Valuing the Environment for Environmental Decision-Making
The same thing
is good and true for all men, but the pleasant differs from one and
another. Democritus (c. 460-370 B.C.)
The measurement of both the value of environmental resources and changes in the level of environmental quality is a critical step in the development of the objectives of environmental policy. As demonstrated in Chapter 3, the optimal level of pollution requires an estimate of the marginal damage and marginal abatement cost functions. This requires identifying and attaching a monetary value to the specific costs and damages associated with pollution and its cleanup. A second area where a measurement of value is important is in cost-benefit analysis.
The definition of value is an interesting issue because the word “value” is used in two ways. It can be used to express the benefit that a good or service generates. Or it can be used to reflect an individual’s or society’s norms or guiding principles of behavior. This chapter focuses on the first concept of value, which allows the development of a criterion for evaluating policy choices.
The first point that distinguishes the economic view of value from other perspectives is that it is an anthropocentric concept. This means that economic value is determined by people and not be either natural law or government.
The second point is that value is determined by people’s willingness to make trade-offs. In a market, the demand curve represents a marginal willingness to pay function. The area under the demand curve represents the total willingness value or total benefit associated with specific quantities of the good. However, a true measure of the benefits associated with specific quantities of the good needs to consider the cost of producing the good.
Total resource costs can be examined with a marginal cost function. The area under the marginal cost curve at specific quantities is a measurement of the opportunity cost of the resources used in production.
Net value is the area below the demand curve and above the marginal cost curve at the equilibrium level of output. This is equal to the sum of consumers’ surplus and producers’ surplus. Economists use complicated models that show the connectivity of markets when analyzing issues, but the basic concept is the same. Table 4.1 provides and example of this type of analysis.
Nonmarket goods may have both direct use (associated with the tangible uses of environmental resources) and indirect use values. Indirect use values are those associated with more intangible uses of the environment, such as aesthetic benefits or the satisfaction associated derived from the existence of environmental resources. Indirect use values include not only existence value but also bequest, altruistic, option values and the value of ecological services.
A bequest value refers to the fact that an individual values having an environmental resource or quality available for his children or grandchildren. Altruistic values comes from a desire that other people have the opportunity to enjoy the environmental resource. An option value is the closest of these preservation values to a use value. It refers to the value associated with having the resource available for use in the future. None of these values are mutually exclusive.
The value of ecological services (which include nutrient cycling, atmospheric processes, carbon cycling, clean air, clean water, and biodiversity, among other services) are unique among indirect use values in that people do not always know that these services positively affect their well-being.
There are three major classes of techniques for measuring the value of nonmarket goods: revealed preference, stated preference techniques and benefits transfer techniques. Revealed preference approaches look at decisions that people make regarding activities that utilize or are affected by an environmental amenity, to reveal the value of the amenity. Revealed preference focuses on direct use value. Stated preference methods elicit values directly from individuals, through survey methods. Stated preference techniques can be used to measure both direct and indirect use values. The benefit-transfer approach looks at existing studies for values of analogous environmental change, and then adapts these estimates to the problem at hand. This approach will use estimates derived from both revealed preferences and stated preference methods.
One example of a revealed preference approach is the hedonic pricing technique. Hedonic pricing techniques are based on a theory of consumer behavior that suggests that people value a good because they value the characteristics of the good rather than the good itself. According to this theory, an individual would not value a car because the car directly gives him or her utility, but because the characteristics of safety, operating cost per mile, luxury, comfort, and status provide utility. By examining how price varies with changes in these characteristics we can gain some insight into the value of these characteristics. Linking the price of various goods or services to an environmental characteristic associated with that good allows hedonic pricing techniques to derive a value associated with the environmental characteristic. Hedonic pricing techniques have been used to place a value on the willingness to pay for reductions in air pollutants and the willingness to accept a certain level of risk in a job.
