Session 14 NonMarket Valuation

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Session 14Non-Market Valuation
Morteza Rahmatian California State University,
Fullerton mrahmatian_at_fullerton.edu Ashgabad,
November, 2005
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Notion of placing a value on nature

• knowing the price of everything but the value of
  nothing.
• Value and prices are separate ideas.

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What is value?

• First, the economic view of value is
  anthropocentric.
• This means value is determined by people and not
  by either natural law or government.
• Second, value is determined by peoples
  willingness to make trade-offs.
• When an individual spends money on one good,
  there is less available for other goods.

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The argument against..

• The notion that cars, houses and bus rides have
  prices. Putting a price on the environment
  destroys the notion that it has value - rather
  it becomes a chattel that can be sold off.
• How much would you be willing to pay to forego
  your freedom or health?

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Why is monetary valuation important?

• Planning process is influenced by economic
  analysis (CBA)
• Goods and services which have quantities and
  prices can be taken into account in
  decision-making process
• Economic valuation helps to bring the environment
  into decision-making process

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Total Economic Value

• Use values
• Direct use (timber, other forest products)
• Indirect use (ecological functions)
• Option value (WTP to conserve for future use)
• Non-use values
• Existence value (WTP to know an asset exists)
• Bequest value (WTP to pass on asset to next
  generation)
• TEV Direct Use Value Indirect Use Value
  Option Value Existence Value

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Dimensions of environmental value

• Four categories of service that the natural
  environment provides for humans and their
  economic activities
•   resource inputs to production by firms, R
•   sinks for production and consumption wastes, W
• amenity services to households, A
•   life support services for firms and
  households, L

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Techniques for Measuring the Value of Non-market
Goods

• The three major categories for measuring the
  value of non-market goods include
• Revealed preference techniques, which look at
  decisions people make in reaction to changes in
  environmental quality.
• Stated preference techniques, which elicit values
  directly through survey methods.
• Benefits-transferred techniques, which look at
  existing studies for value of analogous
  environmental change.

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Techniques to place monetary values on
environmental impacts

• Market based methods
• Production function approach
• Cost of illness approach
• Cost-based approaches
• Travel Cost Method
• Hedonic pricing Approach
• Non-market based methods
• Contingent valuation Method

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Production function approach

• The environment is an input into the production
  of a marketed good
• Based on damage function which relates cause
  (soil erosion) to effect/damage (reduced soil
  fertility)
• Applicability deforestation, wetland and reef
  destruction, water pollution in agricultural and
  fisheries
• Measures use value of resources

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Cost of Illness Approach

• Costs of air/water pollution estimated by looking
  at costs of human health impact
• Dose-response function identifies relationship
  between level of pollutant and degree of health
  effect (water quality and diarrhoea)
• Value health effect based on cost of illness,
  including
• cost of medicine, doctors visits, hospital stays,
  other incidental expenses
• Loss of earnings due to illness

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Cost of Illness Approach

• Applicability
• Value health costs of water and air pollution
• Limitations
• Dose-response functions not available locally
• Does not measure WTP to avoid illness

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Cost-based approaches

• Replacement cost approach
• Cost effectiveness analysis
• Defensive expenditure approach
• Limitations
• Costs significantly underestimates benefits
• Use when not possible to quantify benefits
• Applicability
• When benefits are very difficult to value

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Replacement Cost Approach

• Estimates the costs required to replace damaged
  resource or to restore damaged resource to
  original state
• Applicability
• When remedial action must be taken to meet a
  standard (air or water quality)
• When environmental effect requires expenditure to
  replace natural asset (roads, dams, soil, water)
• Limitations
• Assumes complete replacement or restoration is
  possible

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Cost-effectiveness analysis

• Choose the most cost-effective means of reaching
  a pre-set target
• Applicability
• Social programmes (health and population)
• Examples
• maximum level of exposure to a waterborne disease
  agent
• emission standard for industrial facilities
• Limitations
• Compares alternative means of reaching target,
  but can not identify whether alternative are all
  too costly

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Defensive/Preventative Expenditure

• People act to pre-empt damage
• Expenditures provide estimate of minimum
  valuation of potential damage to health or
  environment
• Applicability
• Assess demand for public services (water supply,
  electricity, rubbish collection)
• Example
• To assess demand for urban water supply project,
  look at how much people pay for water from other
  sources to avoid exposure to water-borne
  pathogens
• Provides lower-bound estimate of social benefits
  of public services
• Limitations
• There must be no secondary benefits to expenditure

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Travel Cost Method

• Uses expenditures (transport costs and time) to
  reach a site to estimate willingness to pay
• Application
• Recreational areas, national parks,
  historic/cultural sites
• Time spent collecting fuel wood and water
• Limitations
• Requires survey, skills
• Measures only use value

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Travel Cost Method

• The travel cost method
•  
• The second assumption is that the cost of a visit
  comprises both
• Travel costs Ti, varying with i
• Admission price, P, constant across i
• and that visitors treat travel costs and the
  price of admission as equivalent elements of the
  total cost of a visit (so responding in the same
  way to increases/decreases in either).

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Contingent valuation

• Ask individuals what they are WTP for a change in
  environmental attribute
• Based on hypothetical market
• Requires that respondents understand well the
  good they are being offered and that they answer
  truthfully
• Application
• Changes in the provision of public services
• Only method to measure existence value
• Limitations
• Requires rigorous survey, economic skills
• Due to hypothetical nature, subject to many biases

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 Contingent valuation (CVM)

•   A direct method that involves asking a sample
  of the relevant population questions about their
  WTP or WTA.
• It is called 'contingent valuation' because the
  valuation is contingent on the hypothetical
  scenario put to respondents.
• Its main use is to provide inputs to analyses of
  changes in the level of provision of public
  goods/bads, and especially of environmental
  'commodities' which have the characteristics of
  non-excludability and non-divisibility.

