1. ERE8: Valuation Valuation theory Total economic value
Indirect valuation methods
Hedonic pricing
Travel cost method
Direct valuation methods

2. Last week Renewable resources: Fisheries
Growth rates in biological resources
Steady-state harvest
Perfect market
Open access
Dynamic harvesting
Policy intervention

3. Economic Value
Neo-classical revolution: Value is relative, value measures demand versus supply, value is based on consumption and production
Basis of valuation: People‘s preferences, what people want
Values depend on context
Supply, demand
Uncertainty: Something that is uncertain is worth less, an uncertain loss is worth more
Uniqueness: Something that is unique is worth more

4. What to value?
Individuals can derive value from environmental goods from more sources than direct consumption
Types of environmental services:
source of materials input: fossil fuel, wood products, fish, water etc.
life-support services: liveable climatic regime, breathable atmosphere
amenity services: recreation, wildlife observation, scenic view, passive use values
sink for the assimilation of wastes

5. Why Valuation?
We must make choices about how to manage the human impact on natural systems
Greater use of a particular environmental service or greater protection of a specific natural system results in less of something else (trade-off)
To make the most of scarce resources we must compare what is gained from an activity with what is sacrificed by undertaking that activity
Why? To assess the net impact of changes

6. Uses of Economic Valuation
Regulation can either seek optimum or not
If an optimum is sought, the marginal external cost function must be estimated, and expressed in money
Find optimum: Marginal benefit equals marginal cost (Cost-Benefit Analysis)
Ex ante, e.g., Pigou tax
Ex post, e.g., evaluation of policy
Demonstrate value of environment
Extend national accounts

7. Pollution Damage (billions of US$)
Netherlands
Germany
USA*
Air
21.7
Water
3.0
4.8
Noise
0.0
11.6
n.a.
Total
33.9
26.5
%GDP
2.9
0.8
* Damage avoided

8. Total economic value
Total economic value = Use value + Intrinsic value
Total use value = Actual use value + Option value + Quasi-option value
Option value = Value in potential use by self + Value in potential use by others + Value in potential use by future individuals
Quasi-option value = Value of avoiding irreversibilities in the light of expected future knowledge
Intrinsic value = Existence value

9. Existence Value
Existence value is unrelated to any actual or potential use
Existence value may be related to sympathy, or stewardship
Existence value is not right-based, as rights are absolute, and values are relative
People express, and seem to have existence values

10. Criterion for Cost-benefit Analysis
„benefits“ and „costs“ are meaningless without a social welfare function
defines good an bad consequences
In economics the criterion is the well-being of the members of society
Well-being is defined as
the individuals‘ preferences and
their max. willingness to pay for gains or (WTP)
their min. willingness to accept compensation for losses (WTA)

11. Measures of changes in Welfare for an Environmental Good
Expenditure on private goods, Y D E Y1 I3 B Y0 A C I2 I1 q0 q1
Quantity/quality of environmental good q

12. WTP and WTAC However, people view gains and losses differently
WTP is limited to an individual‘s income, WTAC is unbounded
Confirmed by empirical studies, but not uncontested
Implies that surveys, policies need to be carefully designed
If an individual has the legal right, WTAC is the appropriate concept
It can be difficult to determine property rights (public goods)
Sometimes the current allocation is taken as the legal entitlement
Improvements = WTP and reductions = WTAC

13. Direct & Indirect Valuation
Direct methods (use and non-use values)
Hypothetical/constructed market
Contingent valuation
Indirect methods (use values)
Surrogate market
Hedonic pricing
Travel cost

14. Hedonic analysis
The method uses a market good within which the non-market good is implicitly traded
Households are attracted to localities offering preferred combinations of amenities
The value of a piece of land is related to the stream of benefits to be derived from the land
Obvious benefits: agricultural output or shelter
In addition: access to commercial amenities, to environmental facilities, to the workplace and the environmental quality of the neighbourhood
Given that different locations have varied environmental attributes, this will results in differences in property prices or wage rates

15. Hedonic analysis (2)
In order to live in a location with higher levels of an amenity
Households pay higher house prices
Households accept lower wage rates
Cost differences reflect households’ implicit valuation
Method tries to find a relationship between variations in house prices or wage rates and variations in factors such as proximity to sites to environmental amenities or disamenities

16. Hedonic analysis (3) Step 1:
Estimate price differential due to the environment using multiple regression
p=property characteristics
n=neighbourhood characteristics
e=environmental characteristics
w=worker characteristics
em=employer characteristics
e=environmental characteristics
Step 2:
Derive marginal willingness to pay

17. Drawbacks Markets are in equilibrium
Rents and house prices have adjusted such that individuals are indifferent across locations
Perfect information, no transaction or moving cost
Assumes that households can buy exactly the amount of dwelling-related characteristics it wants
The housing market is unified and not segmented
Data intensive

