1. Contingent Valuation Method (CVM) Lecture I Elina Lampi elina.lampi@economics.gu.se elina.lampi@economics.gu.se

2. Traditionally we observe behavior at the market. However, when it comes to some public goods like environmental (or cultural or some health related) goods there might not be a market. It could also be that we want to evaluate something that does not exist today at the market (a new product/service/project). Or a change in a quality (most often an improvement) of an existing good/service/project. Why do we need valuation methods? (1)

3. Solutions to the problem when there is no market: 1) Indirect methods: Revealed preferences based on market behavior (RP). 2) Direct methods: Stated preferences based on hypothetical market and survey/interview methods (SP). I will only talk about stated-preference methods (SP) during this course. Why do we need valuation methods? (2)

4. 1. Contingent valuation (CV) 2. Choice experiment (CE) The basic idea is to, directly, create a market for the public good in a survey/interview situation. Therefore they are usually also called hypothetical methods since no actual (money) transaction is done. Two important facts: 1.We can measure non-use values (existence, bequest and altruistic values). 2.We can evaluate goods/projects/services that does not exist today or a change in a quality of an existing good/project/service. SP Methods :

5. Brief description of the Contingent Valuation Method (CVM) The words contingent valuation is derived from the application of the method since respondents are asked to value contingent upon the occurrence of a hypothetical situation. The main thing is to present a scenario which includes a detailed description of the good to be offered to the respondents as well as how the respondent is to pay for the good. Main question is the valuation question (Willingness to pay question) for that good.

6. CV survey presents household a change in provision of a non-market good of its present level Q 0 to a greater level Q 1. The households are asked to state their maximum WTP to achieve this change. Then we can define an indirect utility function V(.) that describes the maximum amount of utility a household can derive from their income, Y, given the prices of market goods, P, and the level of provision of the non- market good, Q. More formally….(1)

7. The household´s utility will also depend on other demographic and economic factors, S. The household´s indirect utility function in the general form is thus: V(Y,P,S,Q) Assume that increasing the provision of the good in question represents an improvement i.e. Q 1 gives households higher utility than Q 0. Hence: V(Y,P,S,Q 0 )<V(Y,P,S,Q 1 ) More formally…(2)

8. On the other hand, the more they have to pay for the good the less utility they get (higher cost decreases utility). The maximum WTP is the monetary payment that would ensure that household´s wellbeing with the higher level of provision is identical to their wellbeing at the lower level of provision. I.e. WTP is the maximum amount of money a household can give up for the improvement in for example environmental quality without being worse off than in the initial situation with Q 0. More formally….(3)

9. Thus, C is the compensating variation measure of change in welfare. It is the household´s maximum WTP to achieve the increase in provision of the non-market good. V(Y,P,S,Q 0 )= V(Y-C,P,S,Q 1 ) Moreover, a household´s maximum WTP is bounded by their ability to pay. It cannot be larger than their income. More formally….(4)

10. An analyst does not know the household´s true utility model. She/he has to use a model that is an approximation of the true utility function: V (y,p,s,q) + ε, where ε is the part of the true indirect utility that the analyst is unable to estimate. One common way to interprent η is to think that it describes unobserved variation in tastes. More formally….(5)

11. 1. Design the questionnaire including a scenario: Present a scenario that describes a change in a quality of a public good (or a new good) inclusive the WTP-question. The scenario also describes how a respondent would pay for this provision. Include debriefing questions about why respondents answered certain questions the way they did. Often follow up questions about reasons for stating zero WTP. The main steps of a CV study (1)

12. 2. Draw a sample of the population and send out your survey/interview your respondents. 3. Estimate the WTP (usually mean and median). 4. Extrapolate these responses to the whole population, given that your sample is representative. 5. Analyze the determinants of WTP, for example, are men stating different WTP than women? The main steps of a CV study (2)

