Chapter 4 Valuing the Environment: Methods Valuing the Environment: Methods • • • • 4-2 Introduction Why Value the Environment? Valuation Summary: Nonmarket Valuation Today © 2012 Pearson Education, Inc. All rights reserved. Introduction • This chapter examines valuation methods of environmental resources. • This chapter will also discuss the various valuation techniques. 4-3 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-4 © 2012 Pearson Education, Inc. All rights reserved. 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 4-5 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-6 © 2012 Pearson Education, Inc. All rights reserved. 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! 4-7 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-8 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-9 © 2012 Pearson Education, Inc. All rights reserved. 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? 4-10 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-11 © 2012 Pearson Education, Inc. All rights reserved. Valuation • Types of total economic values 1. Use Value 2. Option Value 3. Nonuse or Passive Value 4-12 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-13 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-14 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-15 © 2012 Pearson Education, Inc. All rights reserved. Valuation –Total willingness to pay (TWP) TWP = Use Value + Option Value + Nonuse Value 4-16 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-17 © 2012 Pearson Education, Inc. All rights reserved. Brief Overview: Valuation Methods • Classifying Valuation methods 4-18 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-19 © 2012 Pearson Education, Inc. All rights reserved. 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? 4-20 © 2012 Pearson Education, Inc. All rights reserved. Valuation Methods 4-21 © 2012 Pearson Education, Inc. All rights reserved. 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? 4-22 © 2012 Pearson Education, Inc. All rights reserved. Problem with CV approach • The Major concerns with CV is the potential for respondents to give biased answers. 1. 2. 3. 4. 5. 4-23 Strategic bias Information bias Starting-point bias Hypothetical bias Discrepancy between WTP and willingness-toaccept (WTA) © 2012 Pearson Education, Inc. All rights reserved. Problem with CV approach 1. Strategic bias • Respondents intentionally provides a biased answer to influence a particular outcome. – – 4-24 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. © 2012 Pearson Education, Inc. All rights reserved. Problem with CV approach 2. Information bias • Arises when a respondent is forced to value attributes that they have little or no experience with. – – 4-25 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. © 2012 Pearson Education, Inc. All rights reserved. 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. – – • 4-26 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. © 2012 Pearson Education, Inc. All rights reserved. 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. – – 4-27 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. © 2012 Pearson Education, Inc. All rights reserved. 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. – 4-28 Economic theory suggest they should be small. © 2012 Pearson Education, Inc. All rights reserved. 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. 4-29 © 2012 Pearson Education, Inc. All rights reserved. TABLE 4.2 Attributes in the Maine Forest Harvesting Conjoint Analysis 4-30 © 2012 Pearson Education, Inc. All rights reserved. TABLE 4.3 A Sample Conjoint Analysis Survey Questionnaire 4-31 © 2012 Pearson Education, Inc. All rights reserved. Valuation Method 4-32 © 2012 Pearson Education, Inc. All rights reserved. Valuation Method: Revealed Preferences Methods • Revealed Preferences: – Observable: They involve actual behavior and expenditures. – Indirect: Infer a value rather than estimate it directly. 4-33 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-34 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-35 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-36 © 2012 Pearson Education, Inc. All rights reserved. Valuation Method: Travel Cost Method Example – Draw a travel cost demand curve based on these data. 4-37 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-38 © 2012 Pearson Education, Inc. All rights reserved. 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 4-39 © 2012 Pearson Education, Inc. All rights reserved. Valuation Method: Travel Cost Method Example – Calculate the consumer surplus for the individual whose travel costs are equal to $5. 4-40 © 2012 Pearson Education, Inc. All rights reserved. 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 4-41 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-42 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-43 © 2012 Pearson Education, Inc. All rights reserved. TABLE 4.1 Economic Methods for Measuring Environmental and Resource Values 4-44 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-45 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-46 © 2012 Pearson Education, Inc. All rights reserved. 4-47 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-48 © 2012 Pearson Education, Inc. All rights reserved. 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”. 4-49 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-50 © 2012 Pearson Education, Inc. All rights reserved. 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. 4-51 © 2012 Pearson Education, Inc. All rights reserved. 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 4-52 © 2012 Pearson Education, Inc. All rights reserved. TABLE 4.4 The Cost of RiskReducing Regulations 4-53 © 2012 Pearson Education, Inc. All rights reserved. TABLE 4.4 The Cost of RiskReducing Regulations (cont.) 4-54 © 2012 Pearson Education, Inc. All rights reserved. Summary • • • • • 4-55 Total economic value Contingent valuation Contingent choice experiment Travel cost Hedonic property and wage © 2012 Pearson Education, Inc. All rights reserved.