Lecture Notes for Economics 435: Economics of Resources
Prepared by Gunnar Knapp, Professor of Economics
January 17, 2000
MEASURING NON-MARKET VALUES
There is currently a great deal of interest among economists in the problem of valuing nonmarket resources. Non-market resources provide outputs or services which are not bought and
sold, such as recreation, wilderness, and clean air. We know that these are valuable and
important--but how valuable and important are they?
There are many important public policy issues which involve tradeoffs between these nonmarket
outputs and other outputs which have easily measurable values, such as timber, oil, or electricity.
For instance, forests may be used to produce timber or to produce scenic environments for hiking
trails. City land may be used for convention centers or for parks. Air may be used for cheaply
disposing of residues from burning coal to produce electricity--or may instead be kept clean so
that we can see distant mountains. We can keep the Grand Canyon as it is to enjoy the scenery,
or we could fill it up to generate hydroelectric power.
Economists, who are concerned with efficiency in the allocation of scarce resources, are
concerned with how these kinds of tradeoffs should be evaluated. They argue that we can make
better decisions about such tradeoffs if we can devise ways to measure the value of non-priced
outputs.
Kinds of Value
Economists suggest that there are different reasons for which we attach value to nom-market
resources, or different kinds of value. The most obvious of these is use value: the value we
derive from actually using or enjoying a resource. If I visit Alaska's Prince William Sound and
enjoy the magnificent views and the wildlife and the sense of wilderness, then I am deriving use
value from this non-market resource.
However, I may still derive value from Prince William Sound even if I never visit. I may have
never been to Prince William Sound, but I may place some value on it just because of the
possibility that I will be able to go there at some time in the future. Economists use the term
option value for the value we derive from the option of using a non-market resource in the
future.
Or I may know that I will never be able to go to Prince William Sound, but I may still place value
upon just knowing that it is there. Economists use the term existence value for the value we
derive purely from the existence of a resource.
In our discussion below we will focus primarily upon the problem of defining and measuring use
value.
Defining Value
Economics of Resources Lecture Notes: Nonmarket Values, page 1
In order to measure value, it is first necessary to define it. Economists generally define value in
either terms of willingness-to-pay (WTP) or willingness-to-accept (WTA). Which definition is
appropriate depends on the purposes for which we are measuring value: in many situations, the
definitions are equivalent. In this lecture, we will discuss how economists measure value defined
in terms of willingness-to-pay. At the end of the lecture, we will discuss when willingness-toaccept is a more appropriate definition.
Economists define the value of a market good which is consumed by one buyer, such as an apple,
as whatever that buyer is willing to pay for it If a good which is individually consumed is
regularly bought and sold in a market, then the price paid provides a good indication of the value
of that good to the people who actually buy it. (For reasons I discuss below, the price paid may
not be the precise willingness-to-pay or value, but it is likely to be fairly close).
Economists define the value of a market good which is collectively consumed, such as a theater
performance or a professional boxing match, as the total amount which the ticket-buyers are
willing to pay for it . If a good which is collectively consumed is regularly bought and sold, then
we can get a good sense of the value of that good by observing the total amount actually paid by
consumers.
The value of a non-market good or service--one which is not regularly bought and sold--cannot
be observed from a market price. Using the concept of willingness-to-pay, economists define the
value of an individually consumed nonmarket good as what the individual consumer would be
willing to pay to consume the good--if he or she had to pay for the right to pick berries. If I pick
berries for free in the park, their value is what I would be willing to pay for the right to pick the
berries, if I had to pay.
Economists define the value of a collectively consumed nonmarket good as the total amount the
public would be willing to pay for the good if they actually did have to pay for it directly. If my
neighbors and I use a local park, the value of the park is the total of what each of us would be
willing to pay for the right to use the park, if we had to pay. This is the definition which is
relevant for measuring the value of collectively consumed nonmarket goods such as clean air,
wilderness, and the existence of species.
Value and the demand curve
We can use a demand curve to depict these definitions of value. Recall that the demand curve
illustrates, for any given price, the total quantity which buyers would be willing to buy during a
given time period. At any given quantity, the height of the demand curve shows the amount
which some buyer is willing to pay for the last unit purchased. The area under the demand curve
corresponding to that last unit also shows the amount which some buyer is willing to pay for this
last unit (since this area is approximately a rectangle with a width of one and the height of the
demand curve).
