2281AES Economics and Natural Resources

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2281AESEconomics and Natural Resources

• Module 10 Economic Valuation of Environmental
  Costs and Benefits Household Production
  Function
• Lisa Alder

Water Science and Technology Board (2004) Valuing
Ecosystem Services Toward Better Environmental
Decision-Making
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TABLE 1 Classification of Valuation Approaches
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Definition

• Consumers often gain utility not directly from
  the goods that they purchase
• Instead they transform the goods by a household
  production function HPF into something that they
  value (Becker and Lancaster mid 1960s).

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HPF Composition

• Some form of modeling of household behavior
• Assumption of a substitute/complementary
  relationship between the environmental good or
  service and marketed commodities consumed by
  household.
• Constructed on the efficiency conditions
  marginal productivity of work at home equals the
  wage rate.

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HPF Approaches

• Allocation of time models for recreation or other
  activities involving household labor allocation
  (travel cost),
• averting behavior models for health and welfare
  impacts of pollution, and
• hedonic price models for the impacts of
  environmental quality on choice of housing

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HPF Estimates

• Important although ignored in national income
  accounting.
• Estimated to account for 40 50 percent of the
  total production in Western countries, and in
  less advanced economies this fraction is
  presumably even higher (Bonke, 1992).

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HPF Economic Theory

• Early neoclassical models ignored productive role
  of households (treated all non labour time as
  leisure).
• Mainstream economists (Mincer 1962, 1963 and
  Becker 1965) use New Home Economics and apply
  quantitative methodologies to household decision
  making.
• Study of non market commodities and the
  associated allocation of household time now is
  part of economic theory

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Early Measures of Utility

• household utility is generated by commodities
  that are produced by combining the market goods,
  auxiliary goods, with time in a household
  production function (Becker 1965).
• The outputs of this production process are the
  utility generating commodities.
• market goods and time are not desired for their
  own sake but as inputs into commodity production.
  
• All activities in household are productive.

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Weaknesses

• Focus on market prices, inputs and production
• Severe lack of data.
• Most of the inputs and the output are
  unobservable
• Not usually possible to identify the models
• The lack of information on specific household
  production inputs and production technology cause
  identification problems.

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Gronau model

• Later Gronaus model (1977) assumed consumption
  goods and commodities are perfect substitutes
  (work at home and in the market are perfect
  substitutes).
• Direct utility is based on a persons indifference
  to the composition of the goods and services
  consumed (whether they are produced at home or
  purchased in the market).

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Advanced Measures of Utility

• In the Gronau model, a household maximizes a
  joint utility function subject to certain
  constraints considering the technology and
  resources.
• The utility function derives from consumption
  goods, commodities produced at home, and leisure
  of the members of the household

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Strengths

• first to apply HPF to time allocation data
• Successfully identified/estimated HP value
• Reduced the complexity of identification of a
  household production technology by assuming
  perfect substitution between market goods and
  home produced goods.
• analysed consumption patterns to yield amenity
  (non-use) values
• Can be inexpensive to apply

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Weaknesses

• Requires detailed information on household
  expenditures using consistently defined
  consumption categories.
• Amenity values are recovered from knowledge of
  market demands (demand-dependency)!!??.

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HP and the Environment

• Households allocates some labour, time and income
  for activities affected by environmental
  quality (state of the environment or
  goods/services it provides).
• Household combine labour, environmental quality,
  and other goods to produce a good or service,
  for its own consumption and welfare (i.e.,
  household utility).
• By determining how changes in environmental
  quality influence this household production
  function and thus the welfare of the household,
  it is possible to value these changes.

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Valuing the Environment

• Underlying Assumptions will vary depending with
  environmental problem and valuation approach.
• all applications of the HPF approach use
  derivation of derived demand for the
  environmental asset in question.
• Valuation of environmental quality can be
  extracted from information on the households
  purchases of marketed goods.

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General Production Function Models

• Value the support and protection that
  environmental goods and services provide economic
  activity in a two-step procedure (Barbier, 1994)
• The physical effects of changes in a biological
  resource or ecological service on an economic
  activity are determined.
• The impact of these environmental changes is
  valued in terms of the corresponding change in
  marketed output of the relevant activity.
• e.g. The biological resource or ecological
  service is an input to the economic activity -
  its value equated with its impact on the
  productivity of any marketed output.

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Static and Dynamic Approaches

• In static approaches, the welfare contribution of
  changes in the environmental input is determined
  through producer and consumer surplus measures of
  any corresponding changes in the one-period
  market equilibrium for the output (Barbier,
  2000).
• In dynamic approaches, the ecological service is
  considered to affect an intertemporal, or
  bioeconomic, production relationship.

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Coastal Wetland Example

• a coastal wetland that serves as breeding and
  nursery habitat for fisheries could be modeled as
  part of the growth function of the fish stock,
  and any welfare impacts of a change in this
  habitat support function can be determined in
  terms of changes in the long-run equilibrium
  conditions of the fishery.

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Discounting

• Discounting of many environmental policy impacts
  is important as these impacts extend over long
  durations and the timing must be factored into
  any valuation analysis.
• Discounting is the approach most commonly used in
  economic analysis to capture the timing of
  benefits and costs.

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Two Types of Discounting

• discounting as a means of weighing the utility of
  future generations differently from that of
  present generations (utility discounting) and
• discounting as a means of weighing consumption
  (through benefits and costs) differently at
  different times (consumption discounting).

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Weaknesses

• Dealing with average consumption patterns it may
  be necessary to determine population-weighted
  variables for different countries or regions.
• Many of the countries have highly uneven
  distributions of income and spending
• Consumption patterns of countries is generated by
  a representative consumer.