Hedonic Pricing for a Cost Benefit
Analysis of a Public Water Supply
Scheme
Presentation by Amy Walker
Citation
• Paper by T. Coelli, J. Lloyd-Smith, D.
Morrison and J.Thomas
• Found the article through AgEcon Search
Primary Questions
• Should the Comprehensive Water Supply
•
Scheme of Southwestern Australia be expanded?
Are previous C-B analyses incorrect?
– Agaton found benefits to equal only 25% of costs
– Farmers dispute this for not valuing security and
domestic convenience
– However, farmers costs are less than project costs
South Western Australia
Methods
• Ex ante cost benefit analysis
– Latin for “from before”
– Meaning before the event, based on proir
assumptions; a forecast
• Hedonic Pricing to value benefits
• Log-log functional form
Methods- Hedonic Pricing
• “The implicit marginal price or hedonic price
approach to the analysis of a market for a
differentiated good explores the relationship that
exists between the price of a good and the
bundle of characteristics which the good
possesses, to explain variations in the prices of
the differentiated goods under consideration”
(3).
Methods- Hedonic Pricing
• A method of estimating demand or value that
decomposes the good into characteristics that can be
valued. The value of the good is worth the value of all
the characteristics.
• Under perfect competition, with products which can
accurately be valued by the sum of their parts, you can
make a model which values any one of those parts.
Using a partial derivative, you get a marginal value for
one more unit of a particular characteristic.
• In this case, the aim is to give Scheme connection a
monetary value to compare to the costs.
Methods- Hedonic Pricing
• This method and equation was first used
in 1974 by Rosen.
• Pi = f(Zi) + ui
• Pi = price of the i-th good
• Zi = a vector of the characteristic of the
good
• ui = random disturbance term
Methods- Hedonic Pricing
Dummy variables used for non- numeric data such as quality of pasture and
whether or not the property was connected to the Scheme. After
consideration of the Lakes District, saltiness was added as a dummy
variable.
Methods- Hedonic Pricing
• Variables split into three categories
1. Those influencing profitability
-Rainfall, area, salt, pasture, fence, and water
2. Those influencing residential amenity
-Home
3. Those influencing both production and
consumption
-Buildings, scheme, and distance
Methods- Log-log functional form
• “Economic theory rarely offers a strong
direction as to the correct functional form
to be used” (6).
Methods- Log-log functional form
“A large number of coefficients have T-Ratios of less than one.”
Pasture 1&2, Fence 1&2, Water 2, Light and Medium soil were
removed.
Methods- Log-log functional form
Final form and data
Data Sources
• Agaton (1981) to help frame the study
• Valuer General’s Office of Western Australia
– Data from 129 land sales, 62 of them on Scheme
water
– Sales between March 1987 and June 1989
• Stone (1989)
– provided the present value of average capital cost of
Scheme connection per farm.
Results
• Scheme water connection values varied between
the northeast and the Lakes District
– Coefficients were 0.0712 and 0.1847 respectively
– This gives average per hectare prices of $18.44 and
$77.39
• Reasons
– Higher crop and flock densities in the Lakes District
mean higher marginal benefit of a gallon of water.
– Saltiness of Lakes District means dams, water tables
and catchments are less viable. Scheme water is
much more valuable.
Results
• Benefit Cost Ratios are the same or less than Agaton
study. This is even a generous estimate because:
– Farm prices reflect benefits both of Scheme connection AND
value of piping from Scheme to elsewhere on the farm.
– This estimate ignores the opportunity cost of taking water from
dams on the west coast.
– Does not account for maintenance costs of the Scheme.
Results
• Even though this study included the value
farmers attribute to Scheme water in the
marketplace through real estate, the
benefit cost ratios are the same or smaller
depending on location.
• “Scheme expansion cannot be justified on
economic grounds” (19).