Introduction to Infrastructure Economics

Introduction: Economics
 Economics is a science which studies human behavior as a relationship between
ends and scarce means which have alternative uses (Robbins, 1932).
 Economics is the study of how societies use scarce resources to produce
valuable commodities and distribute them among different people (Samuelson
and Nordhaus, 2007).
 Economics is thus the ‘study of scarcity’ and analyzes the rational behavior-
the choices made in micro frame work in allocation of scarce resources to
alternative uses
 Household are constrained by individual budgets and businesses by technology
and resources
Meaning of Infrastructure
 Infrastructure is the system of public works in a country, state or region,
including roads, utility lines and public buildings.
 Infrastructure refers to the substructure or underlying foundation or network
used for providing goods and services; especially the basic installations and
facilities on which the continuance and growth of a community, state, etc
depend.
 Infrastructure is the basic facilities and services that are necessary for carrying
out the economic activities and which help in the economic development of the
country. These basic facilities do not produce goods and services but facilitate
the production and distribution processes.
Infrastructure Economics
 Infrastructure economics attempts to study the infrastructure from
economics view point
 The demand and supply of infrastructure in the economy
 The mismatch between demand for infrastructure finance and supply of
investable funds: the infrastructure financing gap
 The cost-benefit analysis of infrastructure projects
 The returns on infrastructure investments
 Infrastructure and economic growth
 Models of infrastructure development
 Types of Infrastructure: Broad Category
(a) Economic Infrastructure (b) Social Infrastructure

These are the basic amenities that do not directly

Economic infrastructure is the basic influence the economic activities, but indirectly have an
facilities which directly benefit the process impact on the economy through achieving certain social
of production and distribution in an objectives. For example, education does not directly
economy. Roads, railways, influence economic activities like production and
telecommunication systems, waterways, distribution but indirectly helps in the economic
airways, financial institutions, electricity, development of the country by spill-over effects. So
water supply etc are the examples of education, health services and sanitation etc. are the
economic infrastructure. examples of social infrastructure.

1
Types of Infrastructure: Detailed Category
Category Name Examples
Category 1 Rural Infrastructure Irrigation, rural connectivity (roads, power, IT), cold
chains and mandis

Category 2 Urban Infrastructure Water, sanitation, sewerage, Telecomm, Internet

Category 3 Core Infrastructure Roads, railways, airports, sea ports, inland waterways,
energy

Category 4 Social Infrastructure Healthcare, education, housing, hospitality

Category 5 Land- Intensive SEZs, industrial parks, townships, IT parks

Economic Indicators of Infrastructure Development

Per Capita Electricity Consumption

Per Capita Energy Use (kg of oil equivalent)

Telephone Line Per 1000 Population

Rail Density Per 1000 Population

Air Transport, Freight Million Tons Per Kilometer

Paved Roads As Percentage of Total Roads

Social Indicators of Infrastructure Development

Number of Hospitals Bed Per 10000 Population

Number of Doctors Per 1 Lakh Population

Number of Primary and Middle Schools Per 10000 Population

Number of High Schools Per 10000 Population

Features of Infrastructure
Features of Infrastructure
Natural
monopoly

High sunk Possibility of

costs price exclusion

Infrastructure

Non-rivals in Non-tradability
consumption of output

Externalities
Infrastructure: Natural Monopoly
• When one firm can potentially supply market’s entire demand for goods and
services at most efficient price, it is said to exist natural monopoly
• When the fixed costs become so large that only one firm can feasibly operate,
and the average costs continue to fall over the entire range of production, the
one firm will emerge as natural monopoly
• The production of certain goods and services are subject to scale economies-
like Infrastructure facilities
• The production of infrastructure facilities ( like railways, electricity, tele-
communications, gas-pipelines and other public-utilities) require a certain
minimum scale of production
Monopoly is a condition in economics, where we find that a single seller is basically able
to run the entire production and distribution for large number of customers available in
the economy. So, in nutshell we can see that, when one firm can potentially supply
markets demand, entire demand of the market of goods and services at most current
price, this particular condition is said to be a natural monopoly.

So, infrastructure build up by the firms each having a feature and that feature is the
natural monopoly. The production of infrastructure facilities such as railways, electricity,
telecommunication, gas pipe lines and other public utilities require a certain minimum
scale of production and the production of certain goods and services are subject to have
the economies of scale, because when such projects are developed, developers or the
facilitators such as government, they consider that what will be at least number of the
subscriber or consumer in the economy.
Fixed cost
But, at same time, they do care about the product. The project is developed in a way, that
there is no other producer available in that particular economy for many years. So,
automatically it becomes the matter of monopoly for them to have the price, to have the
fees, license for their services.

