Revealed Preference Methods
New Bedford
• New Bedford Harbor is a major commercial fishing port
and industrial center in southeastern Massachusetts on
Buzzards Bay. From the 1940s to the 1970s, electrical
parts manufacturers discharged wastes containing PCBs
and toxic metals into New Bedford Harbor, resulting in
high levels of contamination throughout the waters,
sediments and biota of the Harbor and parts of Buzzards
Bay. Hundreds of acres of marine sediment were highly
contaminated. One location contained the highest
concentrations of PCBs ever documented in a marine
environment.
CERCLA
• Comprehensive Environmental Response,
Compensation, and Liability Act
• Aka Superfund
• Allows EPA to name “potentially
responsible parties”
– Anyone who owned the property while the
toxin leaked to the environment.
– Very wide net
Cercla
• Either the “parties” clean it up or EPA does
and sends them the bill
• Spawned huge litigation over who was
responsible.
• Required remediation
• Allowed Natural Resource Damages
– E.g. lost fishing, beach recreation etc.
How Much
• The 5 companies that were found to be
responsible for the damages to New
Bedford Harbor paid $110 million. Of that
total, the amount attributed to damages to
beach recreation and to fishing was $20.2
million
• This is real money.
Types of Value
• Use value.
– Fishing
– Beach visiting
– Can estimate use value based upon observations
about usage
• Passive or non use values
– I like wolves in yellowstone but I don’t go there.
– Can’t measure value based on observations of usage
Value of Non Market Goods
• Revealed Preference
– Observe actions and deduce value
• Travel Cost
• Hedonic
• Averting behavior
• Stated Preference
– Ask
Marketed or Non Marketed
• Marketed
– Electricity
– Can measure use value by looking at electric
meter
• Non Marketed
– Outdoor recreation
– Challenge is to measure non marketed use
values.
Revealed Preference
• Both bundle A and bundle B are affordable
(on or under the budget constraint)
• If bundle A is chosen we say it is revealed
preferred to bundle B.
• We infer preferences from choices/actions.
• Today we do revealed preference
methods, starting with transportation cost
method.
Data on Beach Visits
Table 6.1: Hypothetical data on the price and quantity of beach visits.
Person
1
2
Price
0.9
1.95
Quantity
28
17
3
4
5
3
3.95
5
14
12
5
Objective: Explain quantity as a
function of price
• Quantity is the dependent variable
• Price is an independent variable
Regression
• Statistical method to fit line to data points.
– For our purposes only need to know that we
can recover a formula for a line from the data
points
– Next slide plots our points and shows the line
closest to those points in the sense that the
squares of the vertical distances between
point and line are minimized. (called least
squares)
Plot of Data
Triangles are actual
data; line is
predicted; squares
are residuals—actual
- predicted
Demand for Beach (Idealized)
30
25
Number of Trips
20
15
10
5
0
0
-5
1
2
3
4
5
6
• Q = 30 – 5 * P
– Is the formula for the line.
– We could find the area under the line and that
would be total willingness to pay.
TWTP and CS
Find them for q= 10
Watch the axis
reversal
Demand for Beach (Idealized)
30
25
Number of Trips
20
15
10
5
0
0
-5
1
2
3
4
5
6
Hotelling
• Show Hotelling’s letter and read it.
Fort Point Beach
• Is in New Bedford Harbor.
– It is visited.
– Get data on visits to find value of beach.
– Ted McConnel did this and it was the first of
the natural resource damage cases.
Five observations on costs of travel
to Fort Point and other beaches .
Number of trips to
Fort Point
Travel Cost to
Fort Point
Travel Cost to
Travel Cost to Second
Nearest Other Nearest Other
Beach
Beach
12
2.061
2.30
3.336
15
2.949
3.45
5.276
15
1.526
4.659
4.677
16
1.073
2.730
2.632
20
1.596
3.774
5.535
Travel costs are in 1986 dollars. They include the cost of time
Sample Price Calculation
• five miles from the beach
• automobile of 42 cents. .
• Fifteen minutes travel
– wage rate (after taxes) were $8 per hour
– Cost of commute time would be $2.
• Her total cost of traveling to Fort Point
would then be $2.42.
Demand Curve
• Number of trips = 12.43
-5.48* travel cost to Fort Point
+ 2.03 * travel cost to nearest other beach
+ 2.03 * travel cost to 2nd nearest other
beach
Demand Shift
• The first time he ask people how many
trips they would make given that they
knew there were PCBs in the harbor. The
second time he asked how many trips they
would make if there were no PCBs in the
harbor
Damage Estimate
• two demand curves that were calculated from 495
randomly selected people in the area.
• area under the demand curves is twtp.
• the difference between the areas under these two curves
gives the estimate of the lost consumer surplus in beach
recreation from PCB contamination for the 495 people.
• he divided his estimate by 495 to get consumer surplus
per person, and he multiplied that value by the number
of people in New Bedford (adjusted for those that did not
go to the beach.). This gave him an estimate of the
losses in beach recreation for a single year.
TCM questions
• On a vacation is the travel part of the fun
or part of the cost?
