Valuing the Environment What exactly do economists mean when they talk about “valuing the environment” in monetary terms?

Introduction All or nothing versus marginal decision Willingness to pay (as measured by demand price) is the standard measuring stick of benefit (value) in economics. Decision making based on willingness to pay must reflect individuals’ preferences for the good in question.

The Demand for Environmental Quality As discussed before, the marginal damage cost depicts the amount society is willing to pay to avoid damage or improve the quality of the environment at the margin. That is, it represents the demand curve for environmental quality. [Demonstrate this using graph]

continue... However, discovering the demand (damage) function for environmental assets is not an easy matter. As discussed earlier, it requires assessing the benefits (in monetary terms) of avoided environmental damages or improved enviornmental quality, such as, aesthetic preservation, improved human health as identified in terms of increased ….

continue......mortality and morbidity, and sustenance of ecological diversity. In addition, it is important to note that environmental damages are externalities, hence, lack observable market prices. What could economists do to elicit willingness to pay for environmental goods that have no observable market prices?

continue... Before going any further, however, it is important to note that when economists attempt to measure the benefits from improved environmental quality, what they are measuring is not the value of the environment at all. Instead the preferences of people for an environmental good or environmental bad. [Examples, value of life or intrinsic value of the environment]

Alternative Methods for Valuing the Environment Direct information on (or elicitation of) willingness to pay: –Based on Observed Behavior Market values of environmental commodities increased productivity replacement values –Based on Hypothetical Market Situation Contingent methods-direct survey

continue... Based on the elicitation of willingness to pay that must be inferred from indirect data (market information): –Hedonic property values –Avertive expenditures –Travel cost

The Market Pricing Approach This approach is used when the environmental improvement under consideration causes an increase or decrease in real outputs and/or inputs. Example a decrease in timber harvest and/or extraction of minerals from a legislative enactment that effectively expands the acreage set aside as a wilderness area. Measured by incremental gains in consumers and producers surpluses.

Replacement cost Approach This technique is used as a measure of benefit when the damage that has been avoided as a result of improved environmental conditions can be approximated by the market value of what it cost to restore or replace the damage in question. This technique should be used with some care since in several instances the replicas would probably be of little worth compared to the original.

House Hold Production Function or Avertive Expenditures In this approach, benefits from improvement in environmental quality are measured by looking at households’ expenditures on goods and/or services that are substitutes or complements for the purpose of avoiding environmental damages. Example installing soundproof walling to reduce noise; purchasing radon-monitoring equipment to protect oneself from radon gas exposure, etc.

Travel Cost Methods This method measures the benefit (willingness to pay) stemming from a recreational experience, by looking at the households’ expenditures on the cost of travel to a desired recreational site. Note this technique is a variation of the household production function approach, but strictly used to measure benefits arising from environmental services arising from recreational sites, such as national park.

Hedonic Price Approach In this approach an attempt is made to estimate an implicit price for environmental attributes by looking at real markets in which those characteristics are effectively traded. For example, “clean air” and “peace and quiet” are effectively traded in the property market since purchases of houses and land do consider these environmental dimensions as characteristics of property….

continue... Similarly, the attribute of “risk” is traded in the labor market (miners are paid more than a hotel custodian.) –The key issue in hedonic price approach is the effect of the environmental quality on the prices of some goods and services.

Contingent Valuation Method This technique represents the general approach economists use to elicit willingness to pay for total value of environmental assets. Total Value = Use Value + Nonuse value

continue... None Use Value = Option value + Bequest value + Existence value. Option value refers to a sort of insurance premium individuals may be willing to pay to retain the option of possible future use.

continue... Bequest value refers to the satisfaction that people gain from the knowledge that a natural resource endowment is being preserved for future generations. Existence value refers to the satisfaction that some people derive from the preservation of natural resources so that there remains a habitat for fish, plants, wildlife and so on.

Critical Assessment of the Economist Approach Environmental values should not be reducible to a single one-dimensional standard that is ultimately expressed only in monetary terms. (the existence of intangible values) High levels of uncertainty make the measurement and the very concept of total value meaningless (Krutilla, and the precautionary principle).

continue... Survey techniques used to elicit willingness to pay confuse preference with beliefs (Sagoff). People preference for environmental resources may include aspects of their feeling that are not purely economics. Important ecological connections may be missed when valuing components of asystem separtately.