13. Information gathering about the problem (talk with experts, read material) First draft of scenario Feedback from experts Revision of scenario Focus groups Pilot study If substantial revisions: new pilot (pilot study should be so close to the final survey version as possible) Revisions Main study Analysis Note: Focus groups and pilot studies are extremely valuable tools. However, in reality a CVM-study takes time…

14. What is the change in the good or the change in the quality of the good, and when it will be available. How the respondent will be expected to pay for it (taxes?). How much others will be expected to pay Who will pay (all households?). Conditions for the provision of the good (e.g. more than 50% says Yes). What institutions will be responsible for the delivery of the good or the improvement of the good. More specifically in the scenario

15. We often face the conflict between how much information we CAN give and how much information we NEED to give. Most respondents can not handle to much information. How much, or little, does the respondents know in advance about the problem? How do we communicate complicated matters? Informational content in the scenario

16. Now we will ask you some questions regarding an improved solid waste management a system that may be implemented in your community. Large amounts of funds have to be allocated for collecting solid waste, establishing composting plants, and making compost. According to the budget of urban council of Kandy in year 2000, following amounts had been allocated for solid waste management Wages for labourRs. 924,600 OthersRs. 636,000 If composting units are installed the following expenditures are necessary Investment cost of composting units Rs. 5412,500 Operational cost of composting units Rs. 2480, 520 Example I of a scenario: Waste (an improvement of a private good)

17. Suppose that the high costs of solid waste management make it difficult to implement a proper solid waste management system without people paying for it. Note that the current taxes you pay are inadequate to meet the cost of a proper solid waste disposal. Therefore, an effective solid waste management system will only be implemented if the households in the community pay a sufficient amount of money. Suppose the urban council will collect solid waste by your house once a week, make high quality compost from decomposable solid waste by using composting plants and manage uncompostable solid waste separately. They would collect solid waste from all households that pay a solid waste management fee. Because of the costs of solid waste management a sufficient number of households must choose to participate in the program. Example continued…

18. The fee is per household and paid each month. Every household in the community would pay the same fee. Please remember that this is charged in addition to your municipal taxes. If you use money for this purpose, you cannot use the money for any other purpose.* After the scenario there will be the payment question……(We will come back to them soon) *= the last sentence is to remind about the budget Example continued…..

19. Should be perceived by the respondent to be linked directly to the provision of the good and should be placed directly after the scenario. Should be viewed as mandatory once a commitment has been made, so that respondents take the notion of payment seriously. Typical payment vehicles: - Tax - Utility bills, for example water and electricity bills - Donations In general use coercive payment vehicles. The payment vechile (1)

20. Open-ended How much would you at most pay as solid waste management fee in order for you household to participate in the solid waste management program? Express in per month and per household........................... Rs per month You get a continuous vector of bids. Easy to count mean and median WTP. The payment vechile (2)

21. Closed-ended Single-bounded: Version 2. If the solid waste management fee for your household is Rs....... per month would your household participate in the solid waste management program? 1. Yes2. No If Yes; WTP≥Bid If No; 0≤WTP<Bid The amount they are offered is called for “the bid”. Several bids for different survey versions. (I.e. everybody does not face the same bid). The payment vechile (3)

22. Closed-ended, Double-bounded: 15. If the solid waste management fee for your house hold is Rs X. per month would your household participate in the solid waste management program? 1.Yes  Go to 15b 2.No  Go to 15c 15b. What if the fee for your household instead was Rs 2*X Per month, would your household participate in the solid waste management program? 1. Yes2. No The payment vechile (4)

23. 15c. What if the fee for your household instead was Rs 0.5*X per month, would your household participate in the solid waste management program? 1. Yes2. No So, the respondents end up in four groups: “yes, yes”, “yes, no”, “no, yes”, and “no, no”. The payment vechile (5)

24. An example: First bid=5 if Yes second bid =10 First bid=5 if No second bid =3 (no, no), WTP=0-2 (yes, yes), WTP≥10 (no, yes), WTP=3-4 (yes, no), WTP=5-9 I.e. you get more information than from single-bounded payment. Also here, different bids for different survey versions. The payment vechile (6)