18. Travel Cost Model Widely used for recreation
Natural areas seldom command a price in the market
Basic premise: time and travel cost expenses represent the „price“ of access to the site
WTP to visit the site
Travel is a complement to recreation

19. Travel Cost Model – 2 Application of TCM
Reservoir management, water supply, wildlife, forests, outdoor recreation etc.
History: Harold Hotelling 1947
Value of national parks
Variations of the method
Simple zonal travel cost approach
Individual travel cost approach
Random utility approach

20. Zonal Travel Cost Approach
Gives values of the site as a whole
Based on number of visits from different distances
Travel and time costs increase with distance
Gives information on „quantities“ and „prices“
Construct a demand function of the site

21. Steps Define a set of zones surrounding the site
Collect number of visitors from each zone in a certain period
Calculate visitation rates per population
Calculate round-trip distance and travel time
Estimate visitors per period and derive demand function

22. An Example Visits/1000 = 300 – 7.755 * Travel Costs Zone Visits/Year
Population
Visits/1000
Total travel costs
400
1000 1
2000
200
10.5 2
4000
100
21.0 3
8000 50
42.0
Visits/1000 = 300 – * Travel Costs

23. An Entrance Fee of 10 Euro Zone Costs Visits/1000 Population Visits
10.0
222
1000 1
20.5
141
2000
282 2
31.0 60
4000
240 3
52.0
8000
Total
744
So now we have two points on our demand curve.

25. Drawbacks Not data intensive, but a number of shortcomings
Assumes that all residents in a zone are the same
Individual data might be used instead
More expensive
Sample selection bias, only visitors are included

26. Other problems
Assumption that people respond to changes in travel costs the same way they would respond to changes in admission price
Opportunity cost of time
Single purpose trip
Substitute sites
Unable to look at most interesting policy questions: changes in quality
Use random utility models instead

27. Constructed Markets
Revealed preference methods can only estimate the use value of the environment, and only if that value affects behaviour in a measurable and interpretable manner
For the rest, we have to use either hypothetical markets or experimental markets (together: constructed)
Experimental markets have delivered little estimates (but a lot of insights), so the contingent valuation method remains – this is a stated preference method

28. Contingent Valuation (2)
Interview people, ask them for their willingness to pay for certain environmental goods and services
Advantage: Applicable to more than direct use value
Disadvantages: Hypothetical, people are unfamiliar with the situation, all sorts of biases may occur, interview design is always hard

29. History First applications in early 1960s to value outdoor recreation
1979 the Water Resource Council recommended CV as one of 3 methods to determine project benefits
In the mid 1970s the EPA funded a research program to determine the promise and problems of the method
The Reagan Executive Order (1981)
All federal regulations on environmental policy should be submitted to a Cost-Benefit Analysis
1989 governmental decision on legitimacy of non-use values for TEV and equal standing
1989 Exxon Valdez oil spill
value loss of non-use values for US citizens

30. Design a CV study Define a market scenario Choose elicitation method
Design market administration
Design sampling
Design of experiment
Estimate WTP-function

31. Potential Biases Incentive Implied value Misspecification
Strategic
Compliance
Implied value
Starting point
Range
Relational
Importance
Position
Misspecification
Theoretical
Amenity
Context
Embedding and warm glow

32. Incentive Biases The interviewee deliberately gives a false answer
Strategic bias: Influence the outcome
Compliance/sponsor bias: Comply with presumed expectations
Compliance/interview bias: Try to please/impress the interviewer
Protest votes: Interviewees may object to valuation per se, or to being interviewed

33. Implied Value Biases Starting point bias, in the bidding game
Range bias, in the payment card
Relational bias, if examples of other contributions are mentioned
Importance bias: The fact that the interviewer bothers to ask ...
Position bias, if multiple goods are valued

34. Misspecification Biases -Context
Misspecification of the market scenario
payment vehicle
property right: WTP/WTA
method of provision: like payment vehicle
budget constraint: ability to pay
elicitation: maximum WTP?
instrument: survey may confuse interviewees
question order

35. Other Misspecification Biases
Theoretical
Amenity/symbolic: The perceived good is different than intended
Amenity/part-whole: The interviewee thinks the good is wider or narrower than intended (geographical, issue, policy)
Amenity/metric: Different measurement
Amenity/probability: Different assessments of the chance of delivery

36. Embedding
WTP for same good varies depending on whether it is assessed on its own or embedded as part of a more inclusive package
Kahnemann (1986)
WTP to prevent drop in fish population in all Ontario lakes or small area respectively
Scope effect
Sub-additivity effect
Possible explanations
Substitution and satiation
Purchase of moral satisfaction (warm glow)