An alternative revealed preference approach for determining the value of an environmental asset is the use of travel cost models. The travel cost model is a method for valuing the environmental resource associated with recreational activities. Harold Hotelling first proposed the travel cost method in 1947. The basic premise is that the travel cost to the site can be regarded as the price of access to the site and is therefore a measure of the willingness to pay for environmental assets associated with the recreational site. While this is a useful method for assigning a value to the recreational activity, travel cost models do not give information about the value of changing the quality of the activity. Travel cost models have been widely used and hold great promise for further understanding the way environmental quality affects the value of recreational activities. There are some methodological issues that remain unresolved. These include:
1. how to incorporate the opportunity cost of travel time into the measure of travel cost.
2. how to properly account for substitutes (multiple sites) in estimating a travel cost demand curve.
3. how to account for a variety of sampling biases that arise when data is collected by interviewing recreationists at recreation sites.
4. how to properly measure recreational quality and relate recreational quality to environmental quality.
Stated preference techniques do not have a link to actual choices made. Instead, they solicit value measures directly by asking individuals hypothetical questions. The most widely used stated preference technique is contingent valuation. The contingent valuation method (CVM) ascertains value by asking people their willingness to pay for a change in environmental quality. These questions are asked in a variety of ways, using both open-ended and close-ended questions. The contingent valuation method must also state the mechanism by which the payment will be made. Care must be taken that the contingent valuation exercise does not become a referendum on the payment vehicle. Another aspect of this debate is whether the researcher should or policy analyst should use a measure based on willingness to pay for access to an environmental resource, or willingness to accept a payment to forego access to the resource.
Although widely used, there remains considerable controversy over the use of the contingent valuation method. Issues include the consumer’s lack of practice in making willingness to pay decisions in the environmental market and the potential that the expressed willingness to pay may be biased because the respondent is actually answering a different questions than the surveyor has intended. Another problem is that respondents may make associations among environmental goods that the researcher had not intended. Finally, some researchers argue that there is a fundamental difference in the way that people make hypothetical decisions relative to the way they make actual decisions.
Conjoint analysis is technique that has been employed by researchers in marketing, transportation, and psychology for determining individual preference across different levels of characteristics of a multi-attribute choice. A consumer is asked to make a choice between two hypothetical environmental resources with different characteristics. Statistical techniques are then used to establish a relationship between the characteristics and preference. As long as one of the characteristics is price, it is possible to use the preference function to derive the willingness to pay for changes in levels of the characteristics. Conjoint analysis can be viewed as a hedonic pricing technique, where hypothetical prices substitute for market prices.
Conjoint analysis has several advantages over contingent valuation. Consumers are not ask to make a trade-off directly between environmental quality and money, but rather to state a preference between one bundle of environmental characteristics and another, each with different tax burdens. This is a choice that the consumer is more familiar with and therefore there is less potential for protest bids, signaling and other potential biases.
Benefit transfer refers to a process of taking values from studies that were previously completed in other areas, and applying them to the area where the new decision must be made. This is one way to avoid the costly approach of conducting original valuation research where it is not necessary. Benefit transfer analysis involves a set of methodologies that can be employed to maximize the quality of information that is available. These methodologies focus on ensuring that the reference study (the previously implemented study whose results are being transferred) is congruous with the problem being studied.
An alternative to a focus on willingness-to-pay is to focus on cost-related measures. Three cost-related measures include avoidance cost, replacement cost and restoration cost.
Avoidance cost refers to the costs that people incur to avoid the negative consequences of an environmental change. To the extent that the avoidance measures eliminate the problem, they can be viewed to measure the social cost of the problem.
Replacement cost focuses on the cost of recreating what has been lost to environmental damage. While restoration cost focuses on the cost of repairing the environmental damage. There are some major problems associated with the use of restoration and replacement costs as a measure of value. One concerns the question of whether the recreated or repaired environmental resource is of equal value to that which was damaged or destroyed. Does it provide the same flow of ecological services? The other concerns the notion of authenticity. Is a city park equivalent to a forest?
