GEF Caspian EVE 2005/UNDP and WBI Morteza Rahmatian, Non-Market Valuation Session 14 Non-Market...

Caspian EVE 2005/UNDP and WBI MortCaspian EVE 2005/UNDP and WBI Morteza Rahmatian, Non-Market Valuationeza Rahmatian, Non-Market Valuation

GEF

Session 14Session 14

Non-Market ValuationNon-Market Valuation

Morteza RahmatianMorteza Rahmatian

California State University, FullertonCalifornia State University, Fullerton

[email protected]@fullerton.edu

Ashgabad, November, 2005Ashgabad, November, 2005


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Notion of placing a value on natureNotion of placing a value on nature

““knowing the price of everything but knowing the price of everything but the value of nothing.”the value of nothing.”

Value and prices are separate ideas.Value and prices are separate ideas.


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What is value?What is value? First, the economic view of “value” is First, the economic view of “value” is

anthropocentric.anthropocentric.

This means value is determined by people and This means value is determined by people and not by either natural law or government.not by either natural law or government.

Second, value is determined by peoples’ Second, value is determined by peoples’ willingness to make trade-offs.willingness to make trade-offs.

When an individual spends money on one good, When an individual spends money on one good, there is less available for other goods.there is less available for other goods.


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The argument against..The argument against..

The notion that cars, houses and bus The notion that cars, houses and bus rides have prices. Putting a price on the rides have prices. Putting a price on the environment destroys the notion that it environment destroys the notion that it has value - rather it becomes a chattel has value - rather it becomes a chattel that can be sold off.that can be sold off.

How much would you be willing to pay to How much would you be willing to pay to forego your freedom or health?forego your freedom or health?


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Why is monetary valuation Why is monetary valuation important?important?

Planning process is influenced by economic analysis Planning process is influenced by economic analysis (CBA)(CBA)

Goods and services which have quantities and prices Goods and services which have quantities and prices can be taken into account in decision-making processcan be taken into account in decision-making process

Economic valuation helps to bring the environment into Economic valuation helps to bring the environment into decision-making processdecision-making process


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Total Economic ValueTotal Economic Value

Use valuesUse values Direct use (timber, other forest products)Direct use (timber, other forest products) Indirect use (ecological functions)Indirect use (ecological functions) Option value (WTP to conserve for future use)Option value (WTP to conserve for future use)

Non-use valuesNon-use values Existence value (WTP to know an asset exists)Existence value (WTP to know an asset exists) Bequest value (WTP to pass on asset to next Bequest value (WTP to pass on asset to next

generation)generation) TEV = Direct Use Value + Indirect Use Value + TEV = Direct Use Value + Indirect Use Value +

Option Value + Existence ValueOption Value + Existence Value


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Dimensions of environmental value

Four categories of service that the natural environment provides for humans and their economic activities:

resource inputs to production by firms, R sinks for production and consumption wastes, W amenity services to households, A life support services for firms and households, L


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Techniques for Measuring the Value of Techniques for Measuring the Value of Non-market GoodsNon-market Goods

The three major categories for measuring the value of The three major categories for measuring the value of non-market goods include:non-market goods include:

Revealed preference techniquesRevealed preference techniques, which look at , which look at decisions people make in reaction to changes in decisions people make in reaction to changes in environmental quality.environmental quality.

Stated preference techniquesStated preference techniques, which elicit values , which elicit values directly through survey methods. directly through survey methods.

Benefits-transferred techniquesBenefits-transferred techniques, which look at existing , which look at existing studies for value of analogous environmental change.studies for value of analogous environmental change.


