Ch. 3 Valuing the Environment: Ch. 3 Valuing the Environment: MethodsMethods

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IntroductionIntroduction Benefit-Cost Analysis has always been an important tool in Benefit-Cost Analysis has always been an important tool in

natural resource economicsnatural resource economics• but the Exxon Valdez oil tanker fiasco on the Bligh Reef but the Exxon Valdez oil tanker fiasco on the Bligh Reef

in Prince William Sound, Alaska (March 24, 1989) in Prince William Sound, Alaska (March 24, 1989) heightened awareness among the general public about the heightened awareness among the general public about the techniques techniques

• $2.1 billion spent on cleanup$2.1 billion spent on cleanup• $303 million to compensate fishermen’s losses$303 million to compensate fishermen’s losses• $900 million settlement (paid over 10 years)$900 million settlement (paid over 10 years)• Jan. 2004: U.S. District Court for Alaska awarded $4.5 Jan. 2004: U.S. District Court for Alaska awarded $4.5

billion in punitive damagesbillion in punitive damages• U.S. Supreme Court 8/27/2008 lowered punitive U.S. Supreme Court 8/27/2008 lowered punitive

damages to $507.5 million. Seedamages to $507.5 million. See• http://www.adn.com/news/alaska/story/507095.html

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Why Value the Environment?Why Value the Environment? If you don’t place some value on the If you don’t place some value on the

environment because you believe its intrinsic environment because you believe its intrinsic value is infinite:value is infinite:o The value that may be used is $0!!!The value that may be used is $0!!!oBenefit/cost analysis is becoming more Benefit/cost analysis is becoming more

widely used in many disciplines.widely used in many disciplines.oWe still need to consider nonmarket valuesWe still need to consider nonmarket values

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Valuing BenefitsValuing Benefits Assessing the magnitude of pollution damage:Assessing the magnitude of pollution damage:

– 1) Identify affected categories1) Identify affected categories» Two methods:Two methods:

1) animal experiments but extrapolation to 1) animal experiments but extrapolation to humans is difficulthumans is difficult

2) Epidemiology- statistically estimate 2) Epidemiology- statistically estimate relations between health and pollution relations between health and pollution levels in various localities. Must control levels in various localities. Must control for variety of factors for variety of factors

– 2) Estimate the physical relationship between 2) Estimate the physical relationship between emissions and damage causedemissions and damage caused

– 3) Estimate response by affected parties to 3) Estimate response by affected parties to mitigatemitigate

– 4) Monetary value of damages 4) Monetary value of damages 5

Types of ValuesTypes of Values Stock vs. flow values:Stock vs. flow values:

– Stock value is the present value of the future stream of flow Stock value is the present value of the future stream of flow valuesvalues

– Total economic value: 3 componentsTotal economic value: 3 components

» 1) use value- hunting, fishing, photography, viewing, etc.1) use value- hunting, fishing, photography, viewing, etc.

» 2) option value- preserve future availability to use2) option value- preserve future availability to use

» 3) nonuse value- derive satisfaction knowing a resource 3) nonuse value- derive satisfaction knowing a resource existsexists

– Total willingness to pay (TWP)Total willingness to pay (TWP)

– TWP = use value + option value + nonuse valueTWP = use value + option value + nonuse value

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Classifying Valuation MethodsClassifying Valuation Methods Table 3.1Table 3.1 MethodsMethods Observed behaviorObserved behavior HypotheticalHypothetical DirectDirect Mkt. PriceMkt. Price Contingent valuationContingent valuation

Simulated MarketSimulated Market

IndirectIndirect Travel costTravel cost Attribute-based Attribute-based Hedonic Property Values Hedonic Property Values modelsmodels

Hedonic wage values Hedonic wage values Conjoint AnalysisConjoint Analysis Avoidance expendituresAvoidance expenditures Choice experimentsChoice experiments Contingent rankingContingent ranking

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Valuing Nonmarketed GoodsValuing Nonmarketed Goods Four primary indirect observed behavior methods:Four primary indirect observed behavior methods:

– 1) Travel cost model (Clawson-Knetch Model)1) Travel cost model (Clawson-Knetch Model)– an indirect, observed behavior methodan indirect, observed behavior method

» it is nearly free to go to Yosemite National Park it is nearly free to go to Yosemite National Park (only $20/week for a family, compared to $1,400 for (only $20/week for a family, compared to $1,400 for a week at Six Flags over Texas.)a week at Six Flags over Texas.)

