INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS

INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS

FEC 202: INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS
LECTURE NOTES FOR 4TH SEMESTER BSc. WILDLIFE MANAGEMENT & FORESTRY STUDENTS Prepared by: Y.M. Ngaga P.O. Box 3011, CHUO KIKUU MOROGORO, TANZANIA TEL ; Ext. 4601/4604

FEC 202: INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS
CREDIT HOURS 2.0 COURSE OBJECTIVE An attempt to bring students who are beginning the study of natural resources (Wildlife, Forests, Fish, Water) to the concepts of natural resource and environmental economics.

Aims at acquainting students, to various problems and policy issues associated with development and conservation of natural resources in a relatively concise manner.

A better understanding of the accepted procedures and economic rationale behind the exploitation (use), development and conservation of natural resources and environment. Assessment of various policies and strategies used in development and conservation of natural resources and environment.

Course Assessment The traditional 40% of the course work assessment shall be composed of mid-term/ end-term test (30%) and practical (10%)

INTRODUCTION TO NATURAL RESOURCE ECONOMICS
COURSE OUTLINE INTRODUCTION TO NATURAL RESOURCE ECONOMICS PROPERTY RIGHT AND NATURAL RESOURCE USE PUBLIC GOODS AND PRIVATE GOODS MEASURING RESOURCE SCARCITY 5. DECISION-MAKING OVER TIME

6. VALUATION OF NATURAL RESOURCES
Introduction Total Economic Value The structure of a cost-benefit analysis (CBA)

COURSE OUTLINE (CONT’D)
7. VALUATION TECHNIQUES FOR NON MARKET GOODS (Environmental valuation approaches) 7.1 Introduction 7.2 Contingent Valuation Method (CVM) 7.3 The Travel Cost Method 7.4 The Hedonic Pricing Method 7.5 How good are the valuation methods? 8. SUSTAINABLE ECONOMIC DEVELOPMENT, NATURAL CAPITAL STOCKS AND THE ENVIRONMENT 9. ENVIRONMENTAL CONTROL POLICIES

REFERENCES/READINGS Hartwick, J.M. and N.D. Olewiler, The Economics of Natural Resources. Harper and Row, Publishers, New York. – TOPIC 1, 2 & 5 Hanley, N., J.F. Shogren and B. White, Environmental Economics: In theory and practice. Second edition. Macmillan Press Ltd. Hampshire, UK. Hanley, N. And C.L. Splash, Cost-Benefit Analysis and the Environment. Edward Elgar Publishing House. Tietenberg, T Environmental and Natural Resource Economics. Harper Collins College Publishers

5. Barnett, H. J. and Morse, 1967. Scarcity and Growth
5. Barnett, H.J. and Morse, Scarcity and Growth. The Economics of Natural Resource Availability. John Hopkins University Press, Baltimore, Maryland– TOPIC 4. Gregory, G. R Resource Economics for Foresters. John Wiley and Sons. Chapter 11 & 12. – TOPIC 3. Pearce, D. and D. Moran, The Economic value of Biodiversity. The World conservation Union (IUCN), Earthscan, publications Ltd, London.

1.0 Introduction to Natural Resource Economics
1.1 Background Global natural resource use has been an area of concern by everybody for many years. Newspapers and other media remind us regularly of resource exhaustion and other related issues. Fish stock declines, wild-animals declines, the increase of Co2 in the atmosphere, the destruction of forests, land degradation and rapid growing population and its impact on natural resources. Many of these issues reflect on challenges and issues which form a background to the discussion in this course.

Seeking the answers requires that we accumulate a much better understanding about how choices are made in economic system and how those choices affect the natural resources and the environment. Before we delve into the economics of natural resource use, some basic concepts will be presented.

1.2 What are natural resources
To an economist, they are factors of production inputs, which combined with labour, capital and materials produce goods and services. We can think of a natural resource as a unique factor input, but most natural resources have characteristics that make them very similar to capital. First of all, to be used for consumption or in production processes, most natural resources have to be extracted or harvested e.g. copper, forest, fish and animals.