Economics of Resources Lecture Notes: Nonmarket Values, page 2
Height of the demand curve shows amount that
someone would be willing to pay for the first
unit. Because the width is one, area also shows
approximate amout that someone would be
willing to pay for the first unit.
Price
Height and area show
willingness to pay for
sixth unit.
Q*.
1
6
Quantity
The total area under the demand curve, out to any given quantity, shows the total willingness-topay for that quantity.1 It represents the total amount which could theoretically be extracted from
buyers if units were sold one at a time to the highest bidder. Economists divide this total
willingness to pay into two parts: the amount which is actually paid (or the price times the
quantity) and the amount which consumers don't have to pay, which they refer to as consumer
surplus. The consumer surplus is the area under the demand curve down to the market-clearing
price.
Price
Area =
consumer surplus
Area =
actual
payment
P*
Q*
Quantity
For market goods, the willingness-to-pay for marginal quantities (the last units consumed) is
mostly captured in the actual price the buyer pays.2 In contrast, for non-market goods, which are
consumed for free, the willingness-to-pay for marginal quantities is entirely consumer surplus.
1Technically,
willingness-to-pay may vary slightly from the area under the demand curve due to the effects on
buyers' ability to pay of changes in the amounts which they actually purchase. However, the area under the demand
curve is a valid approximation of willingness-to-pay for our purposes.
2The extent to which willingness-to-pay is reflected in the actual price depends upon the shape of the demand curve.
If the demand curve is flat, or "perfectly elastic," then consumer surplus is zero. The steeper the demand curve, or
the more "inelastic," the greater consumer surplus will be.
Economics of Resources Lecture Notes: Nonmarket Values, page 3
Price
For a market good, the total willingness
to pay for the last unit Q* is primarily
captured in the price the buyer pays.
Consumer surplus is small.
Consumer surplus
P*
Amont paid
by buyer
Q* = market
clearing
quantity.
Price
Quantity
For a non-market good in limited supply
(such as a free campground with a
limited number of camping spaces), the
total willingness to pay for the last unit
Q* is entirely consumer surplus, since
the consumer of the last unit doesn't
have to pay for it.
Consumer surplus
Q* = last unit
consumed.
Quantity
In defining value it is very important to distinguish between the value (market or non-market)
of the last or marginal units consumed, and the total value provided by all goods. For market
goods, the value of the last or marginal unit is essentially equal to the price. This is not the case
if we wish to discuss the total value of all goods consumed, however, since the total value of all
goods may include significant consumer surplus.
When we talk about the value of market resources, we are usually talking about the value of these
resources at the margin. Similarly, when we measure the value of non-market resources, we are
usually interested in measuring the value associated with small changes in the quantity or
character of the resource. You should be cautious about extending the average value measured
for marginal units of a resource to the total resource. This is a common and potentially serious
error.
Value varies
Saying that marginal value depends upon the total quantity consumed is another way of saying
one of the basic principles of resource economics: value varies. Value is not absolute. Value
depends upon the circumstances. This is because our willingness-to-pay for another unit of a
resource is not fixed: it depends upon the circumstances.
Economics of Resources Lecture Notes: Nonmarket Values, page 4
This is simply another way of saying that the demand curve slopes downward. The more we
have of a resource, the less we are willing to pay for the next unit.
If we can easily obtain water from abundant nearby lakes or streams or faucets, then we are not
willing to pay very much for an additional gallon of water. But if we are dying of thirst in the
desert, then we are willing to pay a lot for an additional gallon of water.
If the whole country is wilderness, then our willingness-to-pay to preserve one additional valley
as wilderness is likely to be fairly small. However, if the valley is the last remaining wilderness
in the country, then we may be willing to pay a lot to preserve it as wilderness.
Methods of Measuring Willingness-to-Pay
It is one thing to define value as willingness-to-pay. It is another thing to measure it. How do we
learn what people are willing to pay if they don't actually have to pay?
Over the past three decades, economists have devoted a great deal of attention to this problem.
They have devised a variety of methods for measuring willingness-to-pay. Although the basic
principles behind these methods have gained general acceptance among economists, there is still
a lot of debate about the details.
Economists have developed both direct and indirect methods for measuring willingness-to-pay.
Direct Methods of Measuring Willingness-to-Pay
Direct methods of measuring non-market values are based upon asking people directly about
their willingness-to-pay, in interviews or by using survey questionnaires.
For example, if we wished to know the non-market value of keeping the Arctic National Wildlife
Refuge (ANWR) an undeveloped wilderness, we could interview everyone in the United States
and ask them what they would be willing to pay to keep ANWR an undeveloped wilderness. Or
we could extrapolate the answers by interviewing a sample of the total population.