» but people reveal their value of Yosemite by but people reveal their value of Yosemite by 1)Monetary expenses: food, lodging, 1)Monetary expenses: food, lodging,

transportationtransportation 2)Value of time (opportunity cost of lost 2)Value of time (opportunity cost of lost

income)income)» now let’s look at “Saving Tuolumne” article & now let’s look at “Saving Tuolumne” article &

travel cost model used thereintravel cost model used therein» http://www.ecosystemvaluation.org/travel_costs.ht

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Valuing Nonmarketed GoodsValuing Nonmarketed Goods Four primary indirect observed behavior methods:Four primary indirect observed behavior methods:

– 2) Hedonic (pleasure seeking) models2) Hedonic (pleasure seeking) models» use statistical models to determine how much someone is use statistical models to determine how much someone is

willing to pay for clean air, reduced probability of death willing to pay for clean air, reduced probability of death (more safety)(more safety)

» homes: in cleaner air areas sell for more moneyhomes: in cleaner air areas sell for more money» workers: paid more for riskier jobs, ceteris paribusworkers: paid more for riskier jobs, ceteris paribus

– 3) Avoidance expenditures:3) Avoidance expenditures:» e.g. Air bags or smoke detectors: How much will you pay to e.g. Air bags or smoke detectors: How much will you pay to

reduce probability of death by say 0.0001? $500? Implies reduce probability of death by say 0.0001? $500? Implies value of your life is at least $5,000,000 = $500/.0001value of your life is at least $5,000,000 = $500/.0001

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Valuing Nonmarketed GoodsValuing Nonmarketed Goods 4) 4) Contingent Valuation Model (CVM)Contingent Valuation Model (CVM)

» survey individuals, ask them how much they would survey individuals, ask them how much they would pay to prevent some environmental damage, e.g., pay to prevent some environmental damage, e.g., save the whale, African elephant, Trinity Riversave the whale, African elephant, Trinity River

» use statistical models to determine how much use statistical models to determine how much someone is willing to pay someone is willing to pay

» CVM became very important after Exxon Valdez oil CVM became very important after Exxon Valdez oil spill in Prince William Sound in Alaskaspill in Prince William Sound in Alaska

» Criticisms: Possible Biases: People will say what Criticisms: Possible Biases: People will say what they think you want them to say in a survey, or liethey think you want them to say in a survey, or lie

» Surveys must be carefully constructedSurveys must be carefully constructed It will raise your taxes, are you still willing to It will raise your taxes, are you still willing to

pay $X?pay $X?

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Valuing Nonmarketed GoodsValuing Nonmarketed Goods• Indirect hypothetical methodsIndirect hypothetical methods

• Conjoint analysis: similar to contingent valuation, but Conjoint analysis: similar to contingent valuation, but no willingness to pay is stated. Respondents choose no willingness to pay is stated. Respondents choose between alternate states of the world.between alternate states of the world.

• See Table 3.3See Table 3.3

• Contingent ranking: rank order hypothetical situations Contingent ranking: rank order hypothetical situations differing in terms of environmental amenitiesdiffering in terms of environmental amenities

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4 types of potential survey biases4 types of potential survey biases

1) Strategic bias1) Strategic bias 2) information bias2) information bias 3) starting point bias3) starting point bias 4) hypothetical bias4) hypothetical bias

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Using Geographic Information Systems Using Geographic Information Systems (GIS) for Economics Valuation(GIS) for Economics Valuation

–Spatial relationships are Spatial relationships are importantimportant

–Hedonic property value models Hedonic property value models can used spatial relationscan used spatial relations»E.g. air quality, open spaceE.g. air quality, open space

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Valuing Human LifeValuing Human Life–How much will you pay to reduce How much will you pay to reduce

probability of death by say 0.0001? probability of death by say 0.0001? $500? Implies value of your life $500? Implies value of your life is at least $5,000,000 = $500/.0001is at least $5,000,000 = $500/.0001

See Table 3.4 for cost of saving a lifeSee Table 3.4 for cost of saving a life Are these efficient regulations?Are these efficient regulations?