• I go to Beijing and see the Great Wall and
the Purple Forbidden City. What is my
travel cost to the Wall?
• How many visits did Gloria, my brother
and I make to Rocky Mountain NP. We
stayed a week. We were 11 people. 77?
(recreation visitor days.)
Kerry’s creek
• Kerry Smith was asked to find value of lost
recreation from mine leakage.
• Leakage ruined creek below confluence
and not above.
• So he too difference in recreation value in
the two zones.
• He didn’t have to ask, “how many times
would you go fishing without the arsenic..”
Walt Disney and Mineral King
Travel Cost: Method
• (Krutilla and Fisher. Economics of Natural
Environments. Johns Hopkins University Press.
Baltimore. 1975. pp:189-218.
• miles to measure price
• income by county of origin
• number of skiers by ski area
• D(y, pThisArea, pOtherAreas, snow conditions?)
Cost Benefit Analysis
• A project is not bad if the benefits (to
whomever they may accrue) are greater
than the costs.
– Take $20 from a homeless person and
(magically) give $21 to Bill Gates
– Take $100 from Bill Gates and give $20 to a
homeless person.
Should Mineral King be a Ski
Area
• Would a new area make sense
• Cost of new area (25 million dollars,
present value at 9%)
• Cost of road (25 million dollars)
• Willingness to pay for new area (8.2 to
26.7 million dollars present value)
• Do we need to know what it is worth as
Wilderness?
Why did Disney want it?
• Who paid and who benefited?
• Beers, restaurants and lodging
– long, steep, slippery road
– monopoly profits to Disney
– how does that change Disney’s analysis
– how does that change the public choice
problem
Hedonic Pricing
• First known example:
– Price of cucumbers explained by length, width and
color.
• General idea:
– Explain price of something based upon its
characteristics.
• Frequent use:
– House prices depend on sq ft, lot size, number of
bathrooms, view and so on.
• Method: regress price on characteristics
Example
• Show the Ligget and Bockstael example.
• Note the coliform bacteria.
Table 6.4: Hedonic Price Equation for Housing near Chesapeake Bay (Leggett & Bockstael).
Dependent Variable: Market Price Minus Value of Structure (in $1000s).
Variable
Parameter
Intercept
4445.8358
Lot Size (acres)
131.0783
Lot Size Squared
-8.4342
Distance to Baltimore (miles)
-9.0215
Distance to Annapolis (miles)
-17.0269
Distance to Baltimore x Distance to Annapolis (miles squared)
0.5333
Distance to Baltimore x % of residents who commute out of county -13.2027
% of nearby land densely developed
325.6553
% of nearby land of low density
59.7778
% of nearby area that's water or wetlands
275.9341
% of nearby area open space
20.5546
Served by public sewer?
-0.8928
Inverse of distance to source with water discharge permit (1/miles)
-149.4962
Inverse of distance to marina (1/miles)
0.1445
Inverse of distance to sewage treatment plant (1/miles)
5.9401
Fecal coliform concentration (counts per 100 mL)
-0.0656
Notice in Table 6.4 that the parameter for fecal coliform concentration is a negative number; an
increase in coliform concentration of 100 (an increase with potentially serious health effects) leads
to a decrease of about $6,500 in property value (100*-0.0656 gives the change in property value in
thousands of dollars). In fact, if all properties in the study area met the water quality standard for
Better experimental design
• Would prefer—
• Two communities have same water
quality.
• One gets a sewer outfall
• We find property values before and after in
the two communities
Value of Statistical Life
• The value of a statistical life is the
willingness to pay to avoid a risk that
would result in one more death in the
population
VSL to work in a bad
neighborhood
• job in a safe neighborhood has a risk of death, of 10-4)
each year.
• job in the unsafe neighborhood had three times the risk
(3*10-4) of death each year.
• The company can get people to work in the unsafe
neighborhood only by paying an extra $1000/year.
• I$1000 per year was necessary to accept a risk of 2*10-4;
• the VSL in this case is $1000/(2*10-4) = $5 million.
Wages and risk
• Look at how wages increase with risk of
death.
• Hedonic: wages are dependent variable
• Risk of death: independent variable
• Get VSL
Averting behavior
• Water is contaminated.
• Decide to drink bottled water
• Cost of bottled water is the estimate of the
damage from the contamination.
• Do you believe this? Would you let me
poison your household water if I supplied
you with bottled water?
• In 1987, residents of Perkasie, Pennsylvania, faced
contamination of their drinking water and exposure to
vapor in their homes from trichloroethylene (TCE), a
toxic chemical. The TCE was left by Stainless, Inc. and
was part of its former industrial activities. In response,
many of those residents bought bottled water or water
filters, boiled their water, or hauled water from
elsewhere. Economists Abdalla, Roach, and Epp found
that the costs associated with these activities were
estimated to average between $22 and $48 per
household during the 21-month contamination period.
Final comment
• In this type of analysis, only the lack of
direct use leads to damages. So coliform
in the bay or pcb’s in the harbor only affect
those who live nearby or use the resource.