Second, like capital natural resources yield productive services over time. A fish or animal stock, forest or mine is typically able to supply resources for long period of time. Time is a crucial component of the analysis of natural resource use. Time help distinguish between two main types of resources; renewable and non-renewable resources.

1.3 Classification of natural resources
1.3.1 Renewable natural resource A renewable natural resource is one that can supply productive inputs to an economic system indefinitely (i.e. exhibiting a positive natural rate of growth). Examples include fish, forests, solar energy and animals. More recently, environmental resources such as (clean air and water) have come to be recognized as natural resources that may be degraded in the course of economic development.

As in the case of animals, however, many environmental resources have the quality of self-renewal, and common property problems are evident. Non-renewable natural resources A non-renewable natural resource is one with a finite stock or supply which, once used up is gone e.g. oil, natural gas, coal and other minerals. Again, a predominantly capital theoretical problem is present. Should one extract natural resource now, or is wait until later.

But in a sense, all natural resources are renewable
But in a sense, all natural resources are renewable. They are distinguished by the length of time it takes a particular resource to be reproduced. The classification/distinction above is therefore for practical purposes. The link between renewable and non-renewable resource is thus very close.

1.4 What is economics? Economics is the analysis of how to allocate scarce resources among competing uses. Economics has an extensive set of theoretical and empirical techniques, which are used to analyze the actions of individuals once the objectives are given.

We assume that individuals act in their own self-interest - consumers maximize utility, and firms maximize the present value of profits – and then evaluate the outcome of this maximizing behaviour.

The economic analysis of renewable resources differ from that of non-renewable resources in two ways: It is not concerned with the finite availability of the resource and the time when a resource industry ceases to exist; a renewable resource can remain productive indefinitely, although it may be driven to extinction if it is overexploited. The issue of market structure and the potential for cartelisation is not a prominent feature of renewable resource literature: market power is prone to being completed away by close substitutability between e.g. one fish and another.

2.0 PROPERTY RIGHTS AND NATURAL RESOURCE USE
A property right is a bundle of characteristics that convey certain powers to owner of the right. There are many different characteristics a property right can possess. For example a deed to a piece of land, which gives the holder the power to use the land and appropriate returns from the land.

The owner can prevent others from using the land without permission
The owner can prevent others from using the land without permission. Thus the deed is exclusive and enforceable. The owner of the land may be able to subdivide the property and sell or give others a portion. If so the property right is both divisible and transferable.

The duration of the right is also an important distinguishing feature
The duration of the right is also an important distinguishing feature. For example a freehold title to land is an exclusive, enforceable, transferable and generally divisible right that holds forever. A leasehold is also an exclusive and enforceable and can be transferable and divisible but it is of limited duration.

What does this imply about the economic analysis of natural resource use?
The exclusivity of a right is an important distinguishing characteristic. A private property right gives the holder the power to the exclusive use of a natural resource. A common property right is nonexclusive, anyone is free to use the natural resource belonging to that particular group.

Another term used to describe a common property is OPEN ACCESS but slightly different from common resource in that there is free access to the resource.

The presence or absence of exclusivity has an important impact on many economic issues and on the role of government. With private property rights, markets for the production and exchange of natural resources typically exist. It is possible to obtain efficient allocations of resources without government intervention.

By contrast resources characterized by common property rights cannot achieve an efficient allocation of resources without some form of government intervention and/or the creation of a private property right. Markets for the production and exchange of these natural resources either do not exist or operate inefficiently.

But why land, forest and minerals are generally exploited under private property rights while fisheries, wildlife, air and water are characterized by common property rights? Perhaps due to their ease in delineation These resources are generally immobile and Some argue that private property rights will be established when the resource in question is highly valued.