Although many questions need to be answered to fine-tune the various valuation methodologies, they can be used to help formulate environmental policy.
Net Value - Sum of producer and consumer surplus.
Use Value - value based on tangible use of environmental resource. An example would be the value placed on coal
used for energy.
Non-use Value - value based on intangible use of and
environmental resource. Also referred to as "passive" use values. May include existence
value, bequest value, altruistic value and option value.
Existence Value - value placed on existence of resource
although no current or future use is desire.
Save the whales, although have no desire to see one.
Bequest Value - refers to the desire t have environmental
resources or resource quality available for children or grandchildren to
inherit.
Altruistic Value - occurs out of one individual's concern for
another. Value based on the opportunity
for others to value the environmental resource.
Option Value - closest to use value.
Consumer preserves the option of using resource in the future.
Revealed Preference Approach - techniques which examine decisions
that people make regarding activities that utilize or are affected by an
environmental amenity. Focus on
measuring the use value. Examples
include hedonic pricing techniques, hedonic wage approach and travel cost
method.
Hedonic Pricing Techniques - based on the theory of consumer behavior
that suggests that people value a good because they value the characteristics
of the good.
Hedonic Wage Approach - based on idea that wage willing to accept
will be a function of a host of factors both positive (climate, education) and
negative (crime, pollution).
Travel Cost Method - first proposed by H. Hotelling
in 1947. Basic premise is that travel
cost to a recreational site can be regarded as the price of access to the site.
Contingent Valuation Method (CVM) - a direct valuation technique which
ascertains value by asking people their willingness to pay for certain
environmental characteristics.
Conjoint Analysis - a technique which has been employed in
marketing and psychology for determining individual preferences across
different levels of characteristics of a multi-attribute choice.
Benefit
Transfer Approaches – the
process of taking values from studies that were previously completed in other
areas, and applying them to the area where the new decision is made.
Anthropocentric - centered around
humans.
Biocentric - centered around
nature, the biosystem.
Chapter 4 Short-answer questions
1. Compare and contrast the terms use value, non-use value, existence value, bequest value, altruistic value and option value.
· Use value is based on value associated with the use of the resource in the production of a good or service. Non-use value is not associated with the use of resource in production. Existence, bequest, and altruistic value are subsets of non-use value. The resource has a value associated with its existence, and, similarly, for the enjoyment of others. Option value is closer to user value. This is value associated with potential use.
2. V. Kerry Smith argues that non-use values are the values from the public good aspects of the environmental resources, while use values are the private good or mixed good values of environmental resources. Interpret this statement.
· Use value is associated with the use of the resource in the production of a good or service. Private or mixed property rights are associated with production. Non-use value is associated with having the resource available. If it is available for one, it is available for all.
3. Under what circumstances would a hedonic pricing technique be the most appropriate approach to determining the value of a good? What are the positive and negative aspects of this revealed preference approach?
· Hedonic pricing is appropriate when no actual market exists and the good is associated with a set of characteristics that the consumer can identify. It is possible to examine a variety of environmental issues with this technique. However, the results are greatly influenced by the phrasing of the questions that are asked. Often, the answer is in response to the tone of the question itself.
4. What are the basic differences between the hedonic pricing technique and the hedonic wage technique? Under what circumstance would a hedonic wage technique be the more appropriate technique?
· Hedonic wage models are a subset of hedonic pricing methods. These models are appropriate when one aspect of the problem under consideration is the wage.
5. How do you determine the value of a statistical life? What is the interpretation of "statistical life"?
· The value of a statistical life is a function of the amount an individual must be compensated per year to accept an additional annual risk of dying. This individual willingness to accept risk is expanded into a collective willingness to be exposed to this risk.
