Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

A shift in the supply curve leading to a price decrease is expected to increase the quantity demanded.In practical terms the problem of forecasting demand is solved using specific methodologies, which are based on theassumptions above. In the following sections the main relevant concepts and approaches are outlined.Demand elasticitiesGiven the need to estimate future demand for a specific service or good whose availability and price will change dueto the intervention, demand elasticities are relevant aspects to be addressed in the forecasting exercise.The price elasticity of demand is the ratio of relative variations in the quantity Q of good or service demanded to therelative variation in price. Price elasticity can be expressed as:E pQ1− Q0=QP×P − Pwhere E P is the price elasticity coefficient, Q 1 is the demand with price P 1 , and Q 0 is the demand at the present priceP 0 . As in many cases the project will affect prices, price elasticity plays an important role in demand projections.Demand for a good or service is determined not only by its own price, but also by the price of complementary orsubstitute products, what is called cross elasticity. The cross price elasticity of demand for product A compared toproduct B is given by:If C AB > 0, product B is a substitute for A;If C AB < 0, product B is a complement to A;If C AB = 0, no cross elasticity exists between A and B.Q− Q2 A 1A2B1BCAB= /QAPB1P0− PPrice elasticity differs between products and also, for a given product, between different income groups, as well as inaccordance with the social characteristics of the areas. Therefore, whenever possible the analysis should not belimited to the average per capita income in the whole national economy, but should separately consider differentsocio-economic groups.Income is not only relevant for the size of price elasticities. Income elasticities exist as well, i.e. demand for differentproducts and services is expected to increase or decrease when income changes. For most industrial goods andservices income elasticities are positive, as demand is higher when household income increases. However, forprimary products negative elasticities can be observed. An example is demand for local public transport services thatmay fall when income growth leads to a higher motorisation rate.Demand elasticities are relatively simple parameters that may be used to estimate impacts of new projects. In manycases, however, more complex methodologies are required. This is justified also with the evidence that elasticities arevery context-dependent. Therefore, even if literature values provide a valid reference example, the demand elasticityin principle should be estimated case by case.Demand forecasting techniquesSeveral techniques can be used for demand forecasting, depending on the data available, the resources that can bededicated to the estimates, and the sector involved. The selection of the most appropriate techniques for estimatingthe actual demand and forecasting the future ones with and without the project will depend on the nature of thegood or service, the characteristics of the market and the reliability of the available data.Transparency in the main assumptions and in the parameters and values, as well as the trends and coefficients usedin the forecasting exercise, are matters of considerable importance for the accuracy of the estimates. Furthermore,any uncertainty in the prediction of future demand must be clearly stated (see also Annex D).Assumptions concerning the evolution of the policy and regulatory framework, including norms and standards,should also be clearly expressed.201