There are two major problems with direct methods for measuring willingness to pay. The first is
that is that interviewing people is expensive. The second problem, which is perhaps more
serious, is that people may give inaccurate answers about willingness-to-pay, for various reasons:
o
They may wish to influence the survey results by making the value appear either high or
low (this is known as strategic answering, which causes strategic bias). For example, if
the city is measuring the non-market value of the flower gardens it plants, and I like
flower gardens, then I may deliberately overstate my willingness-to-pay for flower
gardens. On the other hand, if I like flower gardens, but worry that my tax liability will
be based directly upon my answer, I may deliberately understate my willingness-to-pay.
Economics of Resources Lecture Notes: Nonmarket Values, page 5
o
They may not give much thought or effort to answering the question accurately. For
example, they may exaggerate their actual ability to pay for something they know they
like. This problem is known as hypothetical bias.
o
They may give different answers depending upon how the question is framed. For
example, asking people about how much they would be willing to pay using different
methods or vehicles for payment (for example, an annual payment vs. a per-visit
payment) may result in different answers. This problem is known as vehicular bias.
For these reasons, it is very important to design contingent valuation survey questions as
carefully as possible to minimize these kinds of biases. Some economists question whether it is
even possible to get accurate answers about willingness to pay by asking people directly.
Indirect Methods of Measuring Willingness-to-Pay
Indirect methods of measuring non-market values are based upon inferring willingness-to-pay
from their actual payments for other goods or services which are associated with their use of the
non-market resource. The basic advantage of indirect methods is that they are based on actual
behavior. The basic disadvantage of indirect methods is that they can only be used to measure
use value: they cannot be used to measure other kinds of non-market value such as option value
or existence value.
Hedonic Valuation
One indirect method of inferring willingness-to-pay for non-market resources is to observe how
much people are willing to pay for other resources which convey the right or ability to use a nonmarket resource. This method is known as hedonic valuation.
One common application of hedonic valuation is the study of how housing prices are affected by
scenic views or by proximity to parks. Houses near parks or with scenic views tend to be worth
more (and houses under airport runway approaches tend to be worth less). Measuring these
differences (while accounting for other possible reasons for which housing prices may vary) is
one way of inferring the value of parks or scenic views. Although the property owners or renters
don't pay directly for these non-market outputs, they do pay indirectly by paying for the property
which provides them the ability to enjoy the park or view.
The Travel Cost Method
Another indirect method of measuring non-market values is to infer willingness-to-pay from
differing usage patterns for people who face different costs in using a resource. One cost which
differs among different users of nonmarket resources is the travel cost in getting to the resource,
such as expenditures for fuel or tickets and the opportunity cost of travel time. Some people live
close to a resource and can use it at little cost. Others live farther away and face greater costs.
The travel-cost method of measuring willingness-to-pay is based on how usage varies among
people who face different travel costs.
The Travel Cost Method: A Simple Example
Economics of Resources Lecture Notes: Nonmarket Values, page 6
The calculations involved in using the travel cost method can be quite complicated. As a simple
example, we can describe how we might use this method to measure calculate the aggregate
demand for a fishing stream. Suppose that there are only four fishermen: John, Paul, George and
Ringo. They are identical in all respects except that they live different distances from the
stream, which means that they face different costs in getting to the stream. The distances and
costs are shown in the table on the next page.
Derivation of a demand curve for fishing stream use, given different
assumed prices for stream use, based on observed behavior with
different travel costs.
John
Travel distance to stream
Total cost of using the stream when the price
of using the stream is 0:
Cost per fishing trip, @ 20 cents/mile
P rice paid to use stream
Total cost of using stream
Actual f ishing trips per year when the price of
using the stream is 0:
Total cost of using the stream if the price
of using the stream were 1:
Cost per fishing trip, @ 20 cents/mile
P rice paid to use stream
Total cost of using stream
*Assumed f ishing trips per year if the price of
using the stream were 1:
Total cost of using the stream if the price
of using the stream were 2:
Cost per fishing trip, @ 20 cents/mile
P rice paid to use stream
Total cost of using stream
*Assumed f ishing trips per year if the price of
using the stream were 2:
0
P aul George Ringo
5
10
15
0
0
0
1
0
1
2
0
2
3
0
3
15
10
5
0
0
1
1
1
1
2
2
1
3
3
1
4
10
5
0
0
0
2
2
1
2
3
2
2
4
3
2
5
5
0
0
0
Total
fishing
trips
30
15
5
Total cost of using the stream if the price
of using the stream were 3:
Cost per fishing trip, @ 20 cents/mile
0
1
2
3
P rice paid to use stream
3
3
3
3
Total cost of using stream
3
4
5
6
*Assumed f ishing trips per year if the price of
using the stream were 3:
0
0
0
0
0
* Calculated based on actual usage of otherwise identical individuals facing different travel costs, when
the price paid to use the stream is zero.