When the fixed cost becomes so large, it will be feasible for one firm to operate and the
average cost continued to fall over the entire range of production, the one firm will
emerge as the natural monopoly.

Majority of the physical infrastructure developed by different private parties or

developed by the public private partnership today, is not looking for the production for a
day or for a year, but they are looking for the facility developed for years for 20 years, 30
years, 40 years and no other substitute or no other competitor is available in that
particular area, so that they can compete with the developer of that particular
infrastructure.
Price taker versus price maker
There are two types of price decision in the market, few firms are price maker, few firms
are price taker. A firm can become price taker if lots of competitions are available in the
market, if large number of firms are working together, firms will be price taker

A firm becomes a monopoly firm and no other substitute firms are available. That is, no
other competitive firms are available in the market, so firm behaves like the price setter.

But, if there is no firm available in the market, firms behave as a price maker. So, in case
of natural monopoly, firms behave as a price maker not as a price taker, so this is one of
the major features of natural monopoly.
Infrastructure: Sunk Costs
• The expenditures that has already made and cannot be
recovered even when the firm go out of business
• Sunk costs may be a barrier to entry into infrastructure
development projects for private investors
• If sunk costs are high relative to marginal cost, price will
almost surely exceed marginal cost, even though economic
profits are zero
For example, if a firm is building up a flyover, once the flyover is made, even if firm is
going out from the business, the cost involved in the making of the flyover, it cannot be
recovered. The entire cost, which you have involved, which you have incurred, that may
be the sunk cost, because if you are not delivering on time, if you are not delivering with
a proper quality, if you are not delivering with proper care, then whatever investment
you have made, that investment is going to have, that investment, that cost will be sunk
cost after some time, because you are not really in the position to continue with the
business.

So, sunk costs is a barrier to entry,

for example: say a road construction firm is saying that due to non availability of the
stone chips, now whatever cost they have incurred the last two years, the project is not
going to complete on time and it will be delayed the project is now delayed.

So, whatever cost they have incurred, that cost is becoming more costly, because the
project is not delivered on time and there is a danger of sunk cost, because if it is not
delivered on time there will be the breach of contract between the firm and the
regulatory agencies.

And in that case, where any firm who wish to continues such projects, they will have the
fear. Or this type of cost involvement is one of the barrier for many firms to enter
infrastructure projects. Infrastructure development is not any easy area where anybody
can jump in to, but it is one of the risky area infrastructure project developments has lots
of risk involved and this is one of the risk involved in infrastructure development.
And this sunk cost example is an example in majority of the infrastructure projects and
that is going to become a challenge for the infrastructure development. And this is one of
the major features, which makes the infrastructure projects different from other projects.
Because, you have to wait for a long time, you have to wait for the raw materials, which is
a rare, which is not available everywhere. But, at the same time you have so much of
uncertainty in your production if you have lots of if and buts in the production.

Also, telecommunication towers, sewerage, railways etc. have high sunk cost, because if
you are upgrading the technology, the old infrastructure is not going to help you; if you
are shifting from narrow gauge to broad gauge, then narrow gauge line is not going to
help you, you have to rebuild the entire railway line and that is basically the sunk cost the
previous projects are basically as a part of the sunk cost.
 Infrastructure: Non-Tradability of Output
• Infrastructure output are the services that are evoked from the use of
particular infrastructure facility. Thus the characteristics of services are
equally applicable to infrastructure: intangible nature and non-tradability
• This means that infrastructure services must be consumed/purchased at the
place they are produced
• These services generally can not be transported
• This characteristic has significant policy implications, because the viability
of a particular infrastructure establishment has little role to play
• For instance: roads, railways, bridges, airports etc. can not be transported
Infra products are different from other manufacturing products. Like if you have some
manufacturing manufactured products, for example if you have a company, a firm of
producing television sets, the television sets can be transported from or tradable it is the
tradable item from one country to other country, one place to other place.

But, when you are building up the flyovers, when you are making the roads, when you are
having the airports developed, you cannot really trade. These products are not basically
tradable; you cannot really transport your flyovers from one city to other city. The
flyovers where you have built up, that flyover is going to continue for as many as many
years as you want to continue with proper maintenance.
But, other products like electronic items, garment, food grains and cereals and other
items, it can be consumed not only in the place where it is produced, but majority of the
products are basically consumed far away from the area where it is basically produced.