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““The Contingent Valuation Debate: Why The Contingent Valuation Debate: Why Economists Should Care”Economists Should Care”

Paul PortneyPaul Portney Journal of Economic PerspectivesJournal of Economic Perspectives,, Vol. 8, No. 4- Fall 1994, pp. 3-17. Vol. 8, No. 4- Fall 1994, pp. 3-17.

Contingent Valuation: willingness to Contingent Valuation: willingness to pay revealed by respondents is pay revealed by respondents is contingent on the constructed or contingent on the constructed or simulated market presented in the simulated market presented in the survey.survey.

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OutlineOutline 1) Origins of the Contingent Valuation Method1) Origins of the Contingent Valuation Method 2) Describing the Methodology2) Describing the Methodology 3) Moving to the Policy Arena3) Moving to the Policy Arena 4) The NOAA Panel4) The NOAA Panel 5) The Importance of the C.V. debate5) The Importance of the C.V. debate

Natural Resource Damage AssessmentNatural Resource Damage Assessment New RegulationsNew Regulations Putting Theory into PracticePutting Theory into Practice

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1) Origins of the C.V. Method1) Origins of the C.V. Method 1st reference to C. V.: Ciriacy-Wantrup (1947) - benefits of 1st reference to C. V.: Ciriacy-Wantrup (1947) - benefits of

preventing soil erosionpreventing soil erosion Davis (1963) implemented first contingent valuation survey to elicit Davis (1963) implemented first contingent valuation survey to elicit

values of recreational area. He compared them with “travel cost” values of recreational area. He compared them with “travel cost” method.method.

Harold Hotelling first suggested to the National Park Service in 1947 Harold Hotelling first suggested to the National Park Service in 1947 that the price someone “paid” to enter the park varied according to that the price someone “paid” to enter the park varied according to their travel cost.their travel cost.

John Krutilla published “Conservation Reconsidered,” in 1967, John Krutilla published “Conservation Reconsidered,” in 1967, arguably the most influential paper ever written in this area. He arguably the most influential paper ever written in this area. He suggested that many environmental assets had “existence values,” suggested that many environmental assets had “existence values,” e.g., scenic wonders, genetic diversity. Often referred to as e.g., scenic wonders, genetic diversity. Often referred to as “nonuse values.”“nonuse values.”

But, not until late 1980s did C.V. receive any notoriety. But, not until late 1980s did C.V. receive any notoriety.

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2) Describing the Methodology2) Describing the Methodology

Main elements:Main elements: 1) Survey must describe the program1) Survey must describe the program 2) Survey must contain a mechanism for 2) Survey must contain a mechanism for

eliciting the value. E.g. “Your tax bill will eliciting the value. E.g. “Your tax bill will increase $X under this new program. Will increase $X under this new program. Will you vote “yes” or “no” for the program?you vote “yes” or “no” for the program?

3) Survey collects information on 3) Survey collects information on socioeconomic characteristics of respondentssocioeconomic characteristics of respondents

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3) Moving to Policy Arena3) Moving to Policy Arena Why has the controversy entered real world?Why has the controversy entered real world? 3 reasons3 reasons

1) Comprehensive Environmental Response, Compensation and 1) Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), more commonly known as Liability Act of 1980 (CERCLA), more commonly known as “Superfund.” Gave gov’t right to sue for dmages to natural “Superfund.” Gave gov’t right to sue for dmages to natural resources for which they were trustees. Dept. of Interior (DOI) resources for which they were trustees. Dept. of Interior (DOI) was ordered to write regulations and eventually courts required was ordered to write regulations and eventually courts required DOI to give equal weight to use and nonuse values.DOI to give equal weight to use and nonuse values.

2) Exxon Valdez oil tanker spilled 11 million gallons on the Bligh 2) Exxon Valdez oil tanker spilled 11 million gallons on the Bligh Reef in Prince William Sound, Alaska (3/24 1989)Reef in Prince William Sound, Alaska (3/24 1989)

3) Oil Pollution Act of 1990 ordered Dept. of Commerce, through 3) Oil Pollution Act of 1990 ordered Dept. of Commerce, through National Oceanic and Atmospheric Administration (NOAA) to National Oceanic and Atmospheric Administration (NOAA) to write regulations governing damage assessment.write regulations governing damage assessment.