As a result of these differences in travel costs, the fishermen fish different numbers of times per
year. John, who faces no travel costs, fishes 15 times per year. George, who faces a travel cost
of $2 each time he uses the stream, fishes only 5 times per year.
Economics of Resources Lecture Notes: Nonmarket Values, page 7
Observed Trips per Year for Individuals Facing
Different Travel Costs
Travel cost
per trip
Ringo
3
2.5
George
2
1.5
Paul
1
0.5
John
0
0
2
4
6
8
10
12
14
16
Trips per year
We can use our data on trips and travel costs to estimate an aggregate demand curve for the using
the stream. At present, the fishermen pay no price to use the stream: no one is standing at the
bank collecting a fishing permit charge. In other words, the price is zero. This represents one
point on our estimated demand curve.
We can estimate how many trips the fishermen would make if the price were one if we assume
that they would each respond to an increase in the price at the stream bank in the same way that
they would respond to an increase in travel cost. If an official collected a price of $1 at the
stream bank, this would raise the total cost of fishing by $1 for each fishermen. Paul, who
formerly faced a total fishing cost of only $1, now would face a total fishing cost of $2. We
know that when George faced a total fishing price of $2, he only fished 5 times per year. We can
therefore assume that Paul would now fish only 5 times per year.
Using the same method, we can work out how much each of the others would fish at a price of
$1, as well as how much they would fish at a price of $2 and a price of $3. This gives us the
aggregate demand curve shown below which shows estimated use as a function of price (paid at
the stream bank) per use. Study the table carefully and make sure you understand how the
demand curve is derived!
Estimated Aggregate Demand Curve for S tream
price per
use
3
2.5
Demand curve
2.5
Area under the demand
curve = consumer surplus;
numbers show area of
different rectangles and
triangles.
2
1.5
5
10
1
0.5
10= 2 x 5
7.5= 1/2 x 1 x 15
0
0
5
10
15
20
25
30
Total use per year
Using this estimated demand curve, we can estimate the total use associated with
different prices. We can also estimate the consumer surplus or value the fishermen receive from
using the stream. The total consumer surplus is the area under the curve, which can be estimated
as 35 by dividing the area into different triangles and rectangles. (Remember that the formula for
Economics of Resources Lecture Notes: Nonmarket Values, page 8
the area of a triangle is one-half the base times the height!) We can also estimate the value of
marginal uses. For example, the consumer surplus, or area under the curve, for the last fifteen
uses is 1/2 x 1 x 15 = 7.5.
Problems with Indirect Methods of Measuring Non-Market Values
Indirect methods such as the travel cost method have the important advantage of being based
upon what people actually do, rather than what they say. Unfortunately, these methods usually
require collection of extensive data on both usage patterns as well travel costs and other costs
incurred by the users of non-market resources. One potentially important cost, which is not easy
to measure, is the value of the time people spend in using the resource.
Travel cost models usually require numerous simplifying assumptions in order to estimate
demand curves. In our example, we had to assume that all four fishermen would respond
identically to changes in the total costs of fishing. The actual calculations to derive the demand
curves can be quite complicated.
Measuring Option Value and Existence Value
As we stated earlier, adding to the problems associated with measuring non-market value,
economists have pointed out that the persons who place value upon non-market goods or
services, and who might be willing to pay for them, are not necessarily limited to direct users of
the goods or services. Some people may be willing to pay for the option to use a resource in the
future, or even just to know that it exists.
A wide variety of philosophical and practical questions are associated with the issue of whether
to include these kinds of value in non-market value, and if so how to measure them. It may well
be that many people in society place both option value and existence value upon many market
goods, even if they never spend the money to buy them. Does Disneyland have option value and
existence value? Do Porsche sports cars? If we don't (usually) include option and existence
values in measuring the value of market goods and services, should we for non-market goods and
services?
