Lecture 11: Valuation of Environmental Lecture 11: Valuation of Environmental AmenitiesAmenities

Kristin KieselKristin Kiesel

UC BerkeleyUC Berkeley

• Types of Environmental Benefits

• Concepts in Benefit Measurements

• Measurement Issues

• Market and Non-Market Valuation Methods

Types of Environmental BenefitsTypes of Environmental Benefits

Use benefitsUse benefits refer to the utility arising from direct or refer to the utility arising from direct or indirect indirect physical use physical use of a resource including commercial of a resource including commercial use, recreational use, and aesthetic use:use, recreational use, and aesthetic use:

Consumptive use benefitsConsumptive use benefits are private benefits that are derived are private benefits that are derived from resource consumption and contribute to resource depletion. from resource consumption and contribute to resource depletion. Examples are farming, forestry, fishing, grazing, hunting, Examples are farming, forestry, fishing, grazing, hunting, mining. mining.

Non-consumptive use benefitsNon-consumptive use benefits are generally public good are generally public good benefits that do not contribute to resource depletion. Examples benefits that do not contribute to resource depletion. Examples are swimming, boating, hiking, camping, viewing wildlife, are swimming, boating, hiking, camping, viewing wildlife, observing scenic forests, mountains, rivers, waterfalls, etc.observing scenic forests, mountains, rivers, waterfalls, etc.

• Non-use benefitsNon-use benefits refer to utility that is derived from refer to utility that is derived from environmental resources without physical interaction with environmental resources without physical interaction with the resource:the resource:

Option value benefitsOption value benefits arise in situations where depleting a arise in situations where depleting a resource would be an irreversible action. It is derived from resource would be an irreversible action. It is derived from maintaining the option to utilize it in the future. For example, maintaining the option to utilize it in the future. For example, extinct plants could have medicinal value that can not be extinct plants could have medicinal value that can not be discovered anymore.discovered anymore.

Vicarious consumption benefitsVicarious consumption benefits refers to utility derived from refers to utility derived from

the consumption of environmental resources by other the consumption of environmental resources by other individuals. For example, you might like it, if friends that visit individuals. For example, you might like it, if friends that visit you get to see a whale.you get to see a whale.

Types of Environmental Benefits (cont.)Types of Environmental Benefits (cont.)

Stewardship benefitsStewardship benefits are moral benefits that we derive from are moral benefits that we derive from knowing that we are doing our parts as stewards of the worlds’ knowing that we are doing our parts as stewards of the worlds’ resources:resources:

• Bequest benefitsBequest benefits refer to utility derived from passing an refer to utility derived from passing an environmental resource on to children and/or future generations.environmental resource on to children and/or future generations.

• Existence value, or inherent benefitsExistence value, or inherent benefits refer to utility derived refer to utility derived from the knowledge of the mere existence of environmental from the knowledge of the mere existence of environmental resources. You might never see many of the endangered species resources. You might never see many of the endangered species but you might still value their existence. but you might still value their existence.

Types of Environmental Benefits (cont.)Types of Environmental Benefits (cont.)

Concepts in Benefit MeasurementsConcepts in Benefit Measurements

• Willingness to pay (WTP)Willingness to pay (WTP) is the is the maximummaximum amount of money an amount of money an individual would give up in exchange for all the benefits associated individual would give up in exchange for all the benefits associated with an environmental resource. We can think of WTP as the area with an environmental resource. We can think of WTP as the area under an individual’s demand curve as an individual would be willing under an individual’s demand curve as an individual would be willing to pay an amount equal to the total benefits received from the to pay an amount equal to the total benefits received from the environmental good.environmental good.

• Willingness to accept (WTA)Willingness to accept (WTA) is the is the minimumminimum total amount of money total amount of money an individual would accept to an individual would accept to foregoforego all the benefits associated with all the benefits associated with an environmental resource. It is the opposite of WTP in terms of an environmental resource. It is the opposite of WTP in terms of resource allocation or property rights. resource allocation or property rights.

WTP < = > WTA?WTP < = > WTA?WTP is bounded by an individual’s WTP is bounded by an individual’s budget constraintbudget constraint (or income), (or income), WTA is not.WTA is not.

Measurement IssuesMeasurement Issues

• UncertaintyUncertainty about the amount of benefits, especially when we talk about future benefits about the amount of benefits, especially when we talk about future benefitsExample:Example: – Suppose the Department of Fish and Wildlife is considering a management project that improves fish habitat in a Suppose the Department of Fish and Wildlife is considering a management project that improves fish habitat in a

trout-fishing stream. trout-fishing stream. – Suppose that without the program the outcome is certain and equal to a "Status Quo Benefit,”. The outcome of the 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 project, however, is uncertain with three possible outcomes for which the department has rough probability measures:measures:

Probability:Probability: Possible Outcome Under the Project:Possible Outcome Under the Project:1/21/2 Status Quo Benefit + $6M.Status Quo Benefit + $6M.1/41/4 Status Quo Benefit + $3M.Status Quo Benefit + $3M.1/41/4 Status Quo Benefit + $9M Status Quo Benefit + $9M

Expected benefit: Expected benefit: Expected Benefit of no action = Status Quo BenefitExpected Benefit of no action = Status Quo Benefit Expected Benefit with project = Status Quo Benefit + 1/2 · $6M + 1/4 · Expected Benefit with project = Status Quo Benefit + 1/2 · $6M + 1/4 ·

$3M + 1/4 · $9M $3M + 1/4 · $9M = Status Quo Benefit + $6M.= Status Quo Benefit + $6M.