3.0 PUBLIC GOOD AND PRIVATE GOODS
Resources are used in producing goods and services for the satisfaction of society’s wants. These wants are of two very broad types: private wants and public wants; and the goods and services that satisfy these wants are appropriately called private goods and public goods. 3.1 Private goods The private goods bundle is made up of all those goods that are rival and exclusive in consumption. For example, the meat l ate yesterday was not available to others for consumption; if my family lives in a house, that house is not available to other families. From a production standpoint, the market operating through a system of consumer sovereignty effectively allocates most private goods i.e. depletable nature of the good.

3.1 Public Goods Public goods bundle is made up of all those goods that are non-rival or non-exclusive in consumption. How much is consumed by I does not affect how much is left for other people to consume (i.e. undepletable nature of the good). For example the beauty of Mt. Uluguru, clean air, water (lakes and sea), noise etc.

Non-contributors cannot be excluded from the benefits provided by a public good e.g. reduction in air pollution from a power plant are enjoyed by everyone living in an area whether or not their taxes paid for the costs of reduction. We all enjoy benefits from national defense and police protection whether or not we contribute directly to the costs.

For public good (or bad) the ordinary price system is unable to provide efficient outcome.
A public good is characterized by a zero price. The MC = 0 because it does not cost for one to use or not using the good.

CLASSIFICATION OF PUBLIC GOODS
EXCLUSION CONSUM-PTION FEASIBLE NON-FEASIBLE RIVAL Pure private goods Congested goods NON- RIVAL e.g. Bridges Pure public goods

The exclusion is a prerequisite to decide whether or not to treat a good as private or public.

4.0 DECISION – MAKING OVERTIME
Q Should fish or a particular animal be harvested intensively this year or not at all? We make use of pairs of demand and supply diagrams – one diagram for period t and another for period t +1. Intertemporal analysis involves precisely relating the set of schedules in one period to the set in the other period. To do this analysis 3 concepts are important: (1) interest rate (discount rare) (2) compounding (3) Discounting (getting Present Value).

4.1 Interest rate/Discount rate
The interest rate is the crucial link between periods. Interest can be looked upon from several view points: It is the return to capital or rate of growth of capital It is the rental price of money i.e. the reward for waiting. The rate of interest charged gives a measure of the importance of the time element involved. The future always carries less weight than the present. The higher the rate the more the future is discounted. The interest rate (discount rate) is a measure of the investor’s time preference. - the size of discount rate represents the investor’s evaluation of future revenue compared with present. - One with high time preference prefers present income than additional income in future. -Poor individuals have high time preference than richer ones because to them income has to be made immediate if possible.

Accumulate capital (Tshs)
4.2 Compounding Compounding means adding interest to the principal (say V) cumulatively. It is essentially letting the principal (V) grow while interest is calculated on the interest earned period by period. How large will a given amount of capital be after a certain number of years assuming a given rate of interest? Example: the growth of Tsh in 5 years assuming an interest rate of 10 per cent is as follows: Year Accumulate capital (Tshs) Present (Year 0) After 1 year After 2 years After 3 years After 4 years After 5 years 1000 1100 1210 1331 1464 1610 (1000 x .10) (1100 x .10) (1210 x .10) (1331 x .10) 1464 (1464 x .10)

By algebraic calculation:
If V is the initial capital (principal) and i is the interest rate Then After 1 year V1 = V + Vi = (1 + i) V After 2 years V2 = V +Vi+ (V + Vi)i = (1 + i)2V After 3 years V3 = (1 + i)3V and so on for any number of years say n. Based on this we can derive a formula to be used to determine the value at the end of a specified period. Thus in general Vn = Vo (1 + i) n Where Vn = Value at the end of n years Vo = initial value (principal) i = rate of interest n = no of years

4.3 Discounting This is the opposite or inverse of compounding .
The major questions : what is the present value of an income obtained at some future date assuming a given rate of interest? Means deducting the compound interest from a future income (or cost) General formula Present Value Vo = Vn (1 + 1) n This formula gives the present value of Vo of a sum Vn due n years.

