Valuing the Environment: Methods

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Chapter 3. Valuing the Environment Methods
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Review
What is correct regarding the First Law of
Thermodynamics? a. If you use more water to
wash your hands then you should use less water
for bath. b. Your coffee should be hotter than
tea because the coffee use the water boiling for
5 minutes while the tea uses water boiling for 2
minutes.c. Energy and matter cannot be created
or destroyedd. It is about entropy.
Edited from Dr.Trudy Cameron
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Review
What are the implications of entropy for the
long-term use of energy on Planet Earth? a.
Because of entropy, we can look forward to always
being able to use as much energy as we need. b.
In the absence of new energy, a closed system
will use up all of its energy, thus Planet Earth
is doomed to extinction when we run out of
energy c. Fortunately, the sun supplies a steady
stream of energy into the Planet Earth, so in the
long run, when we have used up our stored energy
forms such as oil, we will have to make do with
using no more energy than the sun provides for
us d. Fossil fuels are the only kind of stored
energy we have, and when we dissipate this energy
by using it for work, it will all be over.
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Review

• Overall total net benefits associated with
  consumption of some amount of the services of an
  environmental resource are analogous to what
  familiar concept from general microeconomics?
• a. consumer surplus
• b. profits
• c. producer surplus or economic rent
• d. the sum of producer and consumer surplus

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Review

• An allocation of resources over some future time
  horizon is said to be dynamically efficient if
• a. it maximizes the present discounted value of
  net benefits across all alternative uses of these
  resources over time
• b. if it is not statically efficient
• c. if it maximizes the sum of the current values
  of net benefits in all future periods
• d. if it minimizes the marginal user costs over
  time

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Review

• We do not have to do the benefit-cost analysis to
  any proposal if the U.S. Senate already voted.
• True
• False

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Introduction
Oil Spill
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Introduction

• How to estimate the liabilities of damages, for
  example, Exxon Valdex oil tanker leaking?
• Can normal valuation techniques be applied to
  environmental resources?
• What is the current price of clean air?

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Valuing Benefits

• Damage estimates are used in the design of
  policies and jury judgments which is supported by
  Comprehensive Environmental Response,
  Compensation, and Liability Act.
• It is complex and difficult to estimate the
  damages, for example, pollution control.

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Valuing Benefits (cont.)

• Pollution generate harms to human health that are
  recognizable in overall populations, but which
  have uncertain effects on any single individual.
  A natural example is the emission of toxic
  pollution into air or water, which elevates the
  risk of a person contracting cancer, emphysema,
  or various reproductive disorders. In this case
  one way to view the harm is the elevated
  likelihood of a person becoming ill or dying.

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Valuing Benefits (cont.)

• Identifying physical damages is difficult, let
  alone assigning them monetary values.
• Neither controlled experiments nor statistical
  studies provide us satisfactory results.
• How can we overcome these difficulties?

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Types of Values
Stock Flow

• A Stock
• A Flow
• the value of stock the present value (PV) of
  the stream of services flowing from the stock
• If we maximize the PV of the stream of the
  services, then we use the resource efficiently.

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Types of Values
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Types of Values

• Total Willingness to pay
• Use value Option value Nonuse value

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Example Valuing the Northern Spotted Owl
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• In 1990, an interagency committee proposed a plan
  to set up a habitat conservation areas from
  withdrawing certain forest areas.
• Contingent valuation survey is conducted.
  Benefits/costs3/1
• Survey was conducted nationally, while cost was
  shared by a small group of peoplesharing tax
  dollars

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Classifying Valuation Methods
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Valuation Methods

• Contingent Valuation
• Direct approachit asks people what they are
  willing to pay and/or what they are willing to
  accept for a change in the level of environmental
  service, in a constructed hypothetical market.
• WTP? Hypothetical market?

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Contingent Valuation Method

• Hand out the experiment.

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Contingent Valuation Method

• How to apply CVM?
• Set up a hypothetical market (describing the
  good, payment vehicle, rule)
• Define the elicitation method (take-it-leave-it
  open ended)
• Survey (on site mail telephone Internet)
• Calculate measures of welfare changes (mean WTP)
• Technical specification WTPif(Y, S,P, X)
• Aggregation

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• CVM shortcomings
• Strategic bias
• Information bias
• Starting point bias
• Hypothetical bias
• NOAA panel supported cautiously.
• Meta-analysis can solve the dilemma.

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Travel Cost Model

• Suppose somebody introduced an exotic species
  into the Charleston Lake, such as pike.
  Charleston residents are now worrying about
  quantifying the demand for fishing days at
  Charleston Lake which has been compromised by
  predatory pike.