So, this characteristic has significant policy implications, because the viability of a
particular infrastructure development established, particular infrastructure establishment
has little role to play in terms of the outside consumption.
Intangible
Next, intangible means if you are making a television sets. These television sets can be
assembled in a country. The components of the television sets can be taken from
different parts of the country, equally with the automobile sectors, with the car luxury car
or may be the economy car, where you can, one can take the inputs from here and there,
different components from here and there and then you can assemble it in some other
country. The components can come from many part of the world, but it can be assembled
and produced by a firm and that is the way of reducing the cost of production. But, in
case of infrastructure, you cannot really assemble infrastructure in other part of the
world and then, you cannot sell it in other part of the world.

A flyover is a flyover; you cannot say that flyover 10 percent of flyover will be used by
something somebody, 20 percent of flyovers will be used by some other citizens of this
city. A pizza can be divided in 10 parts, because it is tangible, one can have the division of
a bottle of Pepsi or Coke, but one cannot have the division of the infrastructure, which is
built up and developed
Because, you have to have build up the infrastructure, physical infrastructure in the
country where you are going to suppose you are going to build up this. You cannot really
assemble the infrastructure; you have to build up the infrastructure. So, in todays world
of global integration and globalization where so many manufacturing activities are
offshore, many firms are producing something in China, in India, or in Bangladesh or in
many part of the world, where the low cost of labour is available.

But, at the same time, infrastructure products are not like those manufacturing items that
you can produce or offshore or you can assemble somewhere else and you can transport
it to somewhere else. So, that is basically one of the major another feature of this
particular infrastructure product, for example, roads, railways, bridges, airport, that
cannot be transported at all.
 Infrastructure: Non-Rival Consumption
• Consumption by an individual does not affect the consumption
by others
• Thus an additional consumer can enjoy the benefits of
consuming a good or service without conflicting the benefits
of others
• Zero marginal cost of providing the benefits of a good to an
additional consumer
• For instance: roads and telecomm
What is basically non rival consumption?
Rival consumptions: if I have a glass of Pepsi and if I am taking that glass of Pepsi other
cannot take the same glass of Pepsi, because I am finishing it. So, the consumption or the
utility derived by me, is my own utility. It is not the utility of others and that particular
products are basically having the private consumption.

But, in terms of physical infrastructure such as flyovers or the bridges, it is not the first
one who will go in the morning only they will have an opportunity to use that flyover. But,
anybody even whosoever is going in the last also they will have the equal opportunity to
use that flyover
The consumption of infrastructure products are not like the consumption of private
products, because there is no rivalry in consumption, which is available in the private
consumption. In infrastructure, there is zero marginal cost of providing the benefits of a
good to an additional consumer and producer has no cost involving in providing those
facilities to others.

Like in a restaurant if the capacity is for 50 and if 50 more people are standing outside
and the restaurant has the huge cost to involve for entertaining those people. But in case
of roads whether it is one car running or 100 cars running the huge cost is already paid by
the company and there isn't any non-rivalry in consumption and there is isn't any
marginal cost for the marginal cost involved in the adding those customers.

Adding additional customers in the consumption such as in telecommunication does not

make any change. Once the tower is there, infrastructure is build up whether number of
subscribers are one lakh are one lakh five thousand, it doesn’t matter.
Infrastructure: Price Exclusion
• Price exclusion means that the enjoyment of benefits is contingent on
payment of user charges
• The benefits will be provided only to those who pay for the
services/goods
• Price exclusion is a feature of private goods
• Perfect competition and efficiency merit marginal cost pricing, i.e., P=MC,
that the prices must be set at marginal cost
• But, in the case of infrastructure, it will be very difficult to
recover the costs of providing the facilities
• Thus, pricing of infrastructure facilities are not regulated
through market forces
Another feature of infrastructure is the price exclusion. Price exclusion is a condition
when the benefits will be provided only to those who pay for the services and goods.
Price exclusion is a feature of private goods, when we purchase, when we are purchasing
televisions sets for our household, that television set are not really the television sets for
anybody else in the that particular city, because; that is the television sets for my own
home. When we are paying the price we exclude the consumption of that particular
television sets to other consumer of that particular city.

