Lecture 11 Valuation of Environmental Amenities Kristin Kiesel

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Lecture 11: Valuation of Environmental Amenities Kristin Kiesel UC Berkeley

Lecture 11: Valuation of Environmental Amenities Kristin Kiesel UC Berkeley

 • Types of Environmental Benefits • Concepts in Benefit Measurements • Measurement Issues

• Types of Environmental Benefits • Concepts in Benefit Measurements • Measurement Issues • Market and Non-Market Valuation Methods

Types of Environmental Benefits Use benefits refer to the utility arising from direct or

Types of Environmental Benefits Use benefits refer to the utility arising from direct or indirect physical use of a resource including commercial use, recreational use, and aesthetic use: v Consumptive use benefits are private benefits that are derived from resource consumption and contribute to resource depletion. Examples are farming, forestry, fishing, grazing, hunting, mining. v Non-consumptive use benefits are generally public good benefits that do not contribute to resource depletion. Examples are swimming, boating, hiking, camping, viewing wildlife, observing scenic forests, mountains, rivers, waterfalls, etc.

Types of Environmental Benefits (cont. ) • Non-use benefits refer to utility that is

Types of Environmental Benefits (cont. ) • Non-use benefits refer to utility that is derived from environmental resources without physical interaction with the resource: v Option value benefits arise in situations where depleting a resource would be an irreversible action. It is derived from maintaining the option to utilize it in the future. For example, extinct plants could have medicinal value that can not be discovered anymore. v Vicarious consumption benefits refers to utility derived from the consumption of environmental resources by other individuals. For example, you might like it, if friends that visit you get to see a whale.

Types of Environmental Benefits (cont. ) v. Stewardship benefits are moral benefits that we

Types of Environmental Benefits (cont. ) v. Stewardship benefits are moral benefits that we derive from knowing that we are doing our parts as stewards of the worlds’ resources: • Bequest benefits refer to utility derived from passing an environmental resource on to children and/or future generations. • Existence value, or inherent benefits refer to utility derived from the knowledge of the mere existence of environmental resources. You might never see many of the endangered species but you might still value their existence.

Concepts in Benefit Measurements • Willingness to pay (WTP) is the maximum amount of

Concepts in Benefit Measurements • Willingness to pay (WTP) is the maximum amount of money an individual would give up in exchange for all the benefits associated with an environmental resource. We can think of WTP as the area under an individual’s demand curve as an individual would be willing to pay an amount equal to the total benefits received from the environmental good. • Willingness to accept (WTA) is the minimum total amount of money an individual would accept to forego all the benefits associated with an environmental resource. It is the opposite of WTP in terms of resource allocation or property rights. WTP < = > WTA? WTP is bounded by an individual’s budget constraint (or income), WTA is not.

Measurement Issues • Uncertainty about the amount of benefits, especially when we talk about

Measurement Issues • Uncertainty about the amount of benefits, especially when we talk about future benefits Example: – Suppose the Department of Fish and Wildlife is considering a management project that improves fish habitat in a trout-fishing stream. – Suppose that without the program the outcome is certain and equal to a "Status Quo Benefit, ”. The outcome of the project, however, is uncertain with three possible outcomes for which the department has rough probability measures: Probability: Possible Outcome Under the Project: 1/2 Status Quo Benefit + $6 M. 1/4 Status Quo Benefit + $3 M. 1/4 Status Quo Benefit + $9 M Ø Expected benefit: Expected Benefit of no action = Status Quo Benefit Expected Benefit with project = Status Quo Benefit + 1/2 · $6 M + 1/4 · $3 M + 1/4 · $9 M = Status Quo Benefit + $6 M. Ø Risk aversion: If uncertainty decreases the department’s willingness to pay relative to the expected benefit of the project. A risk averse department has a WTP of less than $6 M. Ø Risk Premium: The difference between the expected benefits and maximum WTP by the department. If the department has WTP = $5 M, then the Risk Premium on the project equals $1 M. • Heterogeneity in valuation of environmental amenities