6. If construction workers are willing to accept a 1/1000 annual risk of death if their income increases by $1200 per year, what is the collective willingness to be compensated to accept the loss of one life?
· 1,200 * 1000 = 1,200,000. A thousand people have a collective willingness to accept $1.2 million to be exposed to this risk that would be expected to lead to the death of 1 additional individual. Therefore, the collective willingness to be compensated to accept a loss of 1 life is $1.2 million.
7. In question 6, under what circumstance would this estimate of the value of a statistical life be incorrect?
· This would be an incorrect estimate if this was a certain risk faced by a specific individual.
8. The travel cost method was first proposed by H. Hotelling in 1947 as a way of determining the value of recreational activity. What is the basic premise of this valuation method?
· Premise of this method is that the price that consumers are willing to pay for a recreational trip is a reflection of the value of the recreational activity.
9. What are some of the drawbacks associated with each of the indirect valuation methods presented in your chapter?
· One drawback is that the design of the question can influence the answer.
· Also, consumers may not make the same decision given an imaginary set of circumstances as they make given a real situation.
10. Assume that the data you have suggest that if
a. travel cost is greater than or equal to $30, no trips are taken;
b. if travel costs are zero, 100 trips are taken.
Draw a travel cost demand curve based on these data. Calculate ordinary consumer surplus for the individual whose travel costs are equal to $14.
· The information provides the end points of a straight line. Use this information to find equation for straight line, plug in $14 for price and solve for quantity. Then calculate consumer surplus, which is area below demand curve and above price at $14.
11. Contingent valuation is one form of direct techniques to solicit value. How does a contingent valuation study attempt to determine willingness to pay for environmental asset? What are some of the drawbacks associated with this method?
· Contingent valuation presents the consumer with situations and asks the consumer to state a willingness to pay. Problems associated with this technique include a difficulty in making choices under imaginary situations and the ability to phrase the question to influence the outcome.
12. How can conjoint analysis be used to directly measure national environmental policy scenarios where these different scenarios have different levels of multiple environmental attributes?
· By constructing different scenarios with differing combinations of attributes and asking the consumer to make dichotomous choices, it is possible to estimate the value associated with these environmental attributes.
13. What is the benefit transfer approach to establishing value associated with the environment? What is attractive about this approach to valuation? What is one drawback associated with this method?
· Benefit transfer approach takes values from previously conducted studies and applies them to the area of concern. The attraction is that estimating values using revealed preferences or stated preferences can be costly. This by passes the study. However, it is very important that the previously implemented study be congruous across several dimensions, with the new area of concern.
14. What is the difference between calculating willingness to pay values versus cost-related measures as a source of value?
· These cost-related measures refer to costs that people incur to avoid the negative consequence of environmental change (avoidance costs) or costs that would be incurred in trying to recreate (replacement costs) or repair (restoration costs) the environmental resource. Often these are more direct and easier to measure than willingness to pay. Although there is some concern about whether the recreated or repaired environmental resource will be authentic or of equal value as the original.
14. Using the following stream of benefits and costs, calculate the net present value associated with this proposed project. Assume a discount rate of 5 percent.
Years 1 -10 Cost is constant at $100,000 each year;
Benefits begin at 50,000 and grow by $5000 every 2 years.
Years 11 - 20 Cost is constant at $500.
Benefits continue to grow by $5000 every 2 years.
· Assuming that in the first year the values are not discounted. Each year following (costs – benefits) divide this by (1 + discount rate)year. Sum these through time.
15. In problem above, how important is your choice of a discount rate? What would happen if the discount rate reflected the average growth rate of the economy?
· The choice of the discount rate is very important because it will determine the importance or weighting of future costs and benefits. If the
16. Compare and contrast an anthropocentric viewpoint on the value of the environment with alternative biocentric approaches to value.
· An anthropocentric approach values everything relative to the usefulness and benefit to humans. A biocentric approach values everything relative to the ecological system of which humans are one component.