But infrastructure is basically inclusive in terms of but once it is produced we are basically
including others also to use it. We are not stopping anybody to use it.
 Infrastructure: Externalities

• Externalities are the spillover effects (costs or benefits) that are not
included in the prices and accrue to other (third) parties than those
involved in the transaction. For instance: health and education
• Externalities are said to exist when production or consumption of an
entity affect the productivity or well being of another entity
• Two conditions are necessary for an externality
1. Interdependence between economic entity
2. Non-compensation for the effects of interdependence
• Two types of Externality:
i.) Positive Externality
ii.) Negative Externality
An externalities is a cost or benefit resulting from some activity or transaction that is
imposed upon parties outside the activity or transaction. Sometime this is also called as
the ‘spillover effects’ or ‘third party’ or ‘neighborhood effects’. So, externalities create a
divergence between the private benefits and costs of economic activity and the social
benefits and cost.

If a particular industry is throwing garbage in your city. It is true that industry is producing
something for some specific consumer who wish to buy the products. So, in the
production and consumption may be different set of consumers are involved to consume
the product which that industries producing. But at the same time when the industry is
throwing out those byproducts in the city or dumping those byproduct somewhere in the
middle of the city, the impact is not only on the people who are basically consuming
those products, but impact is equally on all the citizens passing through that particular
route.
Because whosoever is getting the benefit whether they are paying or not, whether they
are directly involved in the production of those infrastructure are not, everybody gets the
benefit whether the infrastructure developed in a particular city. But the people coming
from other city also, people coming from the other states also, they are also getting the
equal benefit of such infrastructure which is available in the city. If the street light is
available it is available for all. So that is the positive externalities. If a good park is
available, it is good for citizens of that particular place and the citizens outside that
particular city or town
• Two conditions are necessary for externalities: inter dependence
between the economic entities and non-compensation for the
effects of inter-dependence.
• So, to sum up, to conclude, we can see here, that infrastructure
products are completely different from the private products. Even if
infra products are developed by the private bodies and it is more
like a private goods, but, at the same time it has many features of
public goods.
PUBLIC GOODS
• The difference between private goods and public goods are; public
goods are non-rival in consumption while the private goods are rival
in consumption.
• If a country is providing defence to one citizen, the country is
equally providing defence to other citizen because, a country
cannot stop somebody that you cannot be protected, others will be
protected and you cannot be protected.
• A Street light for example street light, if a city is providing street
lights, a city cannot make the rule that this street light is only for
those, who are paying for this and this street light is not for those,
who are not paying for this.
• Public goods are having the free riding problem people even if they
do not want to pay, street lights is being provided to the city.
• But, at the same time when it comes for the payment of those
goods; public goods are facing the problem of non-payment.
Market mechanism provides better and efficient outcomes: prices and quantities
produced are demand and supply driven

But, there are situations where markets cannot operate optimally-market fail to provide
socially efficient outcomes

Two important such situations are: Externalities and Public Goods

Public goods (social or collective goods) are goods that are non-rival in consumption
and/or their benefits are non-excludable
A quasi-public good is a near-public good. It has some of the characteristics of a public
good especially when it becomes rival in consumption at times of peak demand.
Quasi public goods
A quasi-public good is a near-public good i.e. it has many but not all the characteristics of
a public good. Quasi public goods are:
Semi-non-rival: up to a point, extra consumers using a park, beach or road do not reduce
the space available for others. Eventually beaches become crowded as do parks and other
leisure facilities. Open access Wi-Fi networks become crowded
Semi-non-excludable: it is possible but often difficult or expensive to exclude non-paying
consumers. E.g. fencing a park or beach and charging an entrance fee; building toll booths
to charge for road usage on congested routes
For example, private enterprise could provide some bridges, roads and tunnels if a
charging system could be applied which solves the free rider problem. However, it is
unlikely that all an economy’s (households and firm’s) need for transport and
infrastructure could be met this way. Indeed, toll charge systems could be regarded as
inefficient in that traffic slows down to pay at the toll booth, and traffic builds up causing
congestion and increased external costs. However, the introduction of new technology,
such as ‘smarter’ payments systems and number-plate recognition technology means that
the free rider problem can be reduced or eliminated and the price mechanism can
operate. Hence, over time, technology can convert public goods to quasi-public goods,
and eventually to private goods.
 INFRASTRUCTURE AND ECONOMIC
GROWTH
• Infrastructure can be considered as a complementary factor for economic growth,
because the moment a firm is getting the ready infrastructure, a firm is not
worried for their production. But, the moment a firm is not having that ready
infrastructure even if form is investing very high at a very high level, but the firm is
really worried for what type of complementary infrastructure we will receive and
how we will move the production from one part to other part.