Willingness-to-Pay vs. Willingness-to-Accept
Our discussion in this lecture has been based on defining non-market value in terms of
willingness-to-pay. As we mentioned at the beginning of the lecture, economists sometimes
define value in terms of willingness-to-accept.
We can measure the value of something that we don't have in terms of what we would be willingto-pay to get it. How shall we value something that we do have? It may be appropriate to define
the value in terms of our willingness-to-accept compensation for giving it up.
Willingness-to-pay and willingness-to-accept are likely to be similar for goods which can be
easily bought and sold. If there are no transaction costs, I will be willing to accept the same price
in selling an apple that I would have to pay to get another apple.
Economics of Resources Lecture Notes: Nonmarket Values, page 9
However, willingness-to-pay may differ substantially from willingness-to-accept for goods or
resources which have a high value, and for which the amount we would have to pay represents a
substantial portion of our income. In this case our willingness-to-pay is not only affected by how
much pleasure or utility we get from the good or resource relative to other goods or resources,
but also by our income. We may be constrained in what we are willing to pay by our ability to
pay.
Consider the example of what you would be willing to pay in ransom money to save your life.
All your wealth, perhaps, and all you can borrow as well. But no more, because you're not able
to pay more.
On the other hand, consider what you would be willing-to-accept as a payment from somebody in
order for the right to kill you. You might not accept any amount of payment. In technical terms,
there is no upper income constraint to your willingness-to-accept payment for your life.
Which value definition is appropriate for non-market resources can be a matter of considerable
debate. If we are considering flooding the Grand Canyon to generate hydro-electric power,
should we be asking what Americans are willing to pay to preserve the Grand Canyon as it is?
Or should we be asking what we are willing to accept in order to give up what we have? Not
everyone agrees.
Using Non-Market Value Information
Once we have calculated non-market values, what do we do with the information? Generally the
purpose of estimating non-market values is to use the information for cost-benefit analysis, in
order to better take account of non-market values which may be involved in public policy
decisions.
Several kinds of problems can arise in using non-market value information. One problem is
improper interpretations of what has been calculated. One common logical mistake is to use the
total non-market value of a resource as an argument in cost-benefit reasoning, rather than the
marginal change in non-market value associated with the specific public policy choice. For
example, in making the policy decision over whether to explore for and develop oil in the Arctic
National Wildlife Refuge (ANWR), the total non-market value ANWR is probably irrelevant to
correct cost-benefit analysis. What matters is how the total non-market value of ANWR would
change as a result of oil drilling and development.
A second problem, which perhaps troubles me more than most economists, is whether knowing
non-market values is actually useful for public policy discussions. Non-market values are
calculated to ensure that non-market benefits receive proper weighting in cost-benefit
calculations. But cost-benefit calculations never resolve public policy issues anyway: ultimately
public policy decisions are settled through the public policy process. If we need to decide
whether or not to flood the Grand Canyon for a hydro-electric power project, do we need
economists to tell us what we think the Grand Canyon's non-market values are worth?
Ultimately, what we decide as a society about how to use the Grand Canyon will reveal our
willingness-to-pay as a society for the non-market values of the Grand Canyon--regardless of
what our collective total willingness-to-pay as individuals may be.
Economics of Resources Lecture Notes: Nonmarket Values, page 10
I raise this argument in part because I am troubled by the temptation to think that we can leave
public policy decisions up to bureaucratic technicians who can balance the costs and benefits and
tell us the "optimal" thing to do. I worry that we may go too far: in trying to make sure that we
not forget about non-market values, we may weaken rather than strengthen the case for nonmarket values. We should not forget that future generations are not asked--and can't be asked-about their willingness-to-pay.
Most economists respond to this objection by pointing out that like-it-or-not, many public policy
decisions are made by bureaucrats based on technical criteria, and that if these bureaucrats are
not told to include non-market values in their cost-benefit decision-making, they won't.
Historically, this is exactly what happened. Until economists began to derive measures for nonmarket values, they were often ignored in public policy discussions about the costs and benefits
of resource development projects and policies.
Theoretical problems with non-market valuation aside, they also raise a very practical problem:
calculating non-market values is expensive. It requires extensive data collection and analysis,
and even when the calculations are done we are usually quite limited in the ways they can be
applied. I personally wonder if the calculation of non-market values is the best use of our limited
resources for application of economic analysis to certain public policy issues. Other economists
might respond that the costs of not measuring non-market values, in resulting poor policy
decisions, are far higher.
Economics of Resources Lecture Notes: Nonmarket Values, page 11