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Contingent valuation pros and cons

• CVM is seen by many economists as suffering from
  the problem that it asks hypothetical questions,
  whereas indirect methods exploit data on
  observed, actual, behaviour.
• On the other hand, the CVM has two advantages
  over indirect methods
• First, it can deal with both use and non-use
  values, whereas the indirect methods cover only
  the former.
• Second, and unlike the indirect methods, CVM
  answers to WTP or WTA questions go directly to
  the theoretically correct monetary measures of
  utility changes.

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The steps involved in applying the CVM

•  (1) Creating a survey instrument for the
  elicitation of individuals' WTP/WTA. This has
  three components
• (a) Designing the hypothetical scenario,
• (b) Deciding whether to ask about WTP or WTA,
• (c) Creating a scenario about the means of
  payment or compensation.
• (2) Using the survey instrument with a sample of
  the population of interest.

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The CVM steps continued

• (3) Analysing the responses to the survey. This
  can be seen as having two components
• (a) Using the sample data on WTP/WTA to estimate
  average WTP/WTA for the population,
• (b) Assessing the survey results so as to judge
  the accuracy of this estimate.
• (4) Computing total WTP/WTA for the population
  of interest.
• (5) Conducting sensitivity analysis.

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PROBLEMS WITH CVM

• A number of potential 'biases' have been
  identified in the CVM literature
• Two classes of problem are subsumed by the term
  'bias
• Getting respondents to answer the question that
  would, if they answered honestly, elicit
  respondents' true WTP in regard to the policy
  issue that the exercise is intended to inform.
• Getting respondents to answer honestly.

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SURVEY DESIGN

• Many CVM practitioners argue that with good
  survey instrument design bias is not a major
  problem nowadays.
• Good survey instrument design is now seen as
  involving
• Extensive pre-testing
• The use of focus groups

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SOME OTHER DIFFICULTIES

• Averaging responses
• Use of mean or median (treatment of outliers)?
• Treatment of no responses (to a question
  asking whether the individual would be WTP a
  particular sum). Is this a 'protest' or a
  genuine response?.
• Are protest responses to be included in the
  average?
• Clearly, the treatment of outliers and protest
  responses can have significant implications for
  estimated median and, especially, mean WTP.

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Obtaining total WTP

• Given average WTP, total WTP is just that
  average times the size of the relevant
  population.
• A question which arises is what is the relevant
  population?
• At one level the question is answered by the
  conduct of the CVM exercise in regard to sample
  selection.
• At another level, the question may be open and
  unresolved. If it is the existence value
  associated with the Amazon rainforest, say, what
  is the relevant population (and how does that
  relate to the sample?)

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Hedonic Methods Approach

• Uses market price of a good to estimate the value
  of an environmental attribute which is embedded
  in the price of the marketed good
• Example house (size, construction, location,
  environmental and aesthetic attributes, e.g.
  clean air)
• Application
• property prices and air pollution/aesthetic
  traits and access to water supply and rubbish
  collection
• Job markets and risks to life
• Limitations
• requires survey, lots of data, economic
  theory/econometrics
• Relies on existence of properly functioning
  land/property and labour market

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Hedonic Methods Approach

• An indirect method
• Widely used in context of environmental pollution
• Attempts to evaluate attributes of some traded
  good.
• Example
• Traded good housing
• Attribute Air quality
• Uses multiple regression analysis to reveal
  relationship between house rents and levels of
  all relevant attributes
• and in doing so yields implied value of clean
  air.

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THE HEDONIC PRICE METHOD

• The hedonic price method can be used to value an
  attribute, or a change in an attribute, whenever
  its value is capitalized into the price of an
  asset, such as houses or salaries.
• It consists of two steps.
• Suppose one wants to estimate the value of a
  scenic view.

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THE HEDONIC PRICE METHOD

• The first step estimates the effect of a
  marginally better scenic view on the value
  (price) of lots (a slope parameter in a
  regression model), while controlling for other
  variables that affect lot prices.

This results in hedonic price function or
implicit price function. The change in the price
of a lot that results from a unit change in a
particular attribute (i.e., the slope) is called
the hedonic price, implicit price, or rent
differential of the attribute.
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THE HEDONIC PRICE METHOD

• The second step estimates the WTP for scenic
  views, after controlling for tastes, which are
  proxied by income and other socioeconomic
  factors.
• To account for different incomes and tastes,
  analysts should estimate the following WTP
  function (inverse demand curve) for scenic views

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Revealed Preference Approaches- Hedonic Wage
Studies

• The hedonic wage approach is based on the idea
  that an individual will choose the city in which
  he or she resides in order to maximize his/her
  utility.
• The individual will consider wages and a host of
  other positive (educational or recreation
  opportunities) and negative (crime, pollution)
  factors.
• Wages adjust to compensate people for different
  city characteristics.

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Revealed Preference Approaches- Hedonic Wage
Studies

• Suppose a person has two job offers, one in a
  cold weather city and the other in a warm weather
  city.
• Suppose each job offers the same salary.
• If the person chooses the warm weather job, and
  others do too, the labor pool will increase in
  the warm weather city and wages will fall.
• The reverse happens in the cold weather city.
• The difference between the wages in the warm
  weather city and the cold weather city
  compensates people for the disutility of living
  in the cold weather.
• This compensating differential can be used to
  look at value placed on environmental amenities
  or risk.