Chapter 4
Valuing the
Environment:
Methods
Valuing the Environment:
Methods
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4-2
Introduction
Why Value the Environment?
Valuation
Summary: Nonmarket Valuation Today
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Introduction
• This chapter examines valuation methods
of environmental resources.
• This chapter will also discuss the various
valuation techniques.
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Objectives
• Outline the complexities of cost-benefit analysis
including the monetization of costs and benefits.
• Define types of values: use value, option value,
existence value and total willingness to pay.
• Classify the available nonmarket valuation
methods by whether they are based on observed
behavior or a hypothetical market and whether
they are direct or indirect.
• Present the potential biases associated with the
contingent valuation method.
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Valuation
• 1989 Exxon Valdez spill in the coast of
Alaska.
– Damages:
• 1) Cost of cleaning the spilled oil, and restoring the
site. ($2.1 billion)
• Compensating the damage caused to the local ecology
(included local fishermen and others who depended on
it) ($303 million).
• 2010 Deepwater Horizon, Gulf of Mexico
– 20x greater than Exxon Valdez spill
– Net cost of the spill: $42.4 billion
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Valuation
• How can we estimate economic damages
that cause environmental harm?
– How were the damages in the Exxon and the
Deepwater case determined?
– Explore special techniques that are used the
value the damages from environmental
degradation or benefits from environmental
improvements.
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Why Value the Environment?
• Many federal agencies require benefit/cost
analysis for decision-making. The goal is to choose
the most desirable project given the limited
budget.
– Benefit/Cost analysis is used for
• Natural resources damage assessment e.g., Oil Spills.
(NOAA)
• Designation of critical habitat (US Fish and Wildlife
Services)
• Dam relicensing applications (The Federal Energy
Regulatory Commission)
• We need to incorporate nonmarket values for these activities
for the analysis to not be flawed!
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Should Humans Place an Economic
Value on the Environment?
• Philosophers believe that environment should have
an “intrinsic” value, that is independent of human
interests.
• Allowing humans to determine the value of other
species would have no more moral basis than
allowing other species to value human life.
• Humans should only use environment when
necessary for survival and leave it alone.
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Should Humans Place an Economic
Value on the Environment?
• Economist put “instrumental” value, i.e.,
environmental value is derived from its usefulness
to human wants. “Human Preferences”
– We quantify use and non-use values too.
• Dilemma:
– When humans fail to value the environment, it may be
assigned a default value of zero in calculation to guide
policy.
– A value of zero will tend to justify a great deal of
environmental degradation.
• Majority of the environmental professionals
support economic valuation as a means to
demonstrate environmental value to modern
society.
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Why Value the Environment?
• Valuing Environmental Services:
• Pollution control as an example:
– Multiple damages from pollution (Costs):
1. Polluted air and water can cause disease when
ingested. (Obvious)
2. Loss of enjoyment from outdoor activities.
(nonmarket impacts)
3. Damage to vegetation, animals and materials etc.
(nonmarket impacts)
• How do we assess the magnitude of this
damage?
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Valuating the impact
• Assessing the magnitude of damage
requires;
1. Identifying the affected categories.
2. Estimating the relationship between the
pollutant emissions and damages caused to
categories.
3. Estimating responses by the affected parties
towards averting/migrating some portion of
the damage.
4. Placing a monetary value on the physical
change.
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Valuation
• Types of total economic values
1. Use Value
2. Option Value
3. Nonuse or Passive Value
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Valuation
1. Use Value (Current Use)
• The willingness to pay for direct use of the
environmental resource
• Ex., fish harvested from the sea, timber
harvested form the forest, water extracted
for irrigation etc.
– Requires one of your sense (sight, sound,
touch, taste smell) to use the resource.
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Valuation
2. Option Value (Future Use)
• The willingness to pay for the future ability
to use the environment
• The value people place on having the option
to use or ensuring something exists for
potential future use.
