1. Economic valuation – Why and how?
Søren Bøye Olsen, Associate Professor, Head of Studies
Department of Food and Resource Economics
Faculty of SCIENCE
University of Copenhagen

2. Søren Bøye Olsen, University of Copenhagen
Background
Economics is not just about profits and money. It is about how we (society) prioritize in situations with scarce resources.
Economic Valuation - Why and how?

3. Does the view have a value? (It is free of charge!)
Søren Bøye Olsen, University of Copenhagen
Does the view have a value? (It is free of charge!)
But does it have the same value now???
(still free of charge)
Economic Valuation - Why and how?

4. Let’s go for a nice and cosy walk (free of charge)…
Søren Bøye Olsen, University of Copenhagen
Let’s go for a nice and cosy walk (free of charge)…
But is it still nice and cosy now???
(the price is the same)
Economic Valuation - Why and how?

5. Søren Bøye Olsen, University of Copenhagen
Economic Valuation - Why and how?

6. Does the price express the value of a good?
Søren Bøye Olsen, University of Copenhagen
Does the price express the value of a good?
If so, then only goods that are traded would have a value
Dupuit (1844) and Marshall (1879) point out that the price of a good is not necessarily the same as the true value of the good
Though this view was not really accepted in economics until the 1970s
Marshall (1879): The “economic measure”of a satisfaction is “that which a person would be just willing to pay for any satisfaction rather than go without it.”
Economic Valuation - Why and how?

7. A good or service may provide many different types of values
Søren Bøye Olsen, University of Copenhagen
A good or service may provide many different types of values
Total economic value
Total use values
Total non-use values
(Passive use value)
Actual use value
Potential use value
Direct use value
Indirect use value
Bequest/ testamentary value
Existence value
Option value
Own value
Economic Valuation - Why and how?

8. Public goods (the economist’s version)
Søren Bøye Olsen, University of Copenhagen
Public goods (the economist’s version)
Non-rivalry and non-excludability
Examples: National defence, public fireworks, lighthouses, clean air, free-to-air TV, (Law enforcement, streets, libraries, museums, research and education)
Public goods are often (but not necessarily) financed by public spending
Prone to market failures (e.g. externalities and free-riding)
-> non-optimal use of resources
Often under-produced, overused or degraded
In particular for non-marketed goods
No price = No value?
To determine the optimal supply of a good we need to know the value of the good (i.e. demand for the good)
Economic Valuation - Why and how?

9. Price Supply Demand Quantity/quality q*
Søren Bøye Olsen, University of Copenhagen
Price
Supply
Demand
Quantity/quality q*
Economic Valuation - Why and how?

10. Why do we need to know these values?
Søren Bøye Olsen, University of Copenhagen
Why do we need to know these values?
We don’t have unlimited resources
Scarcity -> Prioritisation cannot be avoided!
This also goes for non-marketed and public goods
Can the decision-makers justify that:
their prioritisation decisions are optimal in the sense that they maximize the welfare in society (i.e. the welfare of individuals)?
they spend taxpayers’ money in the best possible way for society (i.e. optimal supply)?
(welfare) benefits outweigh the (financial) costs?
Economic Valuation - Why and how?

11. Hence, there is a need for economic valuation methods
Søren Bøye Olsen, University of Copenhagen
Hence, there is a need for economic valuation methods
Typically, the value of non-marketed goods is not included in the economic Cost-Benefit Analysis that decision makers often use.
Conclusions may be wrong!
Economic valuation methods enable estimation and incorporation of monetary values for non-marketed goods in CBAs
 Wider and more objective basis for decisionmaking  Better policy decisions (seen from a societal welfare point of view!)
 More transparent policy decisions
Economic Valuation - Why and how?

12. Trade-offs reveal value
Søren Bøye Olsen, University of Copenhagen
Trade-offs reveal value
The trade-offs we make as individuals (i.e. the consumption bundle we choose) reveal how much value we attach to different goods and services, marketed as well as non-marketed Money is a convenient measuring rod, reflecting all other consumption possibilities
Welfare ~ preferences ~ utility ~ value ~ demand ~ choices
Economic Valuation - Why and how?

13. Valuation methods based on stated preferences
Søren Bøye Olsen, University of Copenhagen
Valuation methods based on stated preferences
We ask individuals about what value they would put on a hypothetical change in the good or service we are interested in
Stated Preference Methods
Contingent Valuation Method – CVM
Choice Experiments - CE
Economic Valuation - Why and how?