25. Payment card: Which of the amounts listed below best describes your maximum willingness to pay every year, through a tax surcharge, to improve the landscape around Stonehenge in the ways I have just described? 0£0.5 £1 £2 £3 £4 £5 £7.5 £10 £12.5£15 £20 £30 £40 £50 £75 £100 £150 £200> £200 The payment vechile (7)

26. + More information about WTP + No hint about the cost, i.e. avoids anchoring bias -More difficult to answer (people are not used to give a price for a good, they are used to decide whether to buy or not to buy at the given price) - Large non-response rates and zero WTPs - More outliers - More protest biases - Not incentive compatible (People might have incentives to lie...) Incentive compatible = A respondent has NO incentives NOT to state his/her true WTP. Open-ended

27. Since….. if a respondent believes that the level of the provision of the public good is independent of her response, but that her tax liabilities depends on her answers ⇒ incentive to understate her true value for the good. Or if a respondent believes that her response can have some effect on the level of the provision of the good but it will not affect the real payment ⇒ incentive to exaggerate her WTP if she prefers more of the good or incentive to state lower than her true value (or zero) if she prefers less of the good. If not incentive compatible we might get problem with “strategic bias”. We will come back to it when we talk about respondent behaviour.. More about “incentive compatible”:

28. Closed-ended, single-bounded: + Easy to answer + Resemble market transaction + Incentive compatible + In the public good case this resembles a vote for the public good. + Minimize non-response and avoids outliers. - Less information, which means larger sample size is required (more expensive). -Yea-saying. (The answer does not reveal the true WTP) - Empirical studies have shown that WTP often is larger than in open-ended questions. Closed-ended

29. We will consider the risk for people between the ages of 18 and 70 years. There are currently 6 million people in this age group in Sweden. Although the number of people that die in accidents within this age group varies from year to year, we are still able to calculate the average risks based on statistics from different accident types. For example: During a ten year period, 600 adults die in fire accidents in Sweden. We can then say that the average risk of dying in a fire accident is 600 in 6 million. Example II: Risk description (an improvement of a private good)

30. This is the same as saying that the average risk of dying in a fire accident is 6 in 60 000. For road traffic accidents, the risk of dying during a ten year period is 35 in 60 000 while for drowning accidents the risk is 8 in 60 000. We will now require you to answer a number of questions. In each question there is the possibility of taking a measure that will reduce your own personal risk of dying in a particular accident type. Example continued…

31. In each question we assume that your current level of risk is given. This risk will vary between questions and you are only able to reduce this risk by taking the accident prevention measure. Please take this risk as given, even if you believe that you are able to influence this risk in some other way. Example continued…

33. Closed-ended, Double-bounded: + More information, i.e. smaller sample size than in single- bounded. -Not incentive compatible (Interprets the 2 nd bid as the agency would be willing to bargain about the price making the respondent uncertain about the real price). - Evidence that the preferences are not stable over the experiment. The preferences reflected in the first question are not the same as the preferences in the second question. - Anchoring. - yea saying. Closed-ended

34. Payment card: + Several bids, easier than open-ended and more levels than in closed-ended. -Not incentive compatible. - Vulnerable to the values used in the payment card. - Does not work in telephone interviews. Other formats

35. Effects on the climate depending on various reductions in world carbon emissions: In 1988, the United Nations established the Intergovernmental Panel on Climate Change (IPCC). Its purpose is to provide decision-makers and others interested in climate change with an objective, comprehensive, and transparent source of information about climate change and its observed and projected impacts. Example III: climate change (an improvement of a public good)

36. This panel has concluded that carbon dioxide (CO 2 ) emissions from human activity have most likely contributed to the increase in global average temperature by 1°F over the past 100 years. This panel has also concluded that the global temperature will continue to increase because of emissions already in the atmosphere. There are a small number of experts who disagree with the IPCC consensus, but because the IPCC represents the large majority of climate researchers, this survey will use information from the IPCC. Example continued…