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Techniques to place monetary Techniques to place monetary values on environmental impactsvalues on environmental impacts

Market based methodsMarket based methods Production function approachProduction function approach Cost of illness approachCost of illness approach Cost-based approachesCost-based approaches Travel Cost MethodTravel Cost Method Hedonic pricing Approach

Non-market based methodsNon-market based methods • Contingent valuation Method


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Production function approachProduction function approach

The environment is an input into the production The environment is an input into the production of a marketed goodof a marketed good

Based on damage function which relates cause Based on damage function which relates cause (soil erosion) to effect/damage (reduced soil (soil erosion) to effect/damage (reduced soil fertility)fertility)

Applicability: deforestation, wetland and reef Applicability: deforestation, wetland and reef destruction, water pollution in agricultural and destruction, water pollution in agricultural and fisheriesfisheries

Measures ‘use’ value of resourcesMeasures ‘use’ value of resources


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Cost of Illness ApproachCost of Illness Approach Costs of air/water pollution estimated by looking at Costs of air/water pollution estimated by looking at

costs of human health impactcosts of human health impact Dose-response function identifies relationship Dose-response function identifies relationship

between level of pollutant and degree of health between level of pollutant and degree of health effect (water quality and diarrhoea)effect (water quality and diarrhoea)

Value health effect based on cost of illness, Value health effect based on cost of illness, includingincluding cost of medicine, doctors visits, hospital stays, other cost of medicine, doctors visits, hospital stays, other

incidental expensesincidental expenses Loss of earnings due to illnessLoss of earnings due to illness


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Cost of Illness ApproachCost of Illness Approach

Applicability:Applicability: Value health costs of water and air pollutionValue health costs of water and air pollution

LimitationsLimitations Dose-response functions not available locallyDose-response functions not available locally Does not measure WTP to avoid illnessDoes not measure WTP to avoid illness


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Cost-based approachesCost-based approaches Replacement cost approachReplacement cost approach Cost effectiveness analysisCost effectiveness analysis Defensive expenditure approachDefensive expenditure approach

Limitations:Limitations: Costs significantly underestimates benefitsCosts significantly underestimates benefits Use when not possible to quantify benefitsUse when not possible to quantify benefits

ApplicabilityApplicability When benefits are very difficult to valueWhen benefits are very difficult to value


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Replacement Cost ApproachReplacement Cost Approach Estimates the costs required to replace damaged Estimates the costs required to replace damaged

resource or to restore damaged resource to resource or to restore damaged resource to original stateoriginal state

Applicability:Applicability: When remedial action must be taken to meet a When remedial action must be taken to meet a

standard (air or water quality)standard (air or water quality) When environmental effect requires expenditure to When environmental effect requires expenditure to

replace natural asset (roads, dams, soil, water)replace natural asset (roads, dams, soil, water) Limitations:Limitations:

Assumes complete replacement or restoration is Assumes complete replacement or restoration is possiblepossible


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Cost-effectiveness analysisCost-effectiveness analysis Choose the most cost-effective means of Choose the most cost-effective means of

reaching a pre-set target reaching a pre-set target Applicability: Applicability:

Social programmes (health and population)Social programmes (health and population) Examples:Examples:

maximum level of exposure to a waterborne disease maximum level of exposure to a waterborne disease agentagent

emission standard for industrial facilitiesemission standard for industrial facilities Limitations:Limitations:

Compares alternative means of reaching target, but Compares alternative means of reaching target, but can not identify whether alternative are all too costlycan not identify whether alternative are all too costly


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Defensive/Preventative ExpenditureDefensive/Preventative Expenditure

People act to pre-empt damagePeople act to pre-empt damage Expenditures provide estimate of minimum valuation of Expenditures provide estimate of minimum valuation of

potential damage to health or environmentpotential damage to health or environment Applicability: Applicability:

Assess demand for public services (water supply, electricity, Assess demand for public services (water supply, electricity, rubbish collection)rubbish collection)

Example: Example: To assess demand for To assess demand for urban water supply project, look at how urban water supply project, look at how

much people pay for water from other sources to avoid exposure much people pay for water from other sources to avoid exposure to water-borne pathogensto water-borne pathogens

Provides lower-bound estimate of social benefits of Provides lower-bound estimate of social benefits of public servicespublic services

Limitations:Limitations: There must be no secondary benefits to expenditureThere must be no secondary benefits to expenditure


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Travel Cost MethodTravel Cost Method Uses expenditures (transport costs and Uses expenditures (transport costs and

time) to reach a site to estimate time) to reach a site to estimate willingness to paywillingness to pay

Application:Application: Recreational areas, national parks, Recreational areas, national parks,

historic/cultural siteshistoric/cultural sites Time spent collecting fuel wood and waterTime spent collecting fuel wood and water

Limitations:Limitations: Requires survey, skillsRequires survey, skills Measures only use valueMeasures only use value


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Travel Cost MethodTravel Cost MethodThe travel cost method The second assumption is that the cost of a visit

comprises both:Travel costs Ti, varying with iAdmission price, P, constant across i

and that visitors treat travel costs and the price of admission as equivalent elements of the total cost of a visit (so responding in the same way to increases/decreases in either).