Once all relevant benefits and cost flows are obtained then they are converted into present value (Vn) terms. Discounting therefore permits us to compare values at two different points in the future by converting them into present. Example: Suppose your manager says he will have Tsh. Different amounts of money per year deposited for you for the next five years as indicated. What is the present value of this money assuming 8% interest rate?

Amount Deposited (Tshs)
Year Amount Deposited (Tshs) Discounted value (DV) 5000 (1.08)0 = 1 4000 (1.08)1 = 2 6000 (1.08)2 = 3 (1.08)3 = 4 (1.08)4 =

What is the Net Present Value of NRs at a discount rate 5%
Year NR NDR 1990 (1) -3,500 3500 (1.05)1 -3,333.33 1991(2) -210 (1.05)2 1992(3) -350 1993(4) -650 1994(5) 1,400 1,096.94 1995(6) 2,100 1,567.05 1996(7) 6,400 4,548.36 1997(8) 10,000 6,768.39 1998(9) 67,800 43,704.48 NPV = Σ 53,324.23

5.0 MEASURING RESOURCE SCARCITY
5.1 Some basics There are alternative measures for the scarcity of the economic reserve which may give different answers. Economic reserve is often used to describe that portion of a deposit which it is profitable to extract given current prices and costs. As the ratio of the price of the resource to its marginal extraction cost falls then clearly extracting the resource today becomes less attractive: then the term “economic reserves”. Costs depend partly on the state of technology and on cumulative extraction: clearly these costs will be changing over time. Prices will also change in response to the decisions of extractors over extraction rates. There is also uncertainty over the actual amount of a resource in a give geographic area.

5.2 A Bad measure – life time of a resource
A frequently – cited measure of resource scarcity is the lifetime of a resource. This is usually expressed as the economic reserve of a resources divided by its current annual consumption rate with perhaps and allowance for a predicted growth in this rate over time. As a resource gets scarcer its price will other things equal tend to rise. This will reduce consumption (by substitution for example) and increase production (suppliers move along their marginal cost curves). These changes will of course, change the lifetime measure. What is more as prices rise producers will be encouraged to engage in more exploration which will increase the reserve base if finds are made.

5.3 Unit cost measures Some of the earliest arguments in nature resources economics about scarcity centered around the costs of extraction. Various scholars have pointed out that cumulative extraction could result in increasing unit costs. For example, as a mine is depleted, miners have to travel further and further underground to recover coal causing labour costs per unit of output to rise.

Cumulative production increases average costs which costs are therefore an indicator (a Ricardian indicator) of scarcity Unfortunately many problems exist with this unit cost measure: (a) Technological progress has undoubtedly reduced unit costs over this time period. This will also have the effect of increasing the size of economic reserves. (b) The unit cost hypothesis relies on the assumption that firms will always deplete the lowest cost deposit first, yet to know which deposit is the lowest cost implies a perfect knowledge of the characteristics of all deposits some of which are yet to be discovered!

(c ) Whilst unit capital and labour costs may have been falling this might be due to substitution of some other input for capital and labour. (d) Unit costs are a poor predictor of future scarcity since they are based entirely on past experience and are not foreword looking technological advances could increase future economic reserves even if historically unit costs have risen.

5.4 Real Prices Prices are well – established in conventional microeconomics as indicators of scarcity. For natural resources, a rising real price has been argued by many to be a potentially good measure of increasing scarcity In simple versions of the Hotelling model, the price of a resource rises at the rate of interest along an optimal depletion time path until it is equal to the price of the backstop resource; its closest substitute.

