ECON 6012 Cost Benefit Analysis Memorial University of Newfoundland Lesson 10 (Chapter 15) CONTINGENT VALUATION: USING SURVEYS TO ELICIT INFORMATION ABOUT COSTS AND BENEFITS

Purpose Overview of contingent valuation (CV) surveys, review criticisms of CV, and consider the strengths and weaknesses of the most commonly used CV methods.

Purpose For some public goods, there are no obvious ways to determine preferences through observation of behaviors => no option to use revealed preference methods In these cases, there may be no alternative to asking a sample of people questions about their valuations.

Purpose The primary use of CV is to elicit people’s Willingness-to-Pay (WTP) for changes in the quantity of a good. Valuing “use” or “potential use” goods with CV is relatively non-controversial. Valuing passive use (nonuse) goods with CV is more controversial.

Stated versus revealed preference methods We can ask them => stated preference methods (Contingent Valuation) We can try to infer it from their behaviour in other markets => revealed preference methods The latter include the Travel Cost Method and the Defensive Expenditure Method, both based on the Production Function Approach, and Hedonic Price Methods

Stated versus revealed preference methods Revealed preference methods exploit the idea that some environmental goods/services are related to marketed goods In particular, we may want to find substitutes or complements of those environmental services we want to value

Stated versus revealed preference methods With stated preference methods, we do not need that We simply ask! Example of these methods include contingent behaviour, conjoint analysis, choice experiments, contingent ranking and other complex procedures in constant developing They are all based on asking individuals to state a preference and inferring information from that We will focus on the contingent valuation method

Contingent Valuation Contingent Valuation Methods (CVM) try to directly get the values of WTP or WTA by interviewing a sample of consumers and presenting them with a hypothetical market We want to ask about WTP contingent on the existence of a market

CVM steps Set the hypothetical market obtain bids estimate mean/median WTP or WTA estimate bid curves aggregate the data (from sample to population) evaluate your CVM exercise

Set the hypothetical market Describe the hypothetical environmental market, make it realistic and informative What is the environmental good? How would the payments be made? (bid vehicle) Who would pay? When? How often? How?

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format : a bidding game (higher and higher amounts are suggested until the maximum WTP is reached) close-ended referendum (so we get just a YES/NO answer) aka dichotomous choice Sometimes a compromise is the double-bounded dichotomous choice format

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format : as a payment card (suggesting different values to choose from) as an open ended question: “How much?” (this is quite difficult to answer normally)

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format: Exploit the idea of contingent behaviour: how many trips would you make? How many wolves would you sponsor?

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format: Contingent Ranking Method: rank specific feasible combinations of the good being valued and monetary payments. An example would be low water quality and low taxes vs. high quality and high taxes, including several combinations in between.

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format: This method makes it is easier for the respondent to answer (ordinal procedure). The WTP must be inferred from the rankings, however, rather than being directly elicited. Also, responses tend to be sensitive to the order in which the alternatives are given.

Obtain bids Obtain the WTP/WTA for the environmental good using a certain type of elicitation format. You must also frame the question within a realistic scenario, who is going to pay? Yearly? Only once? Will it be compulsory? A tax?...

Obtain bids Obviously the survey needs to be administered It may matter whether you use mail, phone, internet, or in-person surveys Sometimes it matters the clothes the interviewers wear!!!! Desirability bias could be an issue

Estimate mean/median WTP or WTA From the sample calculate an average bid, normally the mean and the median (which disregards extreme answers) are used Check for protest bids (zero WTP or ridiculous WTA) and other outliers

Estimate bid curves Then try to investigate why different people give different answers Estimate WTP as a function of income, sex, age, education, and level of environmental good bid for (scope)

Estimate bid curves Imagine you ask people whether or not they would be willing to pay $X dollars for a certain environmental improvement. If you ask different people about different amounts, you can track the relationship: the probability that they agree with the payment should decrease with the size of the bid This is the essence of it

Aggregate the data Aggregate the data (from sample to population) What is the relevant population? Did we use a really random sample or does the exercise need correction for sample bias? If the aggregation is over time, what type of discount rate do we use?

Evaluate your CVM exercise Sources of biases: strategic bias (associated with free-riding) If the respondents think that the real payment may be related to the hypothetical answer => understate (free ride) If the respondents think that the real payment will not be related to the hypothetical answer => overstate if you think that the value for you form the good exceeds the expected payment!

Evaluate your CVM exercise Sources of biases: design bias (sample bias, non-response bias, bid vehicle bias, starting point bias, information bias, given changes WTP, so WTP and WTA values become endogenous to the valuation process, interviewer bias)

Evaluate your CVM exercise Sources of biases: Mental account bias (would they spend all their money to save the tigers and all they money to save the whales???) This is also related to the notion of scope bias. Sometimes the respondents give the same WTP for saving one wolf, for 100 wolves, and for all wild mammals! (see Embedding Effects)

The main advantage of CVM It is the best method, the only one, to ascertain non-use values! Including: Existence value Bequest value (which some really consider a type of use value) Option Value (which some really consider a type of use value)

The main advantage of CVM It is the best method, the only one, to ascertain non-use values! This is because you do not need to observe any behaviour in any type of real market Therefore you can value anything

The main disadvantage of CVM It is all hypothetical This is because you do not observe any real behaviour in any type of real market It is a bit wishy-washy for some Traditionally, economists prefer to observe the choices made about real things paid by with real money

The main disadvantage of CVM Traditionally, economists prefer to observe the choices made about real things paid by with real money In this sense, it is interesting to compare the results of the valuation of something that can bought for real using CVM and using real data Often the CVM overestimates WTP

Other disadvantages of CVM There are other, more technical disadvantages you do not need to worry about at this stage They have to do with the distinction between WTA and WTP And also, for most elicitation formats with the way to go from the answers to the question to some form of demand curve The econometrics are complex and need many assumptions to be made by the researcher

Other disadvantages of CVM Apart from that, there is a variety of biases that can affect CVM A well designed study that aims at avoiding those biases can become very costly! Using up too many resources to get to know how much something is worth is not really great!

Philosophical disadvantages… These are common to other tools related to cost-benefit analysis of course… Should humans’ opinion be the only one that counts??? Why don’t we just ask the experts, instead of asking everyone?

Philosophical disadvantages… WTP depends not only on how much one likes/needs something: WTP depends on ability to pay The values of environmental goods are a function of incomes If the distribution of income changes the estimated values could change!

Keywords stated preference methods Contingent Valuation Method (CVM) revealed preference methods sample bias protest bids outliers

Keywords strategic bias design bias bid vehicle starting-point bias Mental account bias non-use value existence value Bequest value Option Value

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