14. Important assumptions about people (Homo Economicus)
Søren Bøye Olsen, University of Copenhagen
Important assumptions about people (Homo Economicus)
People are rational
People know their own preferences perfectly
and will in all situations make choices based on these
People have stable preferences
People tell the truth when we ask them
Economic Valuation - Why and how?

15. The Contingent Valuation Method (CVM) I
Søren Bøye Olsen, University of Copenhagen
The Contingent Valuation Method (CVM) I
Interviews are conducted with a representative sample of the relevant target population
Paper-and-pen questionnaires, telephone, face-to-face, internet
Typically around 1000 respondents or more
Focus on identifying respondents’ maximum Willingness To Pay (WTP) or minimum Willingness to accept compensation (WTA) for a defined change in the good or service of interest on a hypothetical market
WTP (WTA) measures the increase (decrease) in utility/welfare in monetary terms  Demand curve
Economic Valuation - Why and how?

16. The Contingent Valuation Method (CVM) II
Søren Bøye Olsen, University of Copenhagen
The Contingent Valuation Method (CVM) II
Construct a realistic scenario (the hypothetical market)
Describe change in good
How is change going to take place
Who, when, how,…
Accessibility of the good
Open or limited access? Geographical location
Payment vehicle
Tax, donation, price increase, entry fee, etc.
Economic Valuation - Why and how?

17. The Contingent Valuation Method (CVM) III
Søren Bøye Olsen, University of Copenhagen
The Contingent Valuation Method (CVM) III
Different question formats:
Open-ended: ”What is your maximum WTP for the described change in the good?”
Relatively easy to analyze
Cognitively demanding for respondents
Dichotomous choice (yes/no): ”Are you willing to pay 200 DKK for the described change?”
More difficult to analyze
Less cognitively demanding
Other formats
Payment card
Bidding game
Economic Valuation - Why and how?

18. Open ended format Søren Bøye Olsen, University of Copenhagen
Economic Valuation - Why and how?

19. Choice Experiment (CE) method
Søren Bøye Olsen, University of Copenhagen
Choice Experiment (CE) method
Questionnaire-based technique – similar to CVM
Elicits preferences by asking individuals what they would do/choose under hypothetical circumstances
Key policy related features of CE
Identify significant attributes of the environmental good
Internal rank of the attributes
Identifying the value of different policy schemes
Economic Valuation - Why and how?

20. The Choice Modelling Methods (CMM)
Søren Bøye Olsen, University of Copenhagen
The Choice Modelling Methods (CMM)
Increasingly popular non-market valuation techniques used in environmental economics, as well as transportation planning and health economics, originating from marketing science.
Based on the attribute theory of Lancaster (1966):
Goods are defined by their attributes and the levels of these attributes. A good in itself does not give you utility - the attributes do. An example:
Taste
Packaging
“Head”
Calories
Colour
Temperature
Brand
Price
Alcohol percentage
Economic Valuation - Why and how?

21. The Choice Experiment method
Søren Bøye Olsen, University of Copenhagen
The Choice Experiment method
By varying the levels of the attributes, different compositions/representations of the good can be constructed
A “price”-attribute enables estimation of Willingness-To-Pay for each attribute
Respondents state their preferences by choosing the most preferred alternative from a choice set – done repeatedly through a sequence of differing choice set (typically 4 to 8 choice sets per respondent)
Choice set 1:
Choice set 2:
15 DKK
8 DKK
0 DKK q
18 DKK
12 DKK
I choose:
Economic Valuation - Why and how?

22. Consumption (liters/100 km) 6 6.8 6.4
Søren Bøye Olsen, University of Copenhagen
Suppose you are facing the choice of buying a new car. Choose one of the following cars according to your preferences. You may even choose not to buy any of these cars.
Cars attributes
Fiat Punto
1.2 16V ELX
Ford Focus
1.6 16V
Volkswagen Polo
1.4 16V
Price
£ 9,750
£ 10,120
£ 12,935
Number of Seats 5
Cubic capacity
1242
1596
1390
Gear
Manual
Automatic
Maximum speed
172 km/h
185 km/h
171 km/h
Number of doors 3
Consumption (liters/100 km) 6
6.8
6.4
Baggage car
1.080 dm3
1.205 dm3
1.184 dm3
Which would you buy?   
None of the above 

23. Søren Bøye Olsen, University of Copenhagen
Choice Experiments
Case: Converting state forests for “near-natural” management
Economic Valuation - Why and how?