• Ex., You may not go to Yellowstone National
Park in the near future, but if you ever plan
to go in your life, you want to ensure it
exists when you do go.
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Valuation
3. Nonuse Value
•Individuals’ willingness to pay to
preserve a resource that he or she will
never use.
– Bequest Value: Willingness to pay to
ensure a resource is available for your
children
– Existence Values: Willingness to pay to
ensure that a resource continues to exist
in the absence of any future interest.
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Valuation
–Total willingness to pay (TWP)
TWP = Use Value + Option Value +
Nonuse Value
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Valuation
–The goal is to estimate the TWP for
a good or service.
•Market goods = quantifiable. So,
estimating TWP is straightforward.
•Non-market goods = estimating
requires examining behavior or
through responses in survey.
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Brief Overview: Valuation Methods
• Classifying Valuation methods
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Brief Overview: Valuation Methods
• Classifying Valuation methods
1. Revealed preference
• Methods which are based on actual
observable choices and from which actual
resource values can be directly inferred
– To compensate the fishermen from oil spill, you
could look at how much catch declined and the
resulting value of the declined catch.
– To calculate the value of occupational
environmental risk, examine differences in wage
across industries in which workers take on
different levels of risk.
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Brief Overview: Valuation Methods
• Classifying Valuation methods
2. Stated preference
•Methods to elicit respondents’
willingness to pay when the value is
not directly observable.
–Use survey to elicit WTP for a marginal
improvement or to avoid a loss.
» What is the maximum you are willing
to pay to protect Rio Grande wetlands?
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Valuation Methods
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Valuation Method:
Stated Preference Methods
1. Contingent Valuation Method (Direct
Approach)
• It is used to elicit people’s willingness-to-pay (WTP)
in a hypothetical market.
• Provides means of obtaining values that cannot be
derived in more traditional ways.
• Simplest version:
– Asks what value people would place on some
environmental change (Such as change in risk of illness
or loss of habitat etc.)
– E.g., If the Sandia forest were to be cut down
tomorrow, what is the maximum you are WTP to
protect the forest?
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Problem with CV approach
• The Major concerns with CV is the potential
for respondents to give biased answers.
1.
2.
3.
4.
5.
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Strategic bias
Information bias
Starting-point bias
Hypothetical bias
Discrepancy between WTP and willingness-toaccept (WTA)
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Problem with CV approach
1. Strategic bias
• Respondents intentionally provides a
biased answer to influence a particular
outcome.
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–
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Respondents may secure a benefit by not telling
the truth.
E.x., Suppose, the decision to preserve a stretch
of river for fishing depends on whether or not
the survey produces a sufficiently large value for
fishing. The respondent that enjoy fishing may
be tempted to provide an answer that ensures a
high value, rather than a value that reflects their
true valuation.
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Problem with CV approach
2. Information bias
•
Arises when a respondent is forced to value
attributes that they have little or no experience
with.
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–
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E.x., a high school student may not know anything
about preserving endangered species. Cannot form
opinions.
Labao et al. (2008) found that colored photographs as
opposed to black and white photographs influenced
respondents WTP for the Philippine Eagle.
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Problem with CV approach
3. Starting-point bias
•
People’s answer may vary according to the context
in which a question in put. Can arise if a respondent
is asked to check off their answer from a predefined
range of possibilities.
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–
•
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A range from $0-$100 may produce a different
valuation than $10-$100.
Ladenburg and Olsen (2008) investigated the WTP to
protect nature areas in Denmark. They found that
starting point bias was gender specific with female
respondents exhibiting the greatest sensitivity to the
starting point.
Anchoring: Imagine two parties visiting a restaurant that is running a 15-minute wait time for
seating. In scenario 1, the host tells the customer their wait will be 15 minutes. In scenario 2,
the host tells the customer their wait will be 30 minutes. In both, the time for seating begins to
approach 25 minutes. In all likelihood, the party who was told 15 minutes has been waiting in
frustration, checking their watch, and perhaps awaiting an opportunity to voice frustration.