Market and Non-Market Valuation Methods • Market Values: The use of market prices is

Market and Non-Market Valuation Methods • Market Values: The use of market prices is the most direct method (e. g. resort skiing, commercial whale watching, etc. ). But: 1) Market Failure often occurs when providing environmental resources due to externalities. 2) Many environmental resources are not traded in markets due to public good character. Alternative methods

Market and Non-Market Valuation Methods (cont. ) • Engineering and agronomical cost methods: If

Market and Non-Market Valuation Methods (cont. ) • Engineering and agronomical cost methods: If natural resources can be restored (such as forests) engineering and agronomical techniques of mathematical programming can be applied to estimate the cost of restoration. • Hedonic price functions • Travel cost methods • Survey and interviewing techniques: Contingent Valuation (CV)

Hedonic Price Functions • • Goods in general can be thought of as bundles

Hedonic Price Functions • • Goods in general can be thought of as bundles of characteristics. The hedonic price function approach is a method that infers the marginal value of each characteristic (Zi) form the price of the combined bundle: • Implicit prices or valuation (ai) of environmental quality such as air quality can be deduced from market prices of goods such as house prices (e. g. Chay and Greenestone 2005) using statistical analysis and econometric techniques. • Issues?

Travel Cost Methods • The value of recreational amenities is inferred from • associated

Travel Cost Methods • The value of recreational amenities is inferred from • associated expenditures. The travel cost method uses actual travel expenditures (e. g. gas, plane tickets, etc. ), and opportunity costs of time (e. g. wage rate) to infer valuation of recreational activities. Example: • Assume there is only one lake in a region (e. g. lake Tahoe). It attracts 40, 000 visitors/month. Each visitor spends 5 hours boating and 2 hours traveling. The opportunity cost of time is $8/hr for every individual. Gas and car use cost $6/travel hour per visitor. Entry cost is $2/visit. Thus, the total travel cost is: 40, 000 * [8 * 7 + 6 * 2 + 2] = 40, 000 * 70 = $2, 800, 000 • Issues?

Travel Cost Methods (Cont. ) • The $2. 8 million per month is an

Travel Cost Methods (Cont. ) • The $2. 8 million per month is an estimate of a lower bound on WTP for recreational benefits from the lake, because anyone that finds it optimal to spend time at the lake must receive at least enough benefit to cover the travel cost of getting to the lake, but might receive considerably more. • If there are other substitute lakes, travel cost methods become more complex. For example, closure of one lake for a specific recreational activity will cause some people to use substitute lakes. In turn, these get more congested and the benefits of using them will decline. • Travel costs vary based on the starting point of the trip. How does one account for more than one activity in one trip or visits of multiple sites.

Survey and Interviewing Techniques: Contingent Valuation Method (CV) • In a lot of instances,

Survey and Interviewing Techniques: Contingent Valuation Method (CV) • In a lot of instances, there is no other way to elicit nonmarket values than just to ask people directly: – How much would you be WTP for an amenity? – How much would you be WTA to forego an amenity? – How would you vote for a proposition involving an environmental or resource use choice? • Issues?

Major Issues with CV Estimates • Strategic bias (Not telling the truth): Individuals may

Major Issues with CV Estimates • Strategic bias (Not telling the truth): Individuals may report benefits higher or lower than their true benefits in order to advance their own agenda or to hinder the agenda of someone else. • Framing bias: People's answers may vary according to the context in which a question is put. For example, answers to a WTP question may differ depending on whether the starting point of the initial value is $0 or $100. • Ill-formed preferences: People may not have well-formed preferences (e. g. , WTP and WTA) for unfamiliar goods (e. g. , a native of Kansas may not have well-formed preferences for an endangered fish in California that he had never heard of before the survey). • Information bias: Failure to comprehend or to interpret questions correctly. People are limited in their capacity to process, analyze, and retain information. For example, people may infer that an issue is important (and thus has positive WTP) simply because they receive information from a survey, but may have had zero WTP beforehand. .