• So, that is one of the challenge for many underdeveloped states in India today.
Industry is ready to invest, but at the same time, industry is finding it very difficult
that even if we will invest, what will be the mobility of the factors of production?
What will be mobility of the final product? How we will reach to the consumer and
with these questions they really got a different message that it is better to stop
only in the developed states and better not to go to the underdeveloped states.
 So, how infrastructure influence the
economic growth?
• Power and transport is really making a u-turn in the production process
and it really contributes in a very positive direction for the growth of
economy.
• At the same time if you have to really, stimulate the aggregate demand
process as we have seen in Keynesian argument that aggregate demand is the
demand, which makes a change in the economy. So, it really have a very
positive impact on the resource mobilization. So, in such a sense if you really
need a aggregate demand level to be stimulated, you cannot really work on
the previous infrastructure, but you have to add, you have to supplement, you
have to complement the new infrastructure for the economy.
• At the same time there are spill over effects and that induce
investment in other sectors, investment in infrastructure relative to
agriculture is really having more productivity in agriculture that
really going to have a support for the agro based industry. The
production in agro based industry is again going to create an
avenue for other bigger industries and at the same time there is
more inter linkages of the economy and that is only possible
through the more support from the infrastructure.
 Underdeveloped
Infrastructure

Low level of Inadequate

investment service

Vicious cycle
of
infrastructure
development
Low recovery of Inadequate
investment maintenance

Low capacity &

willingness to
pay
One can see here that if a country is having under-developed level of infrastructure that
under-developed level of infrastructure is again creating a different circle and that circle
is not going to really give you a better result in terms of economic growth. Here, in this
diagram one can see that if you have the under-developed infrastructure stage then the
economy is not in the position to provide you a better service facility. So, you have
providing economy is providing the inadequate services and if you are having the
inadequate services provided in the economy, you are also not going to have a full-
fledged maintenance of those infrastructures.
So, in such a situation if you have very weak infrastructure, if transport services are very
poor, nobody wish to pay for that everybody wish to pay for the better infrastructure
facility, nobody wish to pay for the worst infrastructure facility. So, you have low capacity
and willingness to pay when you have low level of maintenance of infrastructure due to
the very poor level of infrastructure services or inadequate services.
So, if you have low capacity to pay, the recovery on the investment is again very low and
again if you have the low returns on the investment, you are again going to have the low
level of investments. And this again low level of investment in infrastructure is making
you very uncertain about a proper development of infrastructure. So, this is the vicious
circle of the poor infrastructure, where you are not really having a better facility. You are
not really having a better infrastructure services and that makes you always put in the
same vicious circle of this infrastructure backwardness and that infrastructure
backwardness leads you to become under-developed for many years.
 Urbanisation

Green economic Infrastructure Increase

growth services competitiveness

High-productivity
jobs
Better infrastructure services improves the urban living conditions and better
urbanization.

If infrastructure services are well enough then you have increased competitiveness in the
market, it means that you have high productivity job in the market. Because, if you have
the competition in the market people will try to invest in your market.

if you have a better infrastructure services available in the city better educational
situation, better health service, better water conditions, better sanitations, you are much
advantageous position compared to other countries.
So, to sum up infrastructure stimulates the economic growth through both demand side
as well as the supply side. Because, as a producer I am ready to get the raw material on
low cost, I am ready to have production on time, because of the availability of electricity
and because of availability of other inputs of the production.

And, as a consumer also I am getting the benefits of infrastructure, as I am going to get

the fresh material; I am going to get a very well packed material on time due to the
infrastructure support.
. So, infrastructure affects the international competition and trade. Because, more you
are in the competitive world, more you are in the low cost production mechanism; China
today proved that due to the low cost of production they are in the position to compete
at the international level. And at the level of international trade they have also proved
that with the development of infrastructure they can really have a change in the
international trade sector.

So, it really attracts foreign investment, because investors are looking for those
destination, where the return is very high and return cannot be very high when the
infrastructure is in the poor stage. So, if the infrastructure is really in a very good stage
foreign investors are also looking to join.
Consumers willing to pay

Producers willing to produce

Foreign investments willing to come

Books
"Economics of the Public Sector" by Joseph E. Stiglitz
“Public Finance and Public Policy" by Jonathan Gruber
"Principles of Public Utility Regulation" by Charles F. Phillips
Economics of Regulation and Antitrust" by W. Kip Viscusi, Joseph E. Harrington, and David
E. M. Sappington
THANK YOU