Catalog

	Table of Contents
p. 49 of 74 BACK | NEXT I. Introduction II. Background III. The Economic Rationale of A Project IV. Macroeconomic and Sectoral Context V. An Integrated Approach To Economic Analysis VI. Identification and Quantification of Costs and Benefits VII. Valuation of Economic Costs and Benefits VIII. Large Projects, Linkages, and National Affordability IX. Least-Cost and Cost-Effective Analysis X. Investment Criteria: Economic Viability XI. Discount Rate XII. Uncertainty: Sensitivity and Risk Analysis XIII. Sustainability of Project Effects XIV. Distribution of Project Effects XV. Projects and Policies XVI. Appendices Appendix 1: Key Questions For The Economic Analysis of Projects Appendix 2: Project Economic Rationale: Market and Nonmarket Failures Appendix 3: The Project Framework Appendix 4: Identification and Measurement of Consumer Surplus Appendix 5: Treatment of Working Capital Appendix 6: Depletion Premium Appendix 7: The Use of Constant Prices In The Economic Analysis of Projects Appendix 8: General Methodology For Building Up Project Statements Appendix 9: Economic Evaluation of Project Output and Input Appendix 10: Economic Price of Traded Goods and Services Appendix 11: Valuation of Nontraded Outputs and Inputs Appendix 12: Shadow Wage Rate and The Shadow Water Rate Factor Appendix 13: The Economic Price of Land Appendix 14: Treatment of Resettlement Components of Projects Appendix 15: Calculating Economic Prices At The Domestic Market Price Or World Market Price Levels Appendix 16: Estimating The Shadow Exchange Rate Factor and The Standard (Or Average) Conversion Factor Appendix 17: Example of An Economic Rate of Return: An Irrigation Rehabilitation Project Appendix 18: Effect On Net Foreign Exchange and Budget Flows: An Example Appendix 19: Least-Cost Analysis and Choosing Between Alternatives Appendix 20: Estimating The Economic Opportunity Cost of Capital Appendix 21: The Treatment of Uncertainty In The Economic Analysis of Projects: Sensitivity and Risk Analysis Appendix 22: User Charges, Cost Recovery, and Demand Management: An Example For Piped Water Appendix 23: Financial Returns To Project Participants: An Illustration Appendix 24: Economic Evaluation of Environmental Impacts Appendix 25: Distribution of Project Effects Appendix 26: Impact On Poverty Reduction Appendix 27: Difference Between Economic and Financial Prices Appendix 28: Use of Economic Prices In Measuring Effective Protection Appendix 29: Exchange Rate Issues In Project Analysis XVII. Others

Guidelines for the Economic Analysis of Projects : XVI. Appendices

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Appendix 7 : The Use of Constant Prices in the Economic Analysis of Projects

1. Project analysis is conducted to determine the economic viability of investing in a project. It entails choosing the project components that are, at the time of approval, expected to provide the highest net economic returns in the future. The stream of future costs and benefits that is compiled is termed the economic project statement. In preparing this statement, prices are used to express the inputs and outputs of a project in value terms to arrive at a common denominator. A consistent set of prices must be used for all future costs and benefits.

2. There are four different ways to define prices, namely

• financial or shadow prices,
• nominal or real prices,
• current or constant prices, and
• absolute or relative prices.

Financial prices are the actual prices at which inputs are bought and outpubts sold and are used in financial analysis. In economic analysis, where prices are distorted due to market or government failure, it is necessary to impute the price that reflects the real economic value of an input or an outputits shadow price.

3. Nominal price is interchangeably used with current price, and real price with constant price. Current price is the term used to define the value of the inputs and outputs, and includes the effects of general price inflation. Constant price refers to a value from which the overall effect of a general price inflation has been removed. Where current prices are adjusted for general inflation, it is assumed that inflation will affect the prices of the inputs and outputs in the project statements to the same extent, such that prices retain the same general relationship to each other. Using constant prices ensures that the future costs and benefits of the identified project alternatives are estimated in the same units as the costs and benefits measured at the time the decision to invest in the project is to be made.

4. Table 1, taken from the World Bank report entitled Commodity Markets and the Developing Countries, illustrates the use of constant and current price projections for a set of commodities. For traded items, the appropriate measure of inflation to adopt in adjusting current to constant prices is a measure of international inflation, such as the manufacturing unit value index of the United States. For nontraded items, an appropriate measure of inflation is the projected rate of increase in domestic prices measured through a gross domestic product deflator, a general consumer price index, or a more specific index, such as a construction price index for construction costs.

I. Relative Price Changes

II. Real Interest Rates

7. An inflation adjustment should also be applied to any interest or discount rate that is used to calculate an annualized value for capital costs or simply a real rate of interest. Where the rate of interest applies to domestic borrowing, a domestic inflation index should be used to deflate the nominal interest rate. Where the rate of interest applies to foreign borrowing, an international inflation rate should be used to deflate the nominal interest rate. For example, a project will borrow at a domestic interest rate of 25 percent when domestic inflation is projected at 21 percent; and at a foreign interest rate of 6.9 percent when international inflation is projected at 2.4 percent. The real interest rates are given by

Domestic borrowing = {(1 + 0.25) / (1 + 0.21)} - 1 = 0.033 or 3.3 percent

Foreign borrowing = {(1 + 0.069) / (1 + 0.024)} - 1 = 0.044 or 4.4 percent

Back Appendix 6: Depletion Premium	Next Appendix 8: General Methodology For Building Up Project Statements