However a number of criticisms can be leveled at the use of real prices as scarcity measures.
The influence of producer cartels on prices of primary products can be great and yet not reflect scarcity changes. Governments intervene in resource markets imposing price controls which distort price signals. Natural resource price do not measure social opportunity costs, partly because producers are not forced to pay for the environmental damages caused by the extraction and processing of these resources. Natural resource prices therefore do not measure one element of social opportunity costs namely the environmental benefits forgone in their production. Finally, the appropriate deflector to select for calculating the real price series is not obvious: should an input price or product price deflactor be chosen?.

5.5 Economic rent In some cases, an efficient depletion path involves resource rents rising at the rate of interest. The intuition behind this is clear; if resource rents represents the rate of return on holding a non-renewable resource deposit then this should be equal at the margin to the return on holding any other kind of asset such as a savings bond. Rent is defined as (price – marginal extraction cost). Rising rents are thus an indicator of scarcity.

However some problems exist with this measure:
Empirical data are scarce. Economic rents are the difference between price and marginal extraction costs, but are not the same as accounting profits. Yet as expected, prices are a component of expected rents, the criticism of the real price measure given in the previous section also apply to the rent measure. The use of rent as a scarcity measure assumes that firms are following optimal depletion plans. Yet there is very little evidence that this is so in reality. While rent is perhaps the best scarcity indicators from a theory point of view. It suffers from empirical drawbacks In deed, it is quite possible for rent on a resource to decrease even though its physical abundance is falling.

5.6 Conclusion With respect to indicators of resource scarcity it is important to distinguish between economic and physical measures. The lifetime of a resource tells us little use. The most commonly used alternatives are unit costs, real prices and rents but none is free from problems.

6.0 WELFARE ECONOMICS To contrast and evaluate the difference between socially optimal allocations of resources and those achieved by private actions, we draw on a large body of work called Welfare economics. Welfare economics is the study of the level and distribution of individual’s and groups well-being in the economy. The basic goal of society is assumed to be the maximization of social welfare which is specified to be a function of the well-being of each of the individuals in society. This can be expressed mathematically as : W = W(U1 U2 , …Un)…………………………..(1) Where W = social welfare and Uj is the well-being of individual j.

Different allocations of resources are compared to see under which outcome society will be the best off. The technique used in the comparison is called “Social welfare criterion – a hypothetical relationship that weights each individual’s well-being or utility in some way then “adds up” the utilities to obtain an aggregate function that is used to compare alternative equilibria. The relationship between changes in individual utility and social welfare can be examined using the total differential equation as: dW=dWdU1 + dW du2….+ dW du1dU2+ …..(2) dU dU dU1 dU2

Where the letter d indicates a small change in a variable e. g
Where the letter d indicates a small change in a variable e.g. dU1 indicates a small change in the utility of individual 1. The term dW/ dU1 indicates the effect on W of a small change in U1 when all other things that affect W are held constant. Multiplying dW/ dU1 by dU1 thus tells us the change in welfare that would result from a given (small) change in U1. Adding together the effects of the changes in utility for all individuals yields the total change in social welfare dW.

The second-order term dW DU1 dU2 indicates DU1 dU2
the effect on social welfare of a change in an individual’s utility that results from a change in some other individual’s utility. This second-order term is ignored in usual economic practice (the effect on each individual’s utility of changes in the well-being of others are sufficiently small that they can be ignored). With this modification the equation becomes: dW = dW dU1 + dW du2 + ….+ dW dUn + …(3) dU dU dUn

The equation 3 says that a policy results in an increase in social welfare when the weighted sum of the changes in individual utilities is positive (dW are the weights) duj The economic theory of social welfare assumes that an increase in the utility of any individual. Other things constant will result in an increase in social welfare (i.e. dW >0for all j). DUj Any policy resulting in an increase in utility for one or more individuals without decreasing the utility of anyone else would increase social welfare. This is the basis for definition of economic efficiency (also referred to as Pareto Optimality).

