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Measuring the Benefits of
Environmental Protection
Introduction
Market benefits
Nonmarket benefits

Nonmarket benefits are determined by
inferring how much people would be
willing to pay or accept for these benefits
if a market for them did exist
Use, Option, and Existence Value

The nonmarket benefits of environmental
protection:
 Use: value in use
 Option: a resource has option value if the
future benefits are uncertain and resource
depletion is irreversible
 Existence: obtaining value from the existence
of a species

Total Value = Use + Option + Existence
Measuring Benefits:
Consumer Surplus
The benefit measure for pollution
reduction is the increase in consumer
surplus due to such a reduction
 Consumer surplus is the difference
between what one is willing to pay and
what one actually has to pay for a
service or a project

Consumer Surplus
from Preservation
Measuring Benefits:
WTP and WTA

There are two ways to determine
surplus:
 Willingness-to-pay (WTP) for improved
quality
 Willingness-to-accept (WTA) compensation
in exchange for degraded quality

In theory, because income differences
are small, WTA should be only a bit
higher than WTP
Problems with WTA and WTP

WTA values are typically 2 to 7 times as
high as WTP values
 This difference persists even in tests
specifically designed to control for inflated
WTA figures
Problems with WTA and WTP
Explaining WTP/WTA Disparities:
1. Prospect theory: people may adopt the
status quo as their reference point and
demand higher compensation to allow
environmental degradation than they are
willing to pay to make improvements
 If prospect theory is correct, it would
reshape our marginal benefit curve for
pollution reduction
Prospect Theory and Marginal
Benefits of Cleanup
Explaining WTP/WTA Disparities:
Substitution
2. The degree of substitutability between
environmental quality and other
consumption goods
 Do environmental goods really have no
good substitutes?
WTP/WTA Disparities:
Which to Use?
The standard practice is to use WTP
because WTA estimates may be less
reliable
 But if we think of common property as
belonging to “the people” then WTA may be
the best measurement
 With either WTA or WTP, the use of
consumer surplus as our benefit measure
automatically leads to higher benefits for
clean-up in wealthier communities.

Risk: Assessment
and Perception
Step 1 in measuring the benefits of
pollution reduction: assess the risks
 Information on health risks come from two
sources:

 Epidemiological: studying past cases of
human exposure
 Animal studies from laboratories
Risk Comparisons:
peanut butter?!
Risk: PCBs
Epidemiological studies have shown that
PCBs cause developmental abnormalities
such as low birth weights and less
developed cognitive and motor weights;
there is also limited evidence of a link
between exposure to PCBs and certain
cancers
 In animal studies PCBs have been found to
generate cancers
 These studies have led the EPA to label
PCBs as “probable human carcinogens”

Making Predictions
Translating information from high-dose
animal studies to low dose human
exposure often generates a much higher
estimated risk of cancer in humans than
other models
 Because of this researchers often adopt
a “conservative” modeling stance

Perceived Risk

Individuals may perceive risk differently
than the actual risk for a few reasons:
 Voluntary vs involuntary risk
 Lack of knowledge
 Distrust of Experts
 People are risk averse
Risk Aversion

An individual is risk averse if they prefer a
“sure thing” to a gamble with a higher
expected payoff:
 E.g.. If I prefer $50 for sure versus a 50%
chance for $110, I am risk averse.
Risk aversion implies that people will dislike
exposure to catastrophic events occuring w/ low
probability more than unpleasant events
occurring w/ high probability– even if they have
the same average cost.
Why is nuclear waste
at the bottom?
Measuring Benefits: Contingent
Valuation
 Contingent
valuation (CV Analysis):
 Survey methods used by economists to
determine the benefits of environmental
protection; the survey responses are
“contingent” upon the questions asked
 Basically, ask people their WTP and/or
WTA
The CV Method of Measuring
Consumer Surplus
Sources of Error in CVs

Hypothetical Bias
 Hypothetical questions  hypothetical responses

Free-riding
 May lead understatement of true WTP

Strategic Bias
 People might inflate their WTP to achieve greater
clean-up if they believe they will not have to pay their
WTP