Meanwhile, the second party heads to their table, pleased that their wait was 5 minutes shorter
than expected.
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Problem with CV approach
4. Hypothetical bias
•
Respondent is being confronted by hypothetical
scenarios. Because they will not actually pay, they
may not treat the issue seriously.
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–
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Ehmke, Lusk and List (2008) found significant
differences in bias across location and/or culture.
(China, France, Indiana, Kansan and Niger)
Landry et al. (2006) found that for door-to-door
interviews, an increase in physical attractiveness of
the interviewer led to sizable increase in giving,
particularly by the male households.
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Problem with CV approach
4. Discrepancy between WTP and willingnessto-accept (WTA)
•
•
Respondent tend to report much higher value when asked
for their WTA compensation for a loss.
Respondent tend to report low value when asked for their
WTP to avoid the same loss.
–
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Economic theory suggest they should be small.
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Valuation Method:
Stated Preference Methods
2. Attribute-based methods (Indirect)
• Choice-based, conjoint analysis, choice
experiments
• Contingent ranking
• The structure is still based on surveys, but instead
of asking directly their WTP, respondents are
asked to choose among different bundle of goods.
Each bundle has a set of attributes and the levels
of each attribute vary across bundles.
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TABLE 4.2 Attributes in the Maine Forest
Harvesting Conjoint Analysis
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TABLE 4.3 A Sample Conjoint Analysis
Survey Questionnaire
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Valuation Method
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Valuation Method:
Revealed Preferences Methods
• Revealed Preferences:
– Observable: They involve actual
behavior and expenditures.
– Indirect: Infer a value rather than
estimate it directly.
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Valuation Method:
Revealed Preferences Methods
1. Travel Cost Method:
– Infer values of recreational resources (park,
wildlife preserve, fishery etc.) by determining
how much visitors spent getting to a site and
then using this information to estimate a
demand curve for willingness to pay for that
site.
• Can only measure the “Use Value” (Flaw!)
– TWO WAYS
1. Examine the number of trips visitors make to a site.
2. Examine whether people decide to visit a site and
which one.
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Valuation Method:
Revealed Preferences Methods
1. Travel Cost Method:
– What is the “price” paid for the site?
• The “price” is the opportunity cost of time
and the travel cost expenses (along with
any entry fee) that you incur while visiting
the recreational site.
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Valuation Method:
Travel Cost Method Example
• Assume that the data you have suggests
that if:
– Travel cost is greater than or equal to
$15, no trips are taken.
– If travel costs are zero, 100 trips are
taken.
– Draw a travel cost demand curve based on
these data.
– Calculate the consumer surplus for the
individual whose travel costs are equal to $5.
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Valuation Method:
Travel Cost Method Example
– Draw a travel cost demand curve based on
these data.
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Valuation Method:
Travel Cost Method Example
– Calculate the consumer surplus for the
individual whose travel costs are equal to $5.
– First, we need to find the trips that are taken
at a cost of $5.
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Valuation Method:
Travel Cost Method Example
• Calculate the consumer surplus for the individual whose
travel costs are equal to $14.
1. Find the equation of the demand curve.
– Use the equation: y = mx+b, where y = price; x =
quantity; m = slope (rise/run); and b is the value of
price when trips = 0.
• Slope (m) = rise/run = -(15/100)
• b = the price when trip = 0 => 15
2. Demand Curve Equation:
 P = -(15/100)*trips + 15 <=> 15 – (15/100)*trips
3. Plug in $5 for the price and solve for quantity.
 Q = 66.67 trips
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Valuation Method:
Travel Cost Method Example
– Calculate the consumer surplus for the
individual whose travel costs are equal to $5.
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Valuation Method:
Travel Cost Method Example
– Calculate the consumer surplus for the
individual whose travel costs are equal to $5.
