Valuation methods II Revealed preference methods (RP) Elina Lampi

RP Methods Also called as “indirect methods” Hedonic pricing Travel cost Defensive expenditures (Defensive behavior) All these methods study a market for a private good. The basic idea is to use the information about the actual behaviour in the private good market to estimate preferences for the public good.

Travel cost method Measures active use values of places such as lakes, rivers, beaches, national parks, and wilderness areas used for recreational purposes. TCM are also called for ”recreational demad model” The minimum amount a person is willing to pay for the good in question has to be his/her travel costs. Otherwise the person would not come and visit the place (Harold Hotelling 1947). Travel-cost method (TCM)

So, TCM estimates the number of trips that a person takes over a period as a function of the cost to get to the site, as well as personal charateristics (age, gender, income, experience level),and travel cost to alternative sites. The following steps are included in a single-site TCM study (Parson 2003): 1.Define the boundaries of the site to be studied. 2.Define the recreational uses and season(s) of use. 3.Develop a sampling strategy for surveying recreational users. 4.Specify a demad estimation model, including all the variables to be used in that model. 5.Adress the issue of multiple purpose recreational trips (one- day trip vs overnight stays). Travel-cost method (TCM)

6. Design and conduct the survey. 7. Measure trip cost. 8. Estimate demand using trip cost and data from the survey. 9. Calculate the acess value of the site. Remeber that some sites has multiple recreational uses. For example rivers where peole can swim, fish, do boating etc. A TCM study might focus on certain types of recreational use like only on fishing (or researchers may be able to aggregate similar classes of recreational use). Travel-cost method (TCM)

A key decision is whether to conduct on-site survey of visitors or a random survey of the overall population. On-site survey is better targeted and gives easier the desired sample size. But you do not get people with zero visits, which impairs the estimation of the vertical intercept of the site demand curve. Travel-cost method (TCM)

So….. 1.Different individuals have different costs to travel to the same place (they have different distance to the place). 2. Each person has different costs to travel to different places. Travel-cost method (TCM)

The area around e.g. a national park will be divided into different zones. The researcher takes into acount the distance between the park and each zone, and how many individuals from each zone visit the park relation to how many lives in the respective zone. Travel-cost method (with Zones)

Steps when conducting the zonal travel cost method: 1. Collect data at site on where the respondents live, how often they visit the place etc. 2. Define the zones and allocate the visitors (estimate the number of visitors per year from each zone) 3. Calculate the average travel cost (and some other costs) 4. Construct the demand curve 5. Calculate consumers surplus (CS) per zone 6. Calculate total CS Travel-cost method

Data from survey (1)

Data from survey (2)

The cost for a visit from area D would (given the data above) be: = 350 kr. Summarizing the data

We do not observe price variation for a given zone. But if we think like this: if the cost in zone A increased from 40 to 125 (cost of B), then the visit per capita would decrease from 0.5 to 0.25 (visit rate of B). Then we can construct a demand curve using the information from all the zones. The total relevant population is What is the demand curve for the park? Total demand = V * populationPrice 0.5 * 850 = 425 ’ 40 kr 0.25* 850 = ’ 125 kr 0.125*850 = ’ 200 kr 0350 kr

Plot the visit rate

The benefit from the visits can be calculated with the area under the demand curve minus the cost of the visit (which is given by each point). Then multiply by population in that area. Getting the consumer surplus for visit rate in C

For area C, the cost is 200. So the consumer surplus in terms of visit rate is: 0.125*150/2 = kr per capita

For area B, the cost is 125. So the consumer surplus in terms of visit rate is: *( ) + ( )*( )/2 = = kr per capita. Getting the consumer surplus for visit rate in B

For area A, the cost is 40. So the consumer surplus in terms of visit rate is: = kr per capita. Getting the consumer surplus for visit rate in A

Then the total consumer surplus in each area would be the consumer surplus per capita times the population in that area: C: * population in C = 9.375*100’ = 937,500 B: * 300’ = 7,031,250 A: * 50’ = 2,765,625 Total consumer surplus: 10,734,375 kr Total consumer surplus

But people are not identical; they have different incomes, opportunity costs for travel (e.g work) and tastes in addition to the travel costs. One tries to control for so many socio-economic and other factors as possible so that, holding all these other factors constant, lower travel costs will mean higher number of visits. Travel-cost method

Problem: 1. How well it is possible to control for these other factors? 2. We cannot measure non-use values (e.g. how people valuate the pure existence of the national park or that they want to have an option to visit the park in the future). Non- visitors? 3. We can only evaluate things that exist today. 4. A trip may have several goals. A person might visit the park and for example also want to meet some friends. Travel-cost method

Problem: 5. There might exists close substitutes for the good (park in our case). 6. Value of time. – Opportunity of travel time=wage rate? Most people consider opportunity time of travel time to be substantially less than their wage rate. In transport economics 20-50% of wage rate. Travel-cost method