24. Choice set example Case: Re-establishment of the stream Lygte Å?
Søren Bøye Olsen, University of Copenhagen
Choice set example
Case: Re-establishment of the stream Lygte Å?
Economic Valuation - Why and how?

25. Visualizations - Lygte Å
Søren Bøye Olsen, University of Copenhagen
Visualizations - Lygte Å
Forløb: Vandføring: Kanter:
Economic Valuation - Why and how?

26. The problem(s) of SP methods
Søren Bøye Olsen, University of Copenhagen
The problem(s) of SP methods
Method subject to much criticism
hypothetical WTP > true WTP ~ credibility
Irrational behavior ~ validity
Economic valuation methods are used to
Estimate social values of non-market (environmental) goods
to facilitate cost-benefit analyses etc.
Not to find a price at which environmental goods can be traded.
Expensive to conduct
Benefit transfer methods often used in practice
Economic Valuation - Why and how?

27. Thank you  Søren Bøye Olsen, University of Copenhagen
Economic Valuation - Why and how?

28. Additional slides if time permits
Søren Bøye Olsen, University of Copenhagen
Additional slides if time permits
Economic Valuation - Why and how?

29. The problems with CVM (I)
Søren Bøye Olsen, University of Copenhagen
The problems with CVM (I)
Cognitive limitations
Lack of biological knowledge (laymen)
How to ”translate” scientific environmental issues to laymen language
Embedding
People often find it difficult to grasp the size of the described change
WTP (100 species)= WTP (10 species)=WTP (1 species)
Primarily a problem for poorly designed studies and studies trying to accomplish too much
Economic Valuation - Why and how?

30. The problems with CVM (II)
Søren Bøye Olsen, University of Copenhagen
The problems with CVM (II)
Willingness-To-Pay or Willingness-To-Accept?
Often great differences are observed even though the described change is essentially the same
Income and substition effects
Psychological explanations
Strategic responses
Responses are purposefully untruthful about their true preferences, hoping to affect the final decision
Exaggerate WTP
Yes/no questions
Economic Valuation - Why and how?

31. The problems with CVM(III)
Søren Bøye Olsen, University of Copenhagen
The problems with CVM(III)
Hypothetical versus real WTP
Hypothetical bias: Respondents very often tend to overstate their actual WTP
Methods are being developed in order to mitigate this
E.g. Cheap Talk: Tell the respondent that other respondents tend to overstate their WTP
Economic Valuation - Why and how?

32. CVM is a controversial method
Søren Bøye Olsen, University of Copenhagen
CVM is a controversial method
Heated discussions both within the environmental economics literature as well as between environmental economists and other sciences and NGOs.
Of great importance is:
Thoroughness in constructing questionnaires (guides are available, e,g, Dillman 2007, Bateman et al. 2002)
Thoroughness in dealing with data and analysis
Thoroughness in reporting results
Openly acknowledge critical assumptions and limitations
Economic Valuation - Why and how?

33. Pros and cons of CMM (I) General advantage of CE (and CMM):
Søren Bøye Olsen, University of Copenhagen
Pros and cons of CMM (I)
General advantage of CE (and CMM):
Similar to real shopping behavior
E.g. bying milk in Netto
Three important advantages of using CMM instead of CVM for economic valuation of environmental goods
Identification of important characteristics of the environmental good
Internal ranking of these characteristics/attributes (relative importance)
The value of different policy options for the same good can be evaluated
Economic Valuation - Why and how?

34. Pros and cons of CMM (II)
Søren Bøye Olsen, University of Copenhagen
Pros and cons of CMM (II)
Disadvantages
Sensitive to study design, attributes and attribute levels, framing of the scenario.
CE might be cognitive difficult, more information vs. increased complexity and variance.
Analysis requires skilled econometricians
Economic Valuation - Why and how?

35. Case: Disproportionate costs of the WFD
Søren Bøye Olsen, University of Copenhagen
Case: Disproportionate costs of the WFD
The European Union’s Water Framework Directive (WFD) seeks to achieve good ecological status of water bodies in the European Union by 2015 and no later than The WFD accepts exemptions to the environmental objectives in cases where achieving good ecological status is disproportionately costly It is suggested in the guidelines to the WFD that judgement of disproportional cost could be based on an economic analysis of the costs and benefits of achieving good ecological status.
Economic Valuation - Why and how?

36. Denmark: 23 catchment areas
Søren Bøye Olsen, University of Copenhagen
Denmark: 23 catchment areas
Economic Valuation - Why and how?