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4) The NOAA Panel4) The NOAA Panel NOAA’s general counsel asked Nobel laureates NOAA’s general counsel asked Nobel laureates

Kenneth Arrow and Robert Solow to chair a panel Kenneth Arrow and Robert Solow to chair a panel of experts to advise NOAA on the following of experts to advise NOAA on the following question:question:

““Is the contingent valuation method capable of Is the contingent valuation method capable of providing estimates of lost nonuse or existence providing estimates of lost nonuse or existence values that are reliable enough to be used in natural values that are reliable enough to be used in natural resource damage assessments?”resource damage assessments?”

Report was published in the Report was published in the Federal RegisterFederal Register on on January 15, 1993.January 15, 1993.

It made both sides unhappy.It made both sides unhappy.

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4) The NOAA Panel4) The NOAA Panel

Opponents were upset with “bottom line”Opponents were upset with “bottom line” CV “can produce estimates reliable CV “can produce estimates reliable

enough to be starting point of a judicial enough to be starting point of a judicial process of damage assessment, including process of damage assessment, including lost passive-use values.”lost passive-use values.”

Proponents of C.V. were upset with the Proponents of C.V. were upset with the stringency of the guidelines for C.V. stringency of the guidelines for C.V. methods.methods.

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4) The NOAA Panel4) The NOAA Panel

Seven of the most important guidelines:Seven of the most important guidelines:

– 1) Use personal interviews; second best is 1) Use personal interviews; second best is telephone; third best is mail surveys.telephone; third best is mail surveys.

– 2) Should elicit willingness to pay to prevent a 2) Should elicit willingness to pay to prevent a future incident rather than minimum future incident rather than minimum compensation required for an incident that has compensation required for an incident that has already occurred.already occurred.

– 3) Use the referendum format: “Would you 3) Use the referendum format: “Would you vote for program X if it raised your taxes Y vote for program X if it raised your taxes Y dollars?”dollars?”

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4) The NOAA Panel4) The NOAA Panel Seven of the most important guidelines:Seven of the most important guidelines:

– 4) Scenario must accurately and understandably 4) Scenario must accurately and understandably describe the expected effects of the program.describe the expected effects of the program.

– 5) Must contain reminders that willingness to pay 5) Must contain reminders that willingness to pay for the program would reduce the amount they for the program would reduce the amount they would have available to spend on other things.would have available to spend on other things.

– 6) Must remind them that substitutes are 6) Must remind them that substitutes are available.available.

– 7) Must include follow up questions to ensure 7) Must include follow up questions to ensure that respondents understood the choice they that respondents understood the choice they made and the reasons for the choice.made and the reasons for the choice.

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5) The Importance of the 5) The Importance of the Contingent Valuation DebateContingent Valuation Debate

Natural Resource Damage Assessments:Natural Resource Damage Assessments: C.V. M. will likely influence future damage C.V. M. will likely influence future damage

awardsawards for example, a CVM conducted for the state of for example, a CVM conducted for the state of

Alaska in the wake of the accident estimated the Alaska in the wake of the accident estimated the losses at nearly $3 billion (Carson, et al., 1992)losses at nearly $3 billion (Carson, et al., 1992)

New RegulationsNew Regulations most significant applications of CVM will most significant applications of CVM will

involve benefit and cost estimates of proposed involve benefit and cost estimates of proposed regulations under Superfund and other lawsregulations under Superfund and other laws

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5) The Importance of the 5) The Importance of the Contingent Valuation DebateContingent Valuation Debate

New RegulationsNew Regulations existence values are not necessarily unique existence values are not necessarily unique

to environmental policyto environmental policy business community tends to oppose use of business community tends to oppose use of

CVMCVM but businesses could use CVM to show but businesses could use CVM to show

that persons derive utility from knowing that persons derive utility from knowing that persons have jobs (which might be that persons have jobs (which might be destroyed due to a new regulation).destroyed due to a new regulation).

