Assessing Benefits for Environmental Decision Making Chapter 7

1. Environmental Benefits: Conceptual Issues Environmental benefits measure damage reductions Policy brings about changes in these damage reductions, and these changes are referred to as __________________ –the reduction in health, ecological, and property damages associated with an environmental policy initiative 2

Types of Incremental Benefits – Primary environmental benefits Damage-reducing effects, a direct consequence of implementing environmental policy – Secondary environmental benefits Indirect gains to society, may arise from a stimulative effect of primary benefits 3

Assign Value to Incremental Benefits Environmental quality is a public, ____________ good: its D cannot be identified But if we could infer society’s D (or MSB) for environmental quality, we could measure incremental benefits as follows: – Area under MSB is TSB – Changes in TSB: incremental benefits 4

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Modeling Incremental Benefits (MSB) 6 MSB ($millions) A (abatement %) D = MSB Incremental Benefits = $91.25 million MSB = A Find baseline TSB before policy Find new TSB after policy is implemented Subtract baseline TSB from new TSB

7 A (abatement %) TSB ($millions) TSB Incremental Benefits = $91.25 million 0 TSB = 25A A 2 Modeling Incremental Benefits (TSB)

Valuing Environmental Quality Two Sources of Value ____________________________________ – (1) User value is the benefit derived from physical use or access to an environmental good Direct user value— the benefit derived from directly consuming services provided by an environmental good Indirect user value—the benefit derived from indirect consumption of an environmental good – (2) Existence value is the benefit received from the continuance of an environmental good 8

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Physical linkage approach –Estimates benefits based upon a ________ relationship between environmental resource and user of resource Behavioral linkage approach –Estimates benefits using observations of ___________ in actual markets or survey responses about hypothetical markets Approaches to Measuring Benefits

Overview (see Table 7.2 on page 154) Physical Linkage Damage Function Method Behavioral Linkage – Direct Methods Political Referendum Method Contingent Valuation Method – Indirect Methods Averting Expenditure Method Travel Cost Method Hedonic Price Method 11

3. Damage Function Method Specifies a relationship between a contaminant (C) and some observed total damage (TD) Estimates benefits as TD declines from the policy-induced change in C – Note: ______________ function is one type of damage function 12

Damage Function Model Total damages (TD) Contaminant (C) Damage function C0C0 TD 0 C1C1 TD 1 Damage reduction in nonmonetary terms Damage reduction in nonmonetary terms 0 Suppose policy causes a decline in the contaminant from C 0 to C 1 13

Assessing the Damage Function Method Estimates only one type of incremental benefit at a time Represents only a first step, since it is not capable of simultaneously monetizing the damage reduction that it identifies 14

Example Suppose a U.S. policy reduces pollution damage to crops, resulting in a higher crop yield as an incremental benefit – Model as an increase in supply (S) Measure the incremental benefit as:  (consumer surplus + producer surplus) 15

Incremental Benefits $ D a S0S0 S1S1 e b Q0Q0 Q of corn P0P0 c P1P1 Q1Q1 0 Incremental benefit = ebc 16

Estimates benefits from survey responses about WTP for environmental quality ____________ upon hypothetical market Steps: – Construct model of hypothetical market – Design survey – Assess honesty of respondents Contingent Valuation Method (CVM)

Assessing the CVM Broad applicability: it can be applied to a variety of environmental goods Can capture existence as well as user value Inherent biases due to survey approach --How to improve survey? Use photographs/maps to more accurately depict the environmental good; and avoid technical jargon 18

Estimates benefits as the ________________ __________ on goods that are substitutes for a cleaner environment – As pollution damages the environment, people incur “averting” expenditures to improve their personal environment – This spending is reduced as policy improves the overall environment This spending reduction is an estimate of the WTP for associated incremental benefits 5. Averting Expenditure Method (AEM) Application: AEM is used to estimate environmental benefits in the areas of urban smog and drinking water. 19

Modeling AEM Define overall environmental quality (E) The relevant market for study is personal environmental quality (X) –D is MB; S is MC or averting expenditures –MC 0 of X 0 is linked to a given level of E 0 –As the overall environment improves, or as E increases from say, E 0 to E 1, the individual incurs lower costs, so MC shifts right from MC 0 to MC 1 and X 0 improves to X 1 Change in spending for the same level of X is an estimate of incremental benefits 20

Modeling AEM $ D = MB a MC 0 (based on E 0 ) MC 1 (based on E 1 ) b X0X0 0 d c X1X1 abc is WTP for improvement in E based on achieving X 1 Personal environmental quality (X) E rises to E 1 21

Modeling AEM $ D = MB a MC 0 (based on E 0 ) MC 1 (based on E 1 ) b X0X0 0 d c X1X1 Personal environmental quality (X) abd is WTP for improvement in E based on achieving X 0 (acts as a lower bound) 22

Assessing the AEM Problem of ______________________ – Some AE yield benefits other than those from improving environmental quality e.g., air conditioning provides comfort as well as filters the air – Hence, the benefit estimate can be biased 23

Estimates benefits as an increase in __________ ___________ in the market for the recreational use of the environment, as policy improves the environmental quality As policy improves the environment, the D for recreational use of the environment increases, causing an increase in CS This CS increase is the benefit estimate Travel Cost Method

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Modeling TCM Market is recreational services of lake Price (P) of admission Number of Visits (V) D0D0 P0P0 Price line V0V0 0 a b Original CS = abP 0 D1D1 d c V1V1 New CS = cdP 0  CS = abcd 26 Policy improves lake’s quality so D increases

Assessing the TCM Estimates only user value Addresses only recreational use (not useful for estimating commercial benefits) 27 Application: TCM is used to value improvements to water bodies used mainly for recreation.

Uses estimated _______, or implicit, price of an environmental attribute to value a policy-driven improvement – e.g., P HOUSE = f(X 1, X 2, ….X n, E), where: each X i is an attribute of the house, and E is the environmental quality in the area Hedonics uses regression analysis, which provides estimates of the prices of the individual attributes, including E Hedonic Price Method (HPM)

This price could be used to estimate the D for environmental quality, which in turn could be used to measure the incremental benefit of improving that quality Recall that incremental benefit can be measured as an area under the D curve 29 The most common example of the HPM is in the housing market: the price of a property is determined by the characteristics of the house (size, features, condition) as well as the characteristics of the surrounding neighborhood (accessibility to schools, level of water and air pollution and noise…) The hedonic pricing model is used to estimate the extent to which each factor affects the price.

Assessing the HPM Logical, intuitive Difficult to employ – Requires complex empirical modeling – Requires extensive data 30