Then consumer surplus, which is area below
demand curve and above price at $5:
=> ½ * (15-5) * 66.67
=$333.33
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Valuation Method:
Revealed Preferences Methods
2. Hedonic property value and hedonic wage
approaches:
– Use regression analysis to infer environmental
component of values in a related market.
• Example, property values are typically lower in areas
with higher levels of air or water pollution (all else
being equal).
• Houses near open space or with nice views will likely
be more expensive than similar houses without those
amenities.
• Workers in high-risk occupations receive higher
wages for taking on that risk.
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Valuation Method:
Revealed Preferences Methods
2. Hedonic property value and hedonic wage
approaches:
– Use market data (house price) and break down the
house sales price into different components:
• Housing characteristics (number of bedrooms, lot size
etc.)
• Neighborhood characteristics (crime rates, school
quality etc.)
• Environmental characteristics (air quality, percentage
of open space, distance to a local landfill etc.)
– Allows for the measurement of marginal willingness to
pay for discrete changes in attribute.
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TABLE 4.1 Economic Methods for Measuring
Environmental and Resource Values
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Valuation
– Benefit Transfers and Meta Analysis
• Implementing a reliable study is enormously costly.
– One solution to this problem is to use a technique
called meta-analysis.
• Meta-analysis utilizes a cross section of
contingent valuation studies for determining
nonuse values.
– Another possible solution is to use benefits
transfer.
• It involves the use of estimates from other
places and other times being used for similar
analysis elsewhere.
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Valuation
– Using Geographic Information
Systems (GIS) to Enhance Valuation
• GIS are computerized mapping models and
analysis tools.
• Incorporating spatial dimensions into economic
analysis, for example, in hedonic property
valuation models.
• You need to collect geocoded data. You can
combine these datasets with the traditional
data to get new insights into different
problems.
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Valuation
– Valuing Human Life
• Controversial subject
– Is life priceless?
– Because resources used to prevent loss of life are
scarce, choices must be made.
– Focus on calculating the change in the probability of
death resulting from a reduction in some
environmental risk and then placing a value on that
change.
– It is not the life itself being valued, but rather a
reduction in the probability that some segment of
the population could be expected to die earlier than
otherwise.
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Valuation
– Valuing Human Life
• Value of Statistical Life (VSL): Individuals WTP
to pay for small changes in mortality risk.
» Does not represent a willingness to pay
to prevent a certain death.
• The value derived is the “implied value of
human life”.
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Valuation
– Valuing Human Life
• Suppose each person in a sample of 100,000 people were
asked how much he or she would be willing to pay for a
reduction in their individual risk of dying of 1 in 100,000 or
0.001% over the next year.
– Reduce the risk of dying => “One statistical life saved”.
• Suppose the average response was $100.
– The total dollar amount (VSL) = $100/person * 100,000 people =
$10 million.
– This group would be willing to pay $10 million to save one
statistical life.
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Valuation
– Valuing Human Life
• Alternative way of calculating VSL = (WTP) /
(change in risk of death)
– Example,
• You are willing to pay $5 to reduce the chance
of dying from 1/100,000 to 1/150,000
• VSL = $5 / [1/100,000 – 1/150,000] = $1.5
million
• VSL is capturing the tradeoff between
money and a very small risk of death.
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Valuation
– Valuing Human Life
• A 1996 survey found that most implied values of human
life was between $3 million and $7 million, with an
average of $5 million.
– Means all government programs resulting in risk
reductions costing less than $5 million per life saved would
be justified in Benefit – Cost terms.
• Aldy and Viscusi (2008) find an inverted U-shaped
relationship between VSL and age.
– VSL for people aged 18-24: $3.7 million
– VSL for people aged 35-44: $9.7 million
– VSL for people aged 55-62: $3.4 million
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TABLE 4.4 The
Cost of RiskReducing
Regulations
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TABLE 4.4 The
Cost of RiskReducing
Regulations
(cont.)
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Summary
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•
•
•
•
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Total economic value
Contingent valuation
Contingent choice experiment
Travel cost
Hedonic property and wage
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