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5) The Importance of the 5) The Importance of the Contingent Valuation DebateContingent Valuation Debate

Putting Theory into PracticePutting Theory into Practice

– the scrutiny of CVM has led some economists the scrutiny of CVM has led some economists to think more deeply about cognitive to think more deeply about cognitive processes, rationality, and the nature of processes, rationality, and the nature of preference for all goods, public or private. preference for all goods, public or private. We may develop an improved theory of We may develop an improved theory of preference and choice.preference and choice.

– CVM is a new technique and may face many CVM is a new technique and may face many of the criticisms similarly faced by of the criticisms similarly faced by experimental economicsexperimental economics

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Valuing the Environment Through Valuing the Environment Through Contingent Valuation Contingent Valuation

W. Michael HanemannW. Michael HanemannJournal of Economic PerspectivesJournal of Economic Perspectives,,

Vol. 8, No. 4- Fall 1994, pp. 19-43. Vol. 8, No. 4- Fall 1994, pp. 19-43.

Conducting Reliable SurveysConducting Reliable Surveys– serious surveys avoid convenience sampling such serious surveys avoid convenience sampling such

as stopping people in the street; they employ as stopping people in the street; they employ statistically based probability samplingstatistically based probability sampling

– only study where people were stopped for a few only study where people were stopped for a few minutes in a mall was one performed for Exxonminutes in a mall was one performed for Exxon

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Conducting Reliable SurveysConducting Reliable Surveys Until mid 1980s, most contingent valuation surveys Until mid 1980s, most contingent valuation surveys

used some version of an open-ended question, like used some version of an open-ended question, like “What is the most you would be willing to pay for…?”“What is the most you would be willing to pay for…?”

Since then, most major CV studies have used closed-Since then, most major CV studies have used closed-ended questions like “If it cost $x, would you be ended questions like “If it cost $x, would you be willing to pay this amount?” or “If it cost $x, would willing to pay this amount?” or “If it cost $x, would you vote for this?” Different people are confronted you vote for this?” Different people are confronted with different dollar amounts. Plotting the proportion with different dollar amounts. Plotting the proportion off “yes” responses against the dollar amount traces off “yes” responses against the dollar amount traces out the cumulative distribution function of willingness-out the cumulative distribution function of willingness-to pay.to pay.

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Conducting Reliable SurveysConducting Reliable Surveys The NOAA panel considered a debriefing session The NOAA panel considered a debriefing session

essential to determine if the person really understood essential to determine if the person really understood the questions.the questions.

Using the median response is usually better than the Using the median response is usually better than the mean, which is very sensitive to responses of the mean, which is very sensitive to responses of the highest bidders.highest bidders.

Diamond and Hausman select studies from the C.V. Diamond and Hausman select studies from the C.V. literature that violate most of the precepts. None uses literature that violate most of the precepts. None uses in-person interviews; many are self-administered; in-person interviews; many are self-administered; most use open-ended questions; none is cast as most use open-ended questions; none is cast as voting; many ask questions with little detail. voting; many ask questions with little detail.

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Objections to SurveysObjections to Surveys Four common objections to surveys:Four common objections to surveys: 1) Surveys are vulnerable to response effects – 1) Surveys are vulnerable to response effects –

Small changes in wording can change survey response; need to use Small changes in wording can change survey response; need to use rigorous cognitive techniques to test for differencesrigorous cognitive techniques to test for differences

2) The survey process creates the values2) The survey process creates the values economists & psychologists have often assumed that consumers use a economists & psychologists have often assumed that consumers use a

“top-down” or “stored-rule” decision process“top-down” or “stored-rule” decision process but now evidence indicates that all cognition is a constructive process; but now evidence indicates that all cognition is a constructive process;

general principle: people are cognitive misers: they tend to resolve general principle: people are cognitive misers: they tend to resolve problems of reasoning and choice in the simplest way possible.problems of reasoning and choice in the simplest way possible.

For non-habituated and complex consumer choices, people often make For non-habituated and complex consumer choices, people often make “bottom-up” decisions; that is they make a decision rule at the moment “bottom-up” decisions; that is they make a decision rule at the moment they need to use it. Real issue is whether preferences have a stable they need to use it. Real issue is whether preferences have a stable construct.construct.

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Objections to SurveysObjections to Surveys Four common objections to surveys:Four common objections to surveys: 3) Ordinary people are ill-trained for valuing the environment3) Ordinary people are ill-trained for valuing the environment

but ordinary people are allowed to vote for many complex but ordinary people are allowed to vote for many complex issues.issues.