WTP price
Lost Consumer Surplus Benefit of clearing pike
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Travel Cost Model

• TCM is often used to assess the value of parks,
  lakes, and similar public areas which host a good
  deal of recreational activity, and which are far
  enough away from many people to require users to
  drive or fly to the site.
• The basic premise of the TCM is that, although
  the actual value of the recreational experience
  does not have a price tag, the costs incurred by
  individuals in traveling to the site can be used
  as surrogate prices.

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Travel Cost Model

• Zonal travel cost is used to collect information
  on the number of visits to the site from
  different distances. These different distances
  can be calculated using zip codes and AAA mileage
  information.
• The surrogate pricetravel cost time cost.
• Researcher can construct function of number of
  visits at different prices.

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Travel Cost Model

• Individual travel cost model uses survey data
  from individual visitors asking them about their
  number of trips to the site.
• Researchers can use individual information such
  as income, race, age in the models.
• This approach will provide more precise results,
  but it requires more data collection and more
  complicated statistical skills.

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Valuing Implied Human Life

• Estimate the implied value of death for
  reducing probabilities a certain amount. For
  example if one million people are willing to pay
  5 on average to reduce chance of death from 1 in
  100,000 to 1 in 150,000, then people are willing
  to pay 5 million dollars to reduces deaths from
  10 to 6.67 per year. 5,000,000/3.33 gives the
  value per life of 1.5 million.
• A 1996 survey found that most implied values of
  human life were between 3 million and 7
  million.

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Issues in Benefit Estimation

• Primary versus Secondary Effects
• What should be counted might vary depending on
  the nature of the local economy. Thus it will
  vary by place and time. Secondary employment
  should be considered in high unemployment areas,
  while it should be ignored if it is only a
  rearrangement. (example cleaning a lake)
• Tangible versus Intangible Effects
• Intangible benefits should be quantified to the
  fullest extent.
• Sensitivity analysis is often used to measure the
  importance of the benefit.

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Approaches to Cost Estimation

• Estimating cost is typically more straightforward
  than estimating some types of benefits.
  Difficulties involve estimating expected future
  costs and getting reliable cost information from
  firms. Some common approaches include the
  following
• 1.      The survey approach involves asking
  polluters about their control costs (drawback?).
• 2.      The engineering approach uses engineering
  information to estimate the technologies
  available and the costs of purchasing and using
  those technologies (problem?).
• 3. The combined approach uses both 1 and 2.

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The Treatment of Risk

• Since it is typically not practical to do a
  benefit-cost analysis for every possible outcome,
  we usually must utilize expected values.
• 1.      A dominant policy is one which confers
  the higher net benefits in every outcome.
• 2.      The expected value of net benefits is the
  sum over the possible outcomes of the present
  value of net benefits of that outcome weighted by
  its probability of occurrence. The policy
  selected should be the one with the highest
  expected present value of net benefits.
• The above approach assumes risk neutrality.
  Whether or not it makes sense for the government
  to assume that society on the whole is risk
  neutral (versus risk loving or risk averse)
  should be discussed.

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Choosing the Discount Rate

• The discount rate is defined as the social
  opportunity cost of capital. The discount rate
  will have two components
• the riskless cost of capital
• and the risk premium.
• The rate on long-term government bonds is a
  common choice as a measure of the cost of
  capital. This can then be adjusted by a risk
  premium to reflect the level of riskiness of the
  particular project being considered.

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Cost-Effective Analysis

• Cost-effectiveness analysis is a useful
  alternative to benefit-cost analysis when the
  measurement of benefits is impossible or
  estimates are unavailable.
• This alternative involves the minimization of the
  costs of achieving a policy target such as an
  emissions standard. A minimum-cost solution
  requires the equalization of the marginal costs
  of all possible alternatives

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Impact Analysis

• Environmental impact statements attempt to
  quantify consequences of an action. Impact
  analysis is useful when the data needed for
  either a benefit-cost analysis or a
  cost-effectiveness analysis is unavailable.
• These present the analyst with as much raw
  information as is available without any
  optimization or benefit-cost analysis. More
  sophisticated environmental impact statements
  sometimes include benefit-cost analysis or a
  cost-effectiveness analysis.

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Problem

• In a research paper, Mark Cohen attempted to
  quantify the marginal benefits and marginal costs
  of U.S. Coast Guard enforcement activity in the
  area of oil spill prevention. His analysis
  suggests that the marginal per-gallon benefit
  from the current level of enforcement activity is
  7.50 while the marginal per-gallon cost is
  5.50. Assuming these numbers are correct, would
  you recommend that the Coast Guard increase,
  decrease, or hold at the current level their
  enforcement activity? Why?