the entire process of examination is considered through three major steps. Identification, evaluation and choice are these three steps. In the course of these three steps, there are various technical analysis tools that are studied, such as, Project Risk Analysis, Profitability Index Calculation and Calculation of Payback Period Inflow and Accounting rate of return. Figure 4: Risk Analysis Matrix (Source: Authors Creation) Profitability Index = Portfolio Value of Cash Inflow/Investment Payback Period Inflow = Total Initial Investment / Annual Cash Discounted Accounting rate of return = Average Net Return / Total Initial Investment However, it should be noted that the abovementioned theories for cost benefit analysis are made by considering accounting perspectives. In reality, economists believe that least government intervention in the market is the best condition required for achieving highest net social welfare (Baker and Hart, 2007). Figure 5: Maximum Welfare without Government Intervention (Source: Pindyck and Rubinfeld, 2012) As denoted in the above graph, in the absence of government intervention, the consumer and producer surplus is highest in a competitive industry. Figure 6: Government Intervention reducing Social Welfare (Source: Pindyck and Rubinfeld, 2012) Nonetheless, as shown in the above graph, any kind of government intervention in the market would surely reduce the level of consumer and producers surplus in the industry. For example, if the government increases incidence of taxation on sellers (as shown in the above graph), then it would surely reduce the overall supply of the concerned product. Lower supply in the market would increase the price of the actual product (as the sellers will transfer a part of the burden on consumers) and finally, will reduce the consumer surplus in the market (Grover and Malhotra, 2003). However, the scopes of commercial activities between firms in the modern days have turned out to be highly complex in nature. Competitive forces in the industry are often offset by the monopolistic authorities that exist due to the survival of concentrated market powers in a firm. Such condition generates information asymmetry in the market. This gives rise to positive or negative externalities. Positive externalities are good, but existence of negative externalities is bad for the economy. During negative externalities, the social marginal cost of a firm is always more than the private marginal cost. Similarly, the huge fund required to be invested in the HS2 project would augment the burden of taxation on the tax payers of Britain, thereby reducing the overall consumer and producer surplus in this industry. Figure 7: Negative Externality (Source: Pindyck and Rubinfeld, 2012) Under such conditions, the government must intervene in the market to reduce the external cost. The main reasons for which the government intervenes in the market are: For rectifying market failures. Redistributing income and wealth for achieving equitability. Enhancing the overall performance. The HS1 project seems to lack adequate advantages; hence, the overall social cost of project is estimated to be more than its economic cost. The lack of the HS1 project seeks requirement for the HS2 project. Figure 8: Public and Private Good (Source: Pindyck and Rubinfeld, 2012) Unlike the case of a private good, for a public good: Market equilibrium price is not the best price. Consumers deny paying for improvements or constructions of such product. Even if consumers pay, it becomes way below the efficiency level. So, the government is forced to intervene and provide supply of such good, which is used by all consumers commonly. HS2 project is a public good service and thus, needs to be financed, guided and implemented only by the government authorities. Cost Benefit Analysis for HS2 Project The economist and government analysts are constantly trying to analyze the worth of investing in the HS2 project through cost benefit analysis tools. The analysis report, recently prepared by Financial Times, is provided below. Figure 9: Analysis Report (Source: Balla and Milliband, 2013) The results of the above analysis reflect that the benefit cost ratio of the project has increased from 1.7 in August 2012 to 2.3 in October 2013, thereby stating that the project is worth the high investing price value. Figure 10: Benefit of HS2 Project (Source: Balla and Milliband, 2013) As denoted by the above graph, the overall journey times required would significantly fall with the essence of HS2 project. The general benefits that the country would experience from the HS2 project are: Getting adequate railway travel spaces that, at present, are highly crowded. The government of the country would get opportunities to enjoy more freight. Utilities of the common people would be enhanced as the journey between places would significantly improve. With improvement of the railway facilities, the number of passengers would increase. It will benefit the commercial activities between important trading cities of the country. Considering the above cost analysis, it can be claimed that HS2 project should be implemented for achieving better future of U.K. Yet, there are a few costs associated with the project, such as: The project requires large fund. It would increase taxations of regular income earners of the country. The contraction process would generate an income of only .15% of the total GDP of the country. Nonetheless, the above analysis explains that the cost of the project will be outweighed by its benefits and thus, the government of the country should invest in the project (Tomphan, 2013). Conclusion From the above analysis, it is claimed that HS2 project would be beneficial for the economy of Britain in the long run. In the current epoch, most of the nations in the world adopt strategic moves for achieving long-term optimal growth. It is true that if a developed nation, like, Britain, desires to attain long run economic prosperity, then it also needs to acquire a strong, balanced and sustainable growth. However, it should be noted that prosperity and growth in a nation can be achieved with the essence of new innovative ideas, productive risk taking, creating employments and working efficiently. It is also true that a modern and efficient infrastructure is the pivotal determining factor required for maintaining a strong balanced successful economic system. Under this regime, it should be noted that investable resources in an economy is always scarce, but the number of productive investment projects are always more. The benefits of the HS2 project will outweigh the costs. So, in view of Lord Heseltine, the ‘mumbo jumbo’ calculation of the economists should consider imaginativeness of the project, instead of just looking into its monetary cost (Mason and Watt, 2013). Reference List Baker, M. and Hart, S., 2007. The marketing book. London: Routledge. Balla, E and Milliband, E., 2013. The only cost-benefit analysis for Hs2 that matters. The Financial Times, 29 October. Depart of Transport, 2013. The strategic case of Hs2. [pdf] DFT. Available at: [Accessed 18 February 2014]. Grover V. and Malhotra, V. K., 2003. A transaction cost framework in operations and supply chain management research: theory and measurement. Journal of Operations Management, 21, p. 457–473. Mason, R. and Watt, N., 2013. HS2 cost-benefit estimates are mumbo jumbo, says Heseltine. The guardian, 12 November. Pindyck, R. S. and Rubinfeld, D. L., 2012. Microeconomics. New Jersey: Pearson Education, 2012. Shaughnessy, J. O., 2013. Business organization. London: Rutledge. Tomphan, G., 2013. HS2 economic case downgraded but benefits still outweigh costs, says DFT. The guardian, 29 October. Read More