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Contingent valuationContingent valuation Ask individuals what they are WTP for a change in Ask individuals what they are WTP for a change in

environmental attributeenvironmental attribute Based on hypothetical marketBased on hypothetical market Requires that respondents understand well the good Requires that respondents understand well the good

they are being offered and that they answer truthfullythey are being offered and that they answer truthfully Application:Application:

Changes in the provision of public services Changes in the provision of public services Only method to measure existence valueOnly method to measure existence value

LimitationsLimitations Requires rigorous survey, economic skillsRequires rigorous survey, economic skills Due to hypothetical nature, subject to many biasesDue to hypothetical nature, subject to many biases


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Contingent valuation (CVM)

A direct method that involves asking a sample of the relevant population questions about their WTP or WTA.

It is called 'contingent valuation' because the valuation is contingent on the hypothetical scenario put to respondents.

Its main use is to provide inputs to analyses of changes in the level of provision of public goods/bads, and especially of environmental 'commodities' which have the characteristics of non-excludability and non-divisibility.


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Contingent valuation: pros and cons

CVM is seen by many economists as suffering from the problem that it asks hypothetical questions, whereas indirect methods exploit data on observed, actual, behaviour.

On the other hand, the CVM has two advantages over indirect methods:

First, it can deal with both use and non-use values, whereas the indirect methods cover only the former. Second, and unlike the indirect methods, CVM answers to WTP or WTA questions go directly to the theoretically correct monetary measures of utility changes.


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The steps involved in applying the CVM:

(1) Creating a survey instrument for the elicitation of individuals' WTP/WTA. This has three components:

(a) Designing the hypothetical scenario,(b) Deciding whether to ask about WTP or WTA,(c) Creating a scenario about the means of

payment or compensation.(2) Using the survey instrument with a sample

of the population of interest.


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The CVM steps continued …

(3) Analysing the responses to the survey. This can be seen as having two components:

(a) Using the sample data on WTP/WTA to estimate average WTP/WTA for the population,

(b) Assessing the survey results so as to judge the accuracy of this estimate.

(4) Computing total WTP/WTA for the population of interest.

(5) Conducting sensitivity analysis.


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PROBLEMS WITH CVM

A number of potential 'biases' have been identified in the CVM literature:

Two classes of problem are subsumed by the term 'bias‘:

Getting respondents to answer the question that would, if they answered honestly, elicit respondents' true WTP in regard to the policy issue that the exercise is intended to inform.

Getting respondents to answer honestly.


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SURVEY DESIGN

Many CVM practitioners argue that with good survey instrument design bias is not a major problem nowadays.

Good survey instrument design is now seen as involving:

Extensive pre-testing

The use of focus groups


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SOME OTHER DIFFICULTIES

Averaging responses

Use of mean or median (treatment of outliers)?Treatment of ‘no’ responses (to a question asking whether the individual would be WTP a particular sum). Is this a 'protest' or a ‘genuine’ response?.Are protest responses to be included in the average?Clearly, the treatment of outliers and protest responses can have significant implications for estimated median and, especially, mean WTP.


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Obtaining total WTP

Given average WTP, total WTP is just that average times the size of the relevant population. A question which arises is: what is the relevant population? At one level the question is answered by the conduct of the CVM exercise in regard to sample selection. At another level, the question may be open and unresolved. If it is the existence value associated with the Amazon rainforest, say, what is the relevant population (and how does that relate to the sample?)


