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

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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

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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

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5

Modeling Incremental Benefits (MSB)

6

MS

B (

$m

illio

ns)

A (abatement %)

D = MSB

250

25

17.5

20

19.0

Incremental Benefits = $91.25 million

MSB = 25 - 0.3A

• Find baseline TSB before policy• Find new TSB after policy is implemented• Subtract baseline TSB from new TSB

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A (abatement %)

TS

B (

$m

illio

ns)

TSB

25

531.25

20

440.0

Incremental Benefits = $91.25 million

0

TSB = 25A - 0.15A2

Modeling Incremental Benefits (TSB)

Valuing Environmental QualityTwo 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

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9

• 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

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2. 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

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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

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Damage Function Model T

ot a

l d

ama g

es (

TD

)

Contaminant (C)

Damage function

C0

TD0

C1

TD1

Damage reduction in nonmonetary termsDamage reduction in nonmonetary terms

0

Suppose policy causes adecline in the contaminantfrom C0 to C1

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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

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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)

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Incremental Benefits

$

D

aS0

S1

e

b

Q0Q of corn

P0

cP1

Q10

Incremental benefit = ebc

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• 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

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4. 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

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• 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

– MC0 of X0 is linked to a given level of E0

– As the overall environment improves, or as E increases from say, E0 to E1, the individual incurs lower costs, so MC shifts right from MC0 to MC1 and X0 improves to X1

• Change in spending for the same level of X is an estimate of incremental benefits

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Modeling AEM

$

D = MBa

MC0 (based on E0)

MC1 (based on E1)b

X00

d

c

X1

abc is WTP for improvement in E based on achieving X1

Personal environmental quality (X)

E rises to E1

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Modeling AEM

$

D = MBa

MC0 (based on E0)

MC1 (based on E1)

b

X00

d

c

X1 Personal environmental quality (X)

abd is WTP for improvement in E based on achieving X0 (acts as a lower bound)

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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

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• 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

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6. Travel Cost Method

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Modeling TCMMarket is recreational services of lake

Pri

ce (

P)

of

adm

issi

on

Number of Visits (V)

D0

P0Price line

V00

a

b

Original CS = abP0

D1

d

c

V1

New CS = cdP0

CS = abcd

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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)

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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., PHOUSE = f(X1, X2, ….Xn, E), where:

• each Xi 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

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7. 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

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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

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