7.0 VALUATION OF NATURAL RESOURCE
7.1 INTRODUCTION Sustainable development can be defined as that development which meets the need of the present generation without compromising the ability of future generations to meet their own needs. Or improving the quality of human life while living within the carrying capacity of supporting ecosystems. Efforts to achieve sustainability at project level should be complemented by adjustment of national accounts to reflect true resource use in order to produce more accurate measurements of real economic performance.

The purpose of valuation
Valuation of the natural resource aspects should achieve several objectives: To ensure that a project’s natural resource costs and benefits are fully reflected in the process of project appraisal. To redress the balance between quantifiable and non-quantifiable benefits. Narrowing the scope of pure judgment: However we cannot pretend that all or even most natural resource effects can be captured in economic or financial values.

Providing a better indicator of economic performance.
Clarifying the gainers and losers from projects. Providing a more secure basis for natural resources policies (such as the polluter pays principle or carbon taxes).

Why is valuation? Market failure : there are no markets for many natural resource goods and services. People are not aware of the cost when they use these goods and hence no account is taken of their costs and benefits. Public goods: these are goods available to all. Nobody can be denied access to them (e.g air lakes, etc) but nobody has any incentive to invest in a public good or to abstain from its consumption. Externalities; people do not bear the external consequences of their own actions. Ignorance and uncertainty about natural resource processes.

What difference does valuation make?
It removes biases against natural resource projects by governments, NGOs, donors and others. Projects which have environmental costs are discouraged. Affects the portfolio of projects. Forces better Environmental Impact Assessments (EIAs).

7.2 TOTAL ECONOMIC VALUE According to a benefit-cost rule decisions to develop a game reserve would have to be justified by showing that the net benefits of development exceed the net benefits of conservation. Development here is taken to mean some use of the reserve that would be inconsistent with retention of the reserve in at least approximately its natural state. The benefit-cost rule would be to develop only if the development benefits minus the development costs is greater than the benefits of conservation minus costs of conservation.

Typically development benefits and costs can be fairly calculated because development has attendant cash flows. For example the benefits of timber production can be measured because market prices for timber are observable. Conservation benefits on the other hand are a mix of associate cash flows and non-market benefits. Conservation benefits are measured by the total economic value (‘TEV) of the natural resource. TEV comprises use and non-use values.

Use values can in turn be broken down into direct use, indirect use and option values
Direct use values are fairly straightforward in concept but are not necessarily easy to measure in economic terms. For example, conservation is consistent with some direct uses of game reserve including hunting. But the value of medicinal plants for the world at large is more difficult to measure.

Indirect use value correspond closely to the ecologist’s concept of ecological functions. For example a tropical forest might help protect watersheds, so that removing forest cover may result in water pollution and siltation depending on the alternative use of which the land is put. Similarly forests stores carbon dioxide (Co2). Natural forests are also biologically diverse – they are home to many endemic species which may have important ecological functions.

Option value relates to the amount that individuals would be willing to pay to conserve an environmental asset for future use. That is no use is made of it now but use may be made of it in the future. Option value is thus like an insurance premium to ensure the supply of something the availability of which would otherwise be uncertain.

Non-use value can be sub-divided into existence and bequest values:
Existence value measures willingness to pay for preservation of an environmental asset that is not related either to current or optional use. Its intuitive basis is easy to understand because a great many people reveal their willingness to pay for the existence of environmental assets through wildlife and other environmental charities but without taking part in the direct use of the wildlife through recreation. To some extent, this willingness to pay may represent vicarious consumption i.e. consumption of wildlife videos and TV programmes.

Empirical measures of existence value obtained through questionnaire approaches (the contingent valuation method) suggest that existence value can be a substantial component of the TEV. Bequest value measures an individual’s willingness to pay to ensure that a particular natural resource is preserved for the benefits of his or her descendants. Some analysts like to treat bequest value as a separate category of economic value. Others regards it as part of existence value. In empirical terms it would be hard to differentiate them. Total economic value can therefore be expressed as: TEV = Direct Use Value + Indirect use Value + Option Value + Existence Value + Bequest value

7.3 THE STRUCTURE OF A COST – BENEFIT ANALYSIS (CBA)
Sound economic analysis of projects and policies is an important means of making the allocation process more efficient and thereby more sustainable. CBA is the key element in the appraisal stage of the project cycle. CBA seeks to assess project costs and benefits using a common yardstick. It can help wildlife managers attain an efficient allocation of resources.