4) Survey responses can’t be verified4) Survey responses can’t be verified 3 ways to validate CV results:3 ways to validate CV results:

1) replication1) replication 2) comparison with estimates from other sources2) comparison with estimates from other sources 3) comparison with actual behavior where this is possible3) comparison with actual behavior where this is possible

when CV measures direct use values, we can compare with when CV measures direct use values, we can compare with estimates obtained through indirect methods.estimates obtained through indirect methods.

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Objections to SurveysObjections to Surveys 4) Survey responses can’t be verified4) Survey responses can’t be verified

– Knetsch and Davis (1966) conducted the first test, comparing Knetsch and Davis (1966) conducted the first test, comparing CV and travel demand estimates of willingness-to pay for CV and travel demand estimates of willingness-to pay for recreation the Maine woods. The difference was less than 3 recreation the Maine woods. The difference was less than 3 %.%.

– Over 80 studies that compare C.V. and indirect methods. Over 80 studies that compare C.V. and indirect methods. Results are often fairly close: overall, the CV estimates are Results are often fairly close: overall, the CV estimates are slightly lower than revealed preference estimates and highly slightly lower than revealed preference estimates and highly correlated w/ them.correlated w/ them.

– Ideal validation is direct testing of contingent valuation Ideal validation is direct testing of contingent valuation predictions against actual behavior. About 10 such tests predictions against actual behavior. About 10 such tests exists. Diamond and Hausman mention only five of these. exists. Diamond and Hausman mention only five of these. The ones not mentioned yield results quite favorable to C.V. The ones not mentioned yield results quite favorable to C.V.

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Objections to SurveysObjections to Surveys 4) Survey responses can’t be verified4) Survey responses can’t be verified

– 5 studies showing validity of C.V.5 studies showing validity of C.V.» 1) Bohm (1972): willingness to pay to see TV program in Stockholm1) Bohm (1972): willingness to pay to see TV program in Stockholm» 2) Bishop and Heberlein (1990): Wisconsin deer hunting permits: 2) Bishop and Heberlein (1990): Wisconsin deer hunting permits:

willingness to pay was $31 in real sale versus $35 in hypothetical sale.willingness to pay was $31 in real sale versus $35 in hypothetical sale.» 3) Dickie, Fisher, and Gerking (1987) boxes of strawberries door-to-door3) Dickie, Fisher, and Gerking (1987) boxes of strawberries door-to-door» 4) Carson, Hanemann and Mitchell (1986) water quality bond election in 4) Carson, Hanemann and Mitchell (1986) water quality bond election in

California in 1985. Predicted 70-75% yes, actual was 73%.California in 1985. Predicted 70-75% yes, actual was 73%.» 5) Cummings, Harrison and Rutstrom (1993) emphasized the importance of 5) Cummings, Harrison and Rutstrom (1993) emphasized the importance of

“reason to say no”“reason to say no”» Diamond and Hausman focus on studies that showed significant difference Diamond and Hausman focus on studies that showed significant difference

in CV and actual; most had flaws such as not asking to vote for higher in CV and actual; most had flaws such as not asking to vote for higher taxes, using an environ. group for hypothetical treatment, comparing taxes, using an environ. group for hypothetical treatment, comparing hypothetical phone responses to actual mail responses (phone response hypothetical phone responses to actual mail responses (phone response rates are much higher than mail).rates are much higher than mail).

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C.V. and Economic TheoryC.V. and Economic Theory Critics of C.V. question the validity of the variables in a Critics of C.V. question the validity of the variables in a

utility function. But according to Gary Becker (Nobel utility function. But according to Gary Becker (Nobel laureate) economists generally assume that “individuals laureate) economists generally assume that “individuals maximize welfare as they conceive it.” maximize welfare as they conceive it.”

Two criticisms raised by Diamond and Hausman concern Two criticisms raised by Diamond and Hausman concern income elasticity of willingness-to-pay and “embedding income elasticity of willingness-to-pay and “embedding effect”effect” income elasticity estimates are generally consistent with income elasticity estimates are generally consistent with

demand for state and local government services in the demand for state and local government services in the U.S. (0.3 to 0.6) and with charitable giving (0.4 to 0.8).U.S. (0.3 to 0.6) and with charitable giving (0.4 to 0.8).