Risk aversion:Risk aversion: If uncertainty decreases the department’s willingness to pay relative to the expected If uncertainty decreases the department’s willingness to pay relative to the expected benefit of the project. A benefit of the project. A risk averserisk averse department has a WTP of less than $6M. department has a WTP of less than $6M.

Risk Premium:Risk Premium: The difference between the expected benefits and maximum WTP by the department. If The difference between the expected benefits and maximum WTP by the department. If the department has WTP = $5M, then the Risk Premium on the project equals $1M.the department has WTP = $5M, then the Risk Premium on the project equals $1M.

• HeterogeneityHeterogeneity in valuation of environmental amenities in valuation of environmental amenities

Market and Non-Market Valuation Methods Market and Non-Market Valuation Methods

• Market ValuesMarket Values: : The use of market prices is the most direct method The use of market prices is the most direct method (e.g. resort skiing, commercial whale watching, etc.). But: (e.g. resort skiing, commercial whale watching, etc.). But:

1) 1) Market FailureMarket Failure often occurs when providing environmental often occurs when providing environmental resources due to resources due to externalities.externalities.

2) Many environmental resources are 2) Many environmental resources are not not traded in marketstraded in markets due todue to public good public good character.character.

Alternative methodsAlternative methods

Market and Non-Market Valuation Methods (cont.)Market and Non-Market Valuation Methods (cont.)

• Engineering and agronomical cost methods:Engineering and agronomical cost methods:If natural resources can be restored (such as forests) If natural resources can be restored (such as forests) engineering and agronomical techniques of mathematical engineering and agronomical techniques of mathematical programming can be applied to estimate the cost of programming can be applied to estimate the cost of restoration.restoration.

• Hedonic price functionsHedonic price functions

• Travel cost methodsTravel cost methods

• Survey and interviewing techniques: Contingent Survey and interviewing techniques: Contingent Valuation (CV)Valuation (CV)

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?

P a1Z1 a2Z2 ......... anZn

Travel Cost MethodsTravel Cost Methods

• The value of recreational amenities is inferred from The value of recreational amenities is inferred from associated expenditures.associated expenditures.

• The travel cost method uses actual travel expenditures (e.g. The travel cost method uses actual travel expenditures (e.g. gas, plane tickets, etc.), and opportunity costs of time (e.g. gas, plane tickets, etc.), and opportunity costs of time (e.g. wage rate) to infer valuation of recreational activities. wage rate) to infer valuation of recreational activities.

Example:Example:

• Assume there is only one lake in a region (e.g. lake Tahoe). It attracts 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 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 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 and car use cost $6/travel hour per visitor. Entry cost is $2/visit. Thus, the total travel cost is:total travel cost is:

40,000 * [8 * 7 + 6 * 2 + 2] = 40,000 * 70 = $2,800,00040,000 * [8 * 7 + 6 * 2 + 2] = 40,000 * 70 = $2,800,000

• Issues?Issues?

Travel Cost Methods (Cont.)Travel Cost Methods (Cont.)

• The $2.8 million per month is an estimate of a lower bound on WTP 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 for recreational benefits from the lake, because anyone that finds it optimal to spend time at the lake must receive at least enough benefit 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 to cover the travel cost of getting to the lake, but might receive considerably more. considerably more.

• If there are other substitute lakes, travel cost methods become more If there are other substitute lakes, travel cost methods become more complex. For example, closure of one lake for a specific recreational complex. For example, closure of one lake for a specific recreational activity will cause some people to use substitute lakes. In turn, these activity will cause some people to use substitute lakes. In turn, these get more congested and the benefits of using them will decline. 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 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 account for more than one activity in one trip or visits of multiple sites.sites.

Survey and Interviewing Techniques: Survey and Interviewing Techniques: Contingent Valuation Method (CV)Contingent Valuation Method (CV)

• In a lot of instances, there is no other way to elicit non-In a lot of instances, there is no other way to elicit non-market values than just to ask people directly: market values than just to ask people directly:

– How much would you be WTP for an amenity?How much would you be WTP for an amenity?

– How much would you be WTA to forego an amenity?How much would you be WTA to forego an amenity?

– How would you vote for a proposition involving an environmental How would you vote for a proposition involving an environmental or resource use choice?or resource use choice?

• Issues?Issues?

Major Issues with CV EstimatesMajor Issues with CV Estimates• Strategic biasStrategic bias (Not telling the truth): Individuals may report benefits higher (Not telling the truth): Individuals may report benefits higher

or lower than their true benefits in order to advance their own agenda or to or lower than their true benefits in order to advance their own agenda or to hinder the agenda of someone else.hinder the agenda of someone else.

• Framing bias:Framing bias: People's answers may vary according to the context in which People's answers may vary according to the context in which a question is put. For example, answers to a WTP question may differ a question is put. For example, answers to a WTP question may differ depending on whether the depending on whether the starting pointstarting point of the initial value is $0 or $100. of the initial value is $0 or $100.

• Ill-formed preferencesIll-formed preferences:: People may not have well-formed preferences (e.g., People may not have well-formed preferences (e.g., WTP and WTA) for unfamiliar goods (e.g., a native of Kansas may not have 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 well-formed preferences for an endangered fish in California that he had never heard of before the survey).never heard of before the survey).

• Information bias:Information bias: Failure to comprehend or to interpret questions correctly. Failure to comprehend or to interpret questions correctly. People are limited in their capacity to process, analyze, and retain People are limited in their capacity to process, analyze, and retain information. For example, people may infer that an issue is important (and information. For example, people may infer that an issue is important (and thus has positive WTP) simply because they receive information from a thus has positive WTP) simply because they receive information from a survey, but may have had zero WTP beforehand.survey, but may have had zero WTP beforehand...