1. Assessing Benefits for Environmental Decision Making Chapter 8 © 2007 Thomson Learning/South-WesternThomas and Callan, Environmental Economics

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

3. 3 Types of Incremental Benefits Primary environmental benefits  Damage-reducing effects that are a direct consequence of implementing environmental policy Secondary environmental benefits  Indirect gains to society that may arise from a stimulative effect of primary benefits or from a demand- induced effect to implement policy

4. 4 Assign Value to Incremental Benefits Since environmental quality is a public, nonmarketed good, its D cannot be identified because of nonrevelation of preferences 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 would be incremental benefits

5. 5 Modeling Incremental Benefits Find baseline TSB before policy Find new TSB after policy is implemented Subtract baseline from new TSB

6. 6 Modeling Incremental Benefits (MSB) MSB ($millions) A (abatement %) D = MSB 250 17.5 20 19.0 Incremental Benefits = $91.25 million MSB = 25 - 0.3A

7. 7 Modeling Incremental Benefits (TSB) A (abatement %) TSB ($millions) TSB 25 531.25 20 440.0 Incremental Benefits = $91.25 million 0 TSB = 25A - 0.15A 2

8. 8 Valuing Environmental Quality Two Sources of Value Total value = User value + Existence value User value is the benefit derived from physical use or access to an environmental good  Direct user value is the benefit derived from directly consuming services provided by an environmental good  Indirect user value is the benefit derived from indirect consumption of an environmental good Existence value is the benefit received from the continuance of an environmental good  Motivated by vicarious consumption and stewardship

9. Approaches to Measuring Benefits

10. 10 Two Major Approaches Physical linkage approach Estimates benefits based upon a technical relationship between environmental resource and user of resource Behavioral linkage approach Estimates benefits using observations of behavior in actual markets or survey responses about hypothetical markets

11. 11 Overview (see Table 7.2) 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

12. Damage Function Method A Physical Linkage Approach

13. 13 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: Dose-response function is one type of damage function

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

15. 15 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

16. 16 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 (CS) + producer surplus (PS))

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

18. Contingent Valuation Method (CVM) Direct Method under Behavioral Linkage Approach

19. 19 CVM Estimates benefits from survey responses about WTP for environmental quality contingent upon hypothetical market Tries to finesse nonrevelation problem Steps: Construct model of hypothetical market Design survey Assess honesty of respondents

20. 20 Assessing the CVM Broad applicability Can capture existence as well as user value Inherent biases due to survey approach

21. Averting Expenditure Method (AEM) Indirect Method under Behavioral Linkage Approach

22. 22 AEM Estimates benefits as the reduction in spending 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

23. 23 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

24. 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

25. 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)

26. 26 Assessing the AEM Problem of jointness of production 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

27. Travel Cost Method Indirect Method under Behavioral Linkage Approach

28. 28 TCM Estimates benefits as an increase in consumer surplus (CS) in the market for a complement to environmental quality (i.e., recreational use), as policy improves that 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

29. 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 Policy improves lake’s quality so D increases

30. 30 Assessing the TCM Estimates only user value Addresses only recreational use (i.e., not useful for estimating commercial benefits Estimates are biased downward if access to site is congested

31. Hedonic Price Method (HPM) Indirect Method under Behavioral Linkage Approach

32. 32 HPM Uses estimated hedonic, 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

33. 33 HPM (continued) 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

34. 34 Assessing the HPM Logical, intuitive Difficult to employ Requires complex empirical modeling Requires extensive data