Most often used in studies about environmental quality. For example to study the effects of air quality, view, proximity to parks, and neighbourhood safety on house prices. (Bad quality= lower house price, good quality=higher house price. Price for the air quality is the difference between house prices). These environmental attributes are not directly traded in markets but they are aspects of a house´s location and therefore bundled with the market value of a house. The term “hedonic” refers to people assigning value to product attributes that gives pleasure. Hedonic Pricing (Hedonic Regression Method)

Problem: 1. We cannot measure non-use values (e.g. how people valuate environmental quality for other people). 2. We can only evaluate things that exist today, e.g. NOT people’s preferences for improvements in environmental quality from today´s level. 3. We are not able to valuate whether people have different preferences (for e.g. noise during daytime than during night time). 4. As with the travel-cost method, the key challenge is to be able to control for other factors that might affect house prices. Hedonic Pricing

Problem: 5. Is it expected or actual level of the house characteristics which determine the price? Most likely the expected. 6. Restrictive assumptions: (i) perfect information on all attributes (e.g. environment), (ii) house market is in equilibrium and (iii) all buyers can move to for them best locations. Hedonic Pricing

Uses information about people´s WTP for reducing the probability of a premature death. 1.One can use CVM study to know respondents´ WTP for changes in the likelihood of premature death. 2.One can conduct wage-risk studies to estimate an additional compensation demanded in the labour market for riskier jobs. Value-of-a-statistical-life (VSL)

(2) When jobs are similar in almost all aspects, except that one job has a higher risk of some harm, the competitive labour markets (with well-informed workers) are expected to yield “a wage premium” paid to those workers who accept the higher risk of premature death or workplace injury. But if workers are not well informed, or labour market is not competitive, or if some people are naturally less risk averse, you will not observe these “wage premiums”. Value-of-a-statistical-life (VSL)

An example of VSL based on wage-risk study: -Measure WTA for a risky job for example police officer, fire man. - By holding factors as age, work experience, education, gender etc constant it has been found that people in risky jobs have higher wages. E.g. a police earns $ 700 more than an average person. -Then you need to know the difference in the risk to die. For example, the risk to die is 1 in 10,000 higher for a police than for people in average. Value-of-a-statistical-life (VSL)

-If you have 10,000 policies so collectively police officers are willing to trade $ 7 million (10,000 * $ 700) for ONE of their lives (since the risk to die was 1 in 10,000). - We can then use the amount of $ 7 million to be the estimate of VSL also in environmental cases. - Note, this is not a value for a specific person´s life but for an average individual. Also called for Value of Statistical Life (VSL). -Environmental protection Agency (EPA) recommends $ 7 million to value-reduced premature mortality for all their programs and policies. This value is based on 26 published VSL studies. Value-of-a-statistical-life (VSL)

In our book we have the formula: VSL= (wage premium) \ (increased probability of death) Which in our example means: $700/0.0001= $ 7 million. Value-of-a-statistical-life (VSL)

Possible problem: 1.Information, do the policy officers really know the real risk to die? 2. Sample selection bias. People who choose risky jobs are probably not as people on average. 3. Different kinds of risks: Involuntary nature of risk in the case of environmental pollution. Voluntary risk in the case of choosing an occupation (at least in the developed world). 4. More suffering and longer periods of disease in pollution- related (environmental risks). Value-of-a-statistical-life (VSL)

Possible problem: 5. Risks are valued for middle-aged working people when those who die prematurely are more likely older and non- working. 6. Median value in developed countries is $ 7 million but only $ 150, 000 in e.g. Bangladesh and $ 600,000 in Chile. BUT moral problem if people in poor countries have no choice but to accept a risky job. However, despite the problems with VSL, simply ignoring the costs of premature death and not including it in a CBA means large underestimation of the benefits of environmental conservation and restoration. Value-of-a-statistical-life (VSL)

Is actions taken by people to reduce their exposure to harm caused by pollution, diseases, and other hazards. An example from your book: a leaking garbage dump creates a plume of contaminated groundwater that affetcs wells used for residential water supplies. If residents respond to groundwater contamination by building water tanks and having uncontaminated water trucked in, these actions are defensive behavior. The cost of this behavior- purchases of tanks and water- reveals the value of clean and safe household water. Defensive expenditure/behavior (1)

Other examples: People might install a special filters in order to get better water quality or special windows to decrease noise. The cost of the defensive expenditure (i.e. the filter) is the value of better environmental quality. But: 1. We cannot measure non-use values. 2. We can only evaluate things that exist today. 3. A cost of e.g. special windows underestimates the problem with noise. The special windows will decrease the noise indoors but not outdoors. Think that a person loves gardening…… Defensive behavior (2)