Embedding Bias
 Answers are strongly affected by the context provided
about the issue at stake: MAIN PROBLEM!
CV: useful or useless?
Economists disagree about the reliability of CV
analysis. Doing a ‘state of the art’ job can be
very expensive
○ Analyses of Exxon Valdez oil spill cost $3 million
Such ambitious efforts are relatively rare
 CVs provide the only available means for
estimating the existence value component of
nonmarket benefits, so they are widely used
Measuring Benefits:
Travel Cost
The travel-cost method measures the
amount of money that people expend to
use the resource (parks, rivers, or
beaches)
 By relating differences in travel cost to
differences in consumption, a demand
curve for the resource can be derived
and consumer surplus estimated

Demand Curve Derived from
Travel-Cost Data
Demand Curve Derived from TravelCost Data
Total Consumer Surplus
= Area A surplus + Area B surplus + Area
C surplus
= 1,000 people * (d + e + f)
+ 1,000 people * [(d + e) – 6 * 25]
+ 1,000 people * (d – 50)

Problems With the
Travel Cost Method
People have different opportunity costs
 Some may have alternative recreational
opportunities that others do not
 The travel cost method has been extended to
address both of these issues

Travel Cost and Beach Values
The value of Florida Beaches (Bell and Leeworthy)
Survey 826 tourists: days spent at the beach and
expenses incurred to use the beach, meals, travel
and access fees, initial travel costs in and out of
the state, length of stay, age, income, and other
control data.
 Hypothesis: holding all the other factors constant,
lower beach expenses --> greater number of days
at the beach.
 Results: a 10% increase in “price” lead to a 1.5%
decrease in time on the beach. Average CS per
day of $38. Over 2 million tourists: $2.37 billion per
year.


Measuring Benefits:
Hedonic Regression
Hedonic regression uses the change in
price from related (complementary) goods
to infer a WTP for a healthier environment
 Confusing label! Hedonic=“pertaining to
pleasure”
 A hedonic regression estimates the
pleasure or utility associated with an
improved environment

Hedonic Regression 1:
Property Values and Pollution
PCB contamination in New Bedford
(Mendehslon et al)
 Compare change in prices for houses sold
before and after contamination became
public. Control for all other factors affecting
home costs.
 Houses closest to the contaminated area:
price declines of $9,000; in area of
secondary pollution, declines of $7,000.
Total damages to home-owners: $36
million

Hedonic Regression 2:
The Value of Human Life
The most ethically charged aspect of
benefit-cost analysis is its requirement
that we put a monetary value on human
life
 Old approach, still used in court
settlements: lifetime earnings. Retired or
disabled person is “worth” $0.
 Economic Approach: wage-risk studies.

Hedonic Regression 2:
The Value of Human Life
Isolate the wage premium people are paid to
accept risk jobs--police officer, firefighter, coal
miner
 With this it is possible to estimate a WTA a
reduction in the risk of death, and implicitly, the
value of life
 Holding all else equal, suppose we observe that
police officers receive extra pay of $500/yr. If the
excess risk of death is 1/10,000 per year then
collectively, 10,000 officers trade one of their lives
each year for $500*10,000=$5 million.

Problems:
1. Accurate information
 Individuals might underestimate or
overestimate risk of death
2. Sample selection bias
 People accepting risky jobs are not likely
representative of the “average” person with
preference toward risk-aversion
3. Involuntary nature of risk
 People may require more to accept risk
imposed upon them without their consent
The Value of a Life

The value obtained from a hedonic
regression is not the value of a specific life
 We would pay just about anything to save our
own life or that of a loved one!

Instead, this is the amount of money the
average individual in a society requires to
accept a higher risk of death
Morally OK?
 As
with any measure of consumer
surplus, this method will put a much
larger value on life for folks from rich
than from poor countries.
 USA: $7 million
 Pakistan: $300,000
Review of Measuring Benefits
1. Is consumer surplus a good measure of
benefits, especially for valuing life?
 2. Which measure should be used: WTP
or WTA?
 3. How reliable is the risk assessment?
 4. How good are the benefit measures?
 5. What discount rate is used to value
future benefits?

WTA and WTP Redux
WTA/WTP: Perfect Substitutes
WTA/WTP: Poor Substitutes
Prospect Theory
or Substitutability?
One study using candy bars and risk of
salmonella from sandwiches, to determine
peoples’ WTA and WTP. Provided support
for the “no-good substitutes” explanation
for the WTA/WTP discrepancy
 Advocates of prospect theory argue people
do not become as attached to a candy bar
or sandwich as they do to a grove of trees
in a local park

Prospect Theory
or Substitutability?
 People are attached to the status quo
because there are no good substitutes for
environmental degradation from the status
quo
 In this sense, the two explanations converge