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Hedonic Methods ApproachHedonic Methods Approach

Uses market price of a good to estimate the value of an Uses market price of a good to estimate the value of an environmental attribute which is embedded in the price of environmental attribute which is embedded in the price of the marketed goodthe marketed good

Example: house (size, construction, location, environmental Example: house (size, construction, location, environmental and aesthetic attributes, e.g. clean air)and aesthetic attributes, e.g. clean air)

ApplicationApplication property prices and air pollution/aesthetic traits and access to water property prices and air pollution/aesthetic traits and access to water

supply and rubbish collectionsupply and rubbish collection Job markets and risks to lifeJob markets and risks to life

Limitations: Limitations: requires survey, lots of data, economic theory/econometricsrequires survey, lots of data, economic theory/econometrics Relies on existence of properly functioning land/property and labour Relies on existence of properly functioning land/property and labour

marketmarket


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Hedonic Methods ApproachHedonic Methods ApproachAn indirect methodWidely used in context of environmental pollutionAttempts to evaluate attributes of some traded good.Example: Traded good = housingAttribute = Air qualityUses multiple regression analysis to reveal relationship

between house “rents” and levels of all relevant attributes …

…and in doing so yields implied value of clean air.


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THE HEDONIC PRICE METHODTHE HEDONIC PRICE METHOD

The hedonic price method can be used to The hedonic price method can be used to value an attribute, or a change in an value an attribute, or a change in an attribute, whenever its value is capitalized attribute, whenever its value is capitalized into the price of an asset, such as houses or into the price of an asset, such as houses or salaries. salaries.

It consists of two steps. It consists of two steps.

Suppose one wants to estimate the value of Suppose one wants to estimate the value of a scenic view. a scenic view.


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The first step estimates the effect of a The first step estimates the effect of a marginally better scenic view on the value marginally better scenic view on the value (price) of lots (a slope parameter in a (price) of lots (a slope parameter in a regression model), while controlling for other regression model), while controlling for other variables that affect lot prices. variables that affect lot prices.

This results in hedonic price function or implicit price function. The change in the price of a lot that results from a unit change in a particular attribute (i.e., the slope) is called the hedonic price, implicit price, or rent differential of the attribute.


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The second step estimates the WTP for The second step estimates the WTP for scenic views, after controlling for “tastes,” scenic views, after controlling for “tastes,” which are proxied by income and other which are proxied by income and other socioeconomic factors.socioeconomic factors.

To account for different incomes and To account for different incomes and tastes, analysts should estimate the tastes, analysts should estimate the following WTP function (inverse demand following WTP function (inverse demand curve) for scenic views:curve) for scenic views:


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Revealed Preference Approaches- Revealed Preference Approaches- Hedonic Wage StudiesHedonic Wage Studies

The hedonic wage approach is based on the The hedonic wage approach is based on the idea that an individual will choose the city in idea that an individual will choose the city in which he or she resides in order to maximize which he or she resides in order to maximize his/her utility.his/her utility.

The individual will consider wages and a host of The individual will consider wages and a host of other positive (educational or recreation other positive (educational or recreation opportunities) and negative (crime, pollution) opportunities) and negative (crime, pollution) factors.factors.

Wages adjust to compensate people for Wages adjust to compensate people for different city characteristics.different city characteristics.


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Revealed Preference Approaches- Revealed Preference Approaches- Hedonic Wage StudiesHedonic Wage Studies

Suppose a person has two job offers, one in a cold weather city and Suppose a person has two job offers, one in a cold weather city and the other in a warm weather city.the other in a warm weather city.

Suppose each job offers the same salary.Suppose each job offers the same salary. If the person chooses the warm weather job, and others do too, the If the person chooses the warm weather job, and others do too, the

labor pool will increase in the warm weather city and wages will fall. labor pool will increase in the warm weather city and wages will fall. The reverse happens in the cold weather city.The reverse happens in the cold weather city. The difference between the wages in the warm weather city and the The difference between the wages in the warm weather city and the

cold weather city compensates people for the disutility of living in the cold weather city compensates people for the disutility of living in the cold weather.cold weather.

This This compensating differentialcompensating differential can be used to look at value placed on can be used to look at value placed on environmental amenities or risk.environmental amenities or risk.

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