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C.V. and Economic TheoryC.V. and Economic Theory ““Embedding effect” criticism: means several different Embedding effect” criticism: means several different

things. Generally the misconception is that with CV you things. Generally the misconception is that with CV you get the same willingness to pay (WTP) if you value one get the same willingness to pay (WTP) if you value one lake, two lakes, or ten lakes. Three notions:lake, two lakes, or ten lakes. Three notions:– 1) “scope effect”: WTP varies inadequately with changes in the 1) “scope effect”: WTP varies inadequately with changes in the

scale or scope of the item being valuedscale or scope of the item being valued– 2) “sequencing effect”2) “sequencing effect”– 3) “subadditivity effect:” 3) “subadditivity effect:” – scope effect: most studies show that scope does matter. Two scope effect: most studies show that scope does matter. Two

exceptions. Desvouges et al. (1992) in shopping mall survey exceptions. Desvouges et al. (1992) in shopping mall survey elicited WTP for preventing the deaths of migratory waterfowl. elicited WTP for preventing the deaths of migratory waterfowl. 2,000, 20,000, and 200,000 out of 85 million birds might die 2,000, 20,000, and 200,000 out of 85 million birds might die each year from exposure to waste-oil holding pondseach year from exposure to waste-oil holding ponds

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C.V. and Economic TheoryC.V. and Economic Theory– How much should willingness to pay vary with scope?How much should willingness to pay vary with scope?– Diamond and Hausman assert that economic theory Diamond and Hausman assert that economic theory

requires it to increase more than proportionately with the requires it to increase more than proportionately with the number of bird deaths. Let qnumber of bird deaths. Let qFF = q = q00-q-qRR+q+qSS, where q, where q0 0 is is

original bird population, qoriginal bird population, qRR is the number at risk, and q is the number at risk, and qSS is is

the number saved. Diamond assumes that people should the number saved. Diamond assumes that people should care only about the ultimate number of birds, qcare only about the ultimate number of birds, qF. F. He He

assumes that preferences are quasiconcave in qassumes that preferences are quasiconcave in q00. The two . The two

assumptions together imply quasiconvexity in qassumptions together imply quasiconvexity in qRR, which , which

is what makes the elasticity of WTP with respect to qis what makes the elasticity of WTP with respect to qRR

greater than unity. His conclusion depends heavily on the greater than unity. His conclusion depends heavily on the assumption of perfect substitution betweenassumption of perfect substitution between qq00, q, qRR, and q, and qSS. .

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Contingent Valuation: Is Some Contingent Valuation: Is Some Number Better than No Number? Number Better than No Number?

Peter A. Diamond and Jerry A. HausmanPeter A. Diamond and Jerry A. HausmanJournal of Economic PerspectivesJournal of Economic Perspectives,,

Vol. 8, No. 4- Fall 1994, pp. 45-64. Vol. 8, No. 4- Fall 1994, pp. 45-64.

Discusses how to judge the content in C.V. Discusses how to judge the content in C.V. surveys together with evidence from surveys surveys together with evidence from surveys that have been done. Tests for consistency that have been done. Tests for consistency indicate that C.V. responses are not indicate that C.V. responses are not consistent with economic theory.consistent with economic theory.

Main flaw: “embedding effect.”Main flaw: “embedding effect.”37

Judging Surveys of Willingness to Judging Surveys of Willingness to Pay for Public GoodsPay for Public Goods

A number of bases exist for forming judgments about whether respondents A number of bases exist for forming judgments about whether respondents are answering the right question and whether the response is roughly are answering the right question and whether the response is roughly correct.correct.– 1) Incredibility test1) Incredibility test– 2) verbal protocol analysis shows that2) verbal protocol analysis shows that

» people have difficulty forming their preferencespeople have difficulty forming their preferences– 3) patterns of WTP responses across individuals3) patterns of WTP responses across individuals

» income elasticities are too low compared to charitable giving resultsincome elasticities are too low compared to charitable giving results– 4) patterns of WTP responses across surveys4) patterns of WTP responses across surveys

» people would pay more to preserve visibility in Grand Canyon people would pay more to preserve visibility in Grand Canyon when it was only question, as compared to when it was third when it was only question, as compared to when it was third question.question.

