Download Session 14 Non-Market Valuation

Session 14
Non-Market Valuation
Morteza Rahmatian
California State University, Fullerton
[email protected]
Ashgabad, November, 2005
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Notion of placing a value on nature
“knowing the price of everything but
the value of nothing.”
Value and prices are separate ideas.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
What is value?
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First, the economic view of “value” is
anthropocentric.
This means value is determined by people and
not by either natural law or government.
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Second, value is determined by peoples’
willingness to make trade-offs.
When an individual spends money on one good,
there is less available for other goods.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
The argument against..
The notion that cars, houses and bus
rides have prices. Putting a price on the
environment destroys the notion that it
has value - rather it becomes a chattel
that can be sold off.
How much would you be willing to pay to
forego your freedom or health?
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Why is monetary valuation
important?
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Planning process is influenced by economic analysis
(CBA)
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Goods and services which have quantities and prices
can be taken into account in decision-making process
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Economic valuation helps to bring the environment into
decision-making process
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Total Economic Value

Use values
 Direct use (timber, other forest products)
 Indirect use (ecological functions)
 Option value (WTP to conserve for future use)
 Non-use values
 Existence value (WTP to know an asset exists)
 Bequest value (WTP to pass on asset to next
generation)
 TEV = Direct Use Value + Indirect Use Value +
Option Value + Existence Value
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Techniques for Measuring the Value of
Non-market Goods
The three major categories for measuring the value of
non-market goods include:
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Revealed preference techniques, which look at
decisions people make in reaction to changes in
environmental quality.
Stated preference techniques, which elicit values
directly through survey methods.
Benefits-transferred techniques, which look at existing
studies for value of analogous environmental change.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Techniques to place monetary
values on environmental impacts
Market based methods
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Production function approach
Cost of illness approach
Cost-based approaches
Travel Cost Method
Hedonic pricing Approach
Non-market based methods
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Contingent valuation Method
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Production function approach

The environment is an input into the production
of a marketed good
 Based on damage function which relates cause
(soil erosion) to effect/damage (reduced soil
fertility)

Applicability: deforestation, wetland and reef
destruction, water pollution in agricultural and
fisheries
 Measures ‘use’ value of resources
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Cost of Illness Approach

Costs of air/water pollution estimated by looking
at costs of human health impact
 Dose-response function identifies relationship
between level of pollutant and degree of health
effect (water quality and diarrhoea)
 Value health effect based on cost of illness,
including
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cost of medicine, doctors visits, hospital stays, other
incidental expenses
Loss of earnings due to illness
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Cost of Illness Approach
 Applicability:
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Value health costs of water and air pollution
 Limitations
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Dose-response functions not available locally
Does not measure WTP to avoid illness
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Cost-based approaches
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Replacement cost approach
 Cost effectiveness analysis
 Defensive expenditure approach
Limitations:
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Costs significantly underestimates benefits
Use when not possible to quantify benefits
Applicability
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When benefits are very difficult to value
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Replacement Cost Approach
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Estimates the costs required to replace
damaged resource or to restore damaged
resource to original state
 Applicability:
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When remedial action must be taken to meet a
standard (air or water quality)
When environmental effect requires expenditure to
replace natural asset (roads, dams, soil, water)
Limitations:
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Assumes complete replacement or restoration is
possible
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Cost-effectiveness analysis
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Choose the most cost-effective means of
reaching a pre-set target
 Applicability:
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Examples:
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Social programmes (health and population)
maximum level of exposure to a waterborne disease
agent
emission standard for industrial facilities
Limitations:
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Compares alternative means of reaching target, but
can not identify whether alternative are all too costly
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Defensive/Preventative Expenditure
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People act to pre-empt damage
Expenditures provide estimate of minimum valuation of
potential damage to health or environment
Applicability:
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Example:
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Assess demand for public services (water supply, electricity,
rubbish collection)
To assess demand for urban water supply project, look at how
much people pay for water from other sources to avoid exposure
to water-borne pathogens
Provides lower-bound estimate of social benefits of
public services
Limitations:
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There must be no secondary benefits to expenditure
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Travel Cost Method
 Uses
expenditures (transport costs and
time) to reach a site to estimate
willingness to pay
 Application:
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Recreational areas, national parks,
historic/cultural sites
Time spent collecting fuel wood and water
 Limitations:
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Requires survey, skills
Measures only use value
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Travel Cost Method
The travel cost method
The second assumption is that the cost of a visit
comprises both:
Travel costs Ti, varying with i
Admission 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).
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Contingent valuation
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Ask individuals what they are WTP for a change in
environmental attribute
Based on hypothetical market
Requires that respondents understand well the good
they are being offered and that they answer truthfully
Application:
 Changes in the provision of public services
 Only method to measure existence value
Limitations
 Requires rigorous survey, economic skills
 Due to hypothetical nature, subject to many biases
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
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?)
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Hedonic Methods Approach
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Uses market price of a good to estimate the value of an
environmental attribute which is embedded in the price of
the marketed good
Example: house (size, construction, location, environmental
and aesthetic attributes, e.g. clean air)
Application
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property prices and air pollution/aesthetic traits and access to water
supply and rubbish collection
Job markets and risks to life
Limitations:
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requires survey, lots of data, economic theory/econometrics
Relies on existence of properly functioning land/property and labour
market
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Hedonic Methods Approach
An indirect method
Widely used in context of environmental pollution
Attempts to evaluate attributes of some traded good.
Example:
Traded good = housing
Attribute = Air quality
Uses 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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
THE HEDONIC PRICE METHOD
The hedonic price method can be used to
value an attribute, or a change in an
attribute, whenever its value is capitalized
into the price of an asset, such as houses or
salaries.
It consists of two steps.
Suppose one wants to estimate the value of
a scenic view.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
THE HEDONIC PRICE METHOD
The first step estimates the effect of a
marginally better scenic view on the value
(price) of lots (a slope parameter in a
regression model), while controlling for other
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.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
THE HEDONIC PRICE METHOD
The second step estimates the WTP for
scenic views, after controlling for “tastes,”
which are proxied by income and other
socioeconomic factors.
To account for different incomes and
tastes, analysts should estimate the
following WTP function (inverse demand
curve) for scenic views:
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Revealed Preference ApproachesHedonic Wage Studies

The hedonic wage approach is based on the
idea that an individual will choose the city in
which he or she resides in order to maximize
his/her utility.
 The individual will consider wages and a host of
other positive (educational or recreation
opportunities) and negative (crime, pollution)
factors.
 Wages adjust to compensate people for
different city characteristics.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF
Revealed Preference ApproachesHedonic Wage Studies
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Suppose a person has two job offers, one in a cold weather city and
the other in a warm weather city.
Suppose each job offers the same salary.
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.
The reverse happens in the cold weather city.
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.
This compensating differential can be used to look at value placed on
environmental amenities or risk.
Caspian EVE 2005/UNDP and WBI
Morteza Rahmatian, Non-Market Valuation
GEF