37. High Good WFD target Moderate Poor and Bad
Søren Bøye Olsen, University of Copenhagen
High
Good
Moderate
Poor and
Bad
WFD target
Copyright: Hime et al. (2009)
Economic Valuation - Why and how?

38. Reduction requirement
Efterafgrøder
FOI og DJF antager få sædskifteændringer og jævn placering i DK
DMU angiver at der er plads til flere efterafgrøder ( ha)
Andel stiger fra 10/14% op til et gennemsnit på ca. 22%. (maks. 37%) (V1+V2 er 70% af det samlede areal)
Arealet med yderligere 24% efterafgrøder er ca. 6% af arealet (Jylland). Areal med yderligere 0-5% er noget større.
Stor geografisk forskellighed

39. 0 €/household/yr 23 €/household/yr Assessing benefits
Søren Bøye Olsen, University of Copenhagen
Assessing benefits
Benefit transfer from Aquamoney Odense CE survey:
0 €/household/yr
23 €/household/yr
10 €/household/yr
Economic Valuation - Why and how?

40. Step 4: Results and sensitivity analysis
Net Value
(Annual)
Location
Baseline Scenario
Baseline benefit
Baseline cost
€ (Mill) B/C
Scenario(1)
Alternate benefit
€ (Mill) B/C
Scenario(2)
Alternate cost
€ (Mill) B/C
Scenario(3)
COSTS > BENEFITS
Bornholm
-1.340
0.0
-0.833
0.4
-1.308
-0.801
Randers fjord
-5.175
0.8
-3.153
Kruså/Vidå
-6.723
0.1
-1.962
0.7
-4.576
0.186
1.0
Djursland
-3.361
-0.768
-2.147
0.446
1.2
COSTS ≈ BENEFITS
The Belt sea (Jutland)
-6.819
6.487
1.3
-5.885
7.421
1.4
Kattegat & Skagerrak
-1.229
5.476
1.9
-0.514
0.9
6.190
2.2
Limfjorden
10.981
1.783
24.975
1.5
Nissum fjord
-1.427
3.608
1.6
0.506
1.1
5.541
Ringkøbing fjord
-0.934
4.931
1.7
-0.966
4.900
Wadden sea
-0.314
10.963
2.1
-0.150
11.127
Mariager fjord
0.336
0.666
The Sea south of Funen
-0.239
0.993
-0.189
1.043
BENEFITS > COSTS
South-west of Zealand
9.342
13.072
10.737
14.466
The Baltic sea
1.879
2.798
2.3
1.874
2.793
Horsens fjord
4.674
2.0
4.979
The Belt Sea (Funen)
7.358
4.0
11.385
5.6
7.489
4.2
11.515
5.9
Odense fjord
20.453
31.636
21.377
4.6
32.559
6.5
The Belt sea (great belt)
3.553
4.1
5.8
3.558
5.482
The Bay of Koge
17.361
25.664
5.7
17.380
25.684
Kalundborg
6.135
4.4
9.391
6.2
6.453
5.3
9.708
7.5
Isefjord& Roskilde fjord
25.776
4.5
25.936
Oresund
29.390
10.0
31.103
21.1
The Bay of Aarhus
42.201
15.8
60.661
22.3
43.053
22.6
61.513
31.8
National
1.8
2.5
Søren Bøye Olsen, University of Copenhagen
Step 4: Results and sensitivity analysis
Economic Valuation - Why and how?

41. Other actual cases – Buffer strips
Søren Bøye Olsen, University of Copenhagen
Other actual cases – Buffer strips
Economic Valuation - Why and how?

42. Other actual cases – Ladegårdsåen
Søren Bøye Olsen, University of Copenhagen
Other actual cases – Ladegårdsåen
Economic Valuation - Why and how?

43. Should CBA dictate political choices?
Søren Bøye Olsen, University of Copenhagen
Should CBA dictate political choices?
Economic Valuation - Why and how?

44. Not an automatic decision rule
Søren Bøye Olsen, University of Copenhagen
Not an automatic decision rule
CBA should inform political decision-making
Not dictate political choices and
Not replace the ultimate authority and responsibility of decision makers.
Why?
Ethical considerations
Equity concerns
Non-economic decision criteria
Political compromise
CBA results are often associated with many assumptions and a high level of uncertainty
(International regulations)
Economic Valuation - Why and how?

45. Søren Bøye Olsen, University of Copenhagen
Economic Valuation - Why and how?