Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 3 Valuing the Environment: Methods

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-2 Introduction This chapter examines valuation methods of environmental resources. This chapter will also discuss the various valuation techniques.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-3 Objectives Outline the complexities of cost-benefit analysis including the monetization of costs and benefits. Define types of values: use value, option value, existence value and total willingness to pay. Classify the available nonmarket valuation methods by whether they are based on observed behavior or a hypothetical market and whether they are direct or indirect. Present the potential biases associated with the contingent valuation method.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-4 Provide an overview of cost estimation methods. Illustrate other complexities including the valuation of human life, benefits transfers, the monetization of intangibles, the treatment of risk and the choice of the discount rate. Present alternatives to benefit-cost analysis: cost- effectiveness analysis and impact analysis. Illustrate the valuation of the environment using examples.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-5 Why Value the Environment? Many federal agencies require benefit/cost analysis for decision-making.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-6

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-7

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-8 Valuing Benefits Types of Values  Use Value the willingness to pay for direct use of the environmental resource  Option Value the willingness to pay for the future ability to use the environment  Nonuse Value individuals’ willingness to pay to preserve a resource that he or she will never use

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 3-9  Total willingness to pay (TWP) TWP = Use Value + Option Value + Nonuse Value

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.1

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.1 (continued)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Valuing Benefits Classifying Valuation Methods  Revealed preference methods Methods which are based on actual observable choices and from which actual resource values can be directly inferred  Direct stated preference methods Methods to elicit respondents’ TWP when the value is not directly observable

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Valuing Benefits Classifying Valuation Techniques  Contingent Valuation Method  Travel Cost Models  Hedonic Property Value and Hedonic Wage Approaches  Contingent Ranking and Conjoint Analysis

Copyright © 2009 Pearson Addison-Wesley. All rights reserved TABLE 3.1 Economic Methods for Measuring Environmental and Resource Values

Copyright © 2009 Pearson Addison-Wesley. All rights reserved  Contingent valuation method It is to elicit people’s willingness-to-pay (WTP) in a hypothetical market Major concerns include strategic bias, information bias, starting-point bias, hypothetical bias and discrepancy between WTP and willingness-to-accept (WTA) A NOAA panel (1993) legitimized the use of contingent valuation. Meta-analysis utilizes a cross section of contingent valuation studies for determining non-use values and could eliminate the biases.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.3

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.3

Copyright © 2009 Pearson Addison-Wesley. All rights reserved  Travel Cost Models infer values of recreational resources by determining how much visitors spent getting to a site and then using this information to estimate a demand curve for that site.  Hedonic property value and hedonic wage approaches use regression analysis to infer environmental values from spending on goods which include those values.  Contingent ranking and conjoint models are useful when project options have multiple levels of different attributes.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved TABLE 3.2 Attributes in the Maine Forest Harvesting Conjoint Analysis

Copyright © 2009 Pearson Addison-Wesley. All rights reserved TABLE 3.3 A Sample Conjoint Analysis Survey Questionnaire

Copyright © 2009 Pearson Addison-Wesley. All rights reserved  Using Geographic Information Systems for Economic Valuation Incorporating spatial dimensions into economic analysis, for example, in hedonic property valuation models (Example 3.4)  Valuing Human Life Controversial subject  Focusing on calculating the change in the probability of death resulting from a reduction in some environmental risk and then placing a value on that change (Table 3.4)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.4

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.4

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. TABLE 3.4 The Cost of Risk- Reducing Regulations

Copyright © 2009 Pearson Addison-Wesley. All rights reserved TABLE 3.4 The Cost of Risk-Reducing Regulations (1 of 2)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved TABLE 3.4 The Cost of Risk-Reducing Regulations (2 of 2)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Issues in Benefit Estimation  Primary Versus Secondary Effects Considering both primary and secondary consequences while implementing environmental projects  Tangible Versus Intangible Benefits Tangible benefits can reasonably be assigned a monetary value. Intangible benefits cannot be assigned a monetary value.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Approaches to Cost Estimation The Survey Approach  Involves asking polluters about their control costs The Engineering Approach  Using engineering information to estimate the technologies available and the costs of purchasing and using those technologies. The Combined Approach  Combining both survey and engineering approaches

Copyright © 2009 Pearson Addison-Wesley. All rights reserved The Treatment of Risk A dominant policy is one which confers the higher net benefits in every outcome. The expected value of net benefits is the sum over the possible outcomes of the present value of net benefits of that outcome weighted by its probability of occurrence. The policy selected should be the one with the highest expected present value of net benefits. The evaluation of irreversible decisions requires extra caution.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Choosing the Discount Rate  The appropriate rate to use will depend on the nature and expected lifetime of the project, who is doing the financing and the level of risk (See Example 3.5). A Critical Appraisal  Concerns exist on the reliability of benefit/cost analysis.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.5

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.5

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Cost-Effective Analysis Second Equimarginal Principle (the Cost- Effectiveness Equimarginal Principle):  The least-cost means of achieving an environmental target will have been achieved when the marginal costs of all possible means of achievement are equal (See example 3.6).

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Example 3.6

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Impact Analysis An impact analysis attempts to quantify the consequences of various actions. Impact analysis places a large amount of relatively undigested information at the disposal of the policy-maker.

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Summary Total Economic Value Valuation Methods  Benefit-cost Analysis Valuation Techniques  Cost effective Analysis  Impact Analysis