37. The table below shows the effects by the year 2050 if the average temperature continues to increase. How much the temperature will increase depends on the amount of future global CO 2 emissions. To limit the temperature increase to just 2°F, 3°F, or 4°F, CO 2 emissions will have to decrease from current levels. If the world does not reduce emissions and continues with “business as usual,” the UN IPCC expects that the temperature will increase by more than 4°F in 2050. This would most likely correspond to large changes in the global ecosystem and most countries would be negatively affected. Example continued

38. Example continued…. Global emissions reduction 85% reduction 60% reduction 30% reduction Temperature increase 2°F increase 3°F increase 4°F increase Harvest Harvests in countries near the equator decrease by 4-6%. Harvests in countries in the northern hemisphere increase by 1–3%. Harvests in countries near the equator decrease by 10–12%. Harvests in countries in the northern hemisphere are unaffected. Harvests in countries near the equator decrease by 14–16%. Harvests in the northern hemisphere decrease by 0–2%. Increased flooding and storms Small tropical islands and lowland countries (for example, Bangladesh) experience increased flooding and storms. Additional low-lying areas in the Americas, Asia, and Africa experience increased flooding and storms. Populous cities face increased flood risks from rivers and ocean storms. Existence of small island countries is threatened. Threatened ecosystems Sensitive ecosystems, such as coral reefs and the Arctic ecosystem, are threatened. Most coral reefs die. Additional sensitive ecosystems and species around the world are threatened. Sensitive and less-sensitive ecosystems and species around the world are threatened.

40. Place more difficult questions as well as questions that respondents might want to ignore (as income) at the end of the survey. The survey and the scenario should not be too long. At the same time you have to be sure that people understand the good to be valued and the changes in the welfare. Test for for selection bias. Respondents and non- respondent might be different due to the survey topic. E.g. environmental friendly persons will answer the survey and others will not respond. Some general remarks (1)

41. Or, respondens with lower incomes do not return the survey instead of stating a lower WTP. Then the results will not be representative for the whole population even if your survey was sent out to a random representative sample of respondents. Compare your sample with numbers at national level! (Ff your study is national.) Try to collect information about non-respondents if possible. Difficult if anonymous answers. Some general remarks (2)

42. Insensitivity to scope In several CV surveys it has been found that the WTP is not very sensitive to the size of the public good. Tested by giving different respondents different survey versions (external) or giving respondents several CV questions (internal). Some observable problematic behavior (1)

43. Warm-glow or “purchase of moral satisfaction” Respondents may get a value from answering in a certain way, for example saying Yes to an environmentally friendly project in order to feel good about themselves. Note: We might also do these things in real life. For example donations in order to feel better. This is likely to be more problematic for goods with a large proportion of non-use values. Some observable problematic behavior (2)

44. Strategic bias (linked to incentive compatible question formats)”: The respondent does not give the true amount for some strategic reason. This typically depends on whether they believe that they: - have to pay as stated -can influence the decision Ways to handle this: -outlier analysis -stress that others will pay too -follow-up questions of reasons for their answer -using median rather than mean Some observable problematic behavior (3)

45. Hypothetical bias Respondents are willing to give more since the WTP question is hypothetical than what they would pay in a real payment situation. This is the major concern with surveys and a lot of it has to do with obtaining warm-glow in the survey situation. The literature assignment of part 2 in this course is about “hypothetical bias”. Some observable problematic behavior (4)

46. Other “biases”: 1.Interviewer bias -Response to please or gain status in the eyes of a particular interviewer. 2. Framing effect -The valuation of a good can depend on the context in which it is framed. 3. Payment vehicle -People often resent taxes and direct payment for things they feel they have a right to. Choose non-controversial, realistic payment vehicle. Some observable problematic behavior (5)