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Judging Surveys of Willingness to Judging Surveys of Willingness to Pay for Public GoodsPay for Public Goods

4) patterns of WTP responses across surveys4) patterns of WTP responses across surveys

» embedding effect: people would pay the same to save one, two or three embedding effect: people would pay the same to save one, two or three stands of timber. Neither income or substitution effect can plausibly stands of timber. Neither income or substitution effect can plausibly explain the embedding effect. explain the embedding effect.

» This seems to confirm the “warm glow” hypothesis. Individuals are This seems to confirm the “warm glow” hypothesis. Individuals are primarily expressing support for the environment that does not vary primarily expressing support for the environment that does not vary much with small changes in the precise environmental change being much with small changes in the precise environmental change being described.described.

» ““Adding up test”: willingness to pay for X and Y (together) should be Adding up test”: willingness to pay for X and Y (together) should be the same as the sum of the willingness to pay for X and the WTP for Y, the same as the sum of the willingness to pay for X and the WTP for Y, having been given X. Schulze et al. (1993) found WTP for complete having been given X. Schulze et al. (1993) found WTP for complete cleanup was $72.46 while WTP for partial cleanup was $72.02. Thus cleanup was $72.46 while WTP for partial cleanup was $72.02. Thus the responses must have been dominated by a warm glow effect.the responses must have been dominated by a warm glow effect.

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Issues in Benefit EstimationIssues in Benefit Estimation Primary versus secondary effectsPrimary versus secondary effects

Tangible versus intangible benefitsTangible versus intangible benefits

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Approaches to Cost EstimationApproaches to Cost Estimation The Survey ApproachThe Survey Approach

The Engineering ApproachThe Engineering Approach

Combined ApproachCombined Approach

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Treatment of RiskTreatment of Risk Expected present value of net benefits for Expected present value of net benefits for

policy j = policy j = EPVNB = EPVNB = PPiiPVNBPVNBij ij (sum over i), j = 1,…,J(sum over i), j = 1,…,J Arrow and Lind argue that risk neutrality is Arrow and Lind argue that risk neutrality is

appropriate. Total cost of risk bearing is appropriate. Total cost of risk bearing is small for public investments.small for public investments.

Discount rate can have a major impact on net Discount rate can have a major impact on net benefits of a project.benefits of a project.

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Choosing the Discount RateChoosing the Discount Rate Discount rate can have a major impact Discount rate can have a major impact

on net benefits of a project.on net benefits of a project. Critical appraisalCritical appraisal

US. Army Corps of Engineers water projects’ US. Army Corps of Engineers water projects’ ex ante benefit estimates are too high. We will ex ante benefit estimates are too high. We will say more on this in water chapter.say more on this in water chapter.

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Cost-Effectiveness AnalysisCost-Effectiveness Analysis When it is difficult to construct a benefit-cost When it is difficult to construct a benefit-cost

estimate, cost-effectiveness can provide guidance. estimate, cost-effectiveness can provide guidance. For a given environmental goal, choose the lowest For a given environmental goal, choose the lowest cost option of obtaining it.cost option of obtaining it.

Second Equimarginal principle (the cost -Second Equimarginal principle (the cost -effectiveness equimarginal principle): least cost of effectiveness equimarginal principle): least cost of achieving an environmental target will have been achieving an environmental target will have been achieved when the marginal costs of all possible achieved when the marginal costs of all possible means of achievement are equal.means of achievement are equal. E.g. pollution control from various sources E.g. pollution control from various sources

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Impact AnalysisImpact Analysis When it is difficult to construct a benefit-cost When it is difficult to construct a benefit-cost

estimate or a cost-effectiveness estimate, use an estimate or a cost-effectiveness estimate, use an impact analysis. impact analysis.

However, it only lists all the impacts. No dollar However, it only lists all the impacts. No dollar values are given. Difficult to compare impacts.values are given. Difficult to compare impacts.

Current impact analysis are more sophisticated Current impact analysis are more sophisticated than predecessors and may contain B/C than predecessors and may contain B/C analysis and cost effectiveness analysisanalysis and cost effectiveness analysis

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The EndThe End

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