It is a tool used in economics to compare benefits and costs before arriving at the decision to invest or not. In any CBA several stages must be conducted and the following structure provides a guide to the essential steps: defining the project, identifying impacts which are economically relevant, physically quantifying impacts, calculating a monetary value, discounting, weighting and sensitivity analysis.

Stage one: Definition of Project
This definition will include: (i) the reallocation of resources being proposed and (ii) the population of gainers and losers to be considered.

Stage Two: Identification of Project Impact
Once the project is defined, the next step is to identify all those impacts resulting from its implementation. For example, listing of all resources used: effects on local unemployment levels: impacts on traffic movements and effects on local property prices.

Stage Three: Which Impacts are Economically Relevant?
The aim of CBA is to select projects which add to the total of social utility by increasing the value of consumables. Thus what are counted as positive impacts are referred to as benefits. What we count as costs (that is negative impacts) will include any decreases in the quality or quantity of such goods or increases in their price.

Stage Four: Physical Quantification of Relevant Impacts
This stage involves determining the physical amounts of cost and benefit flows for a project and identifying when in time they will occur.

Stage five: Monetary Valuation of Relevant Effects
In order for physical measures of impacts to be co-measurable, they must be valued in common units. The common unit in CBA is money whether dollars, pounds or Tanzania Shillings. Prices are therefore very useful in comparing tones of steel with working hours saved since not only are both made co-measurable but some indications of their current relative scarcity is provided.

Stage Six: Discounting of Cost and Benefit Flows and Applying Economic Criterion
Once all relevant cost and benefit flows that can be expressed in monetary amount have been so expressed, it is necessary to convert them all into present value (PV) terms. This necessity arises out of the time value of money or time preference.

Discounting may be done in one of the following
(1) By finding the net value of benefits minus costs for each period (usually each year) and discounting each of these annual net benefits flows throughout the lifetime of the project; or (2) By calculating the discounted values for each element for project then summing the discounted elements. Both approaches should give identical answers.

The most basic criterion applied is the Net Present Value (NPV) test
The most basic criterion applied is the Net Present Value (NPV) test. This simply asks whether the sum of discounted gains exceeds the sum of discounted losses. If so the project can be said to represent an efficient shift in resource allocation given the data used in the CBA.

In other words, the NPV of the project is:
T T NPV = Σ B(1+i) ΣC1 (1 + i)-1 t = t =0 Where Bt and Ct are benefits and costs in year t. i is the discounts rate and T is the time horizon. The criterion for project acceptance is : accept iff NPV > 0 There are a number of alternatives to the NPV criterion. The two most commonly employed are the Internal Rate of Return (IRR) and the Benefit Cost Ratio (BCR). The BCR is the ratio of discounted benefits to discounted costs. The decision rule becomes: proceed iff the benefit-cost ratio exceeds unit.

The benefit-cost ratio is another way of presenting the NPV of a project.
T T BCR = Σ B(1+i) -1 / ΣC1 (1 + i)-1 t=0 t=0 If BCR >1.then NPV > 0 and the project is acceptable.

The IRR is a measure frequently employed in financial investment appraisal. It is the rate of interest which if used as the discount rate for a project would yield a NPV of zero. T T Σ B(1+i) ΣC1 (1 + i)-1 = 0 t = t =0 OR T T Σ B(1+IRR) ΣC1 (1 + IRR)-1 = 0 t= t=0

It is interpreted as the rate of return on the resources used up in the project to be compared with the opportunity cost of investment funds which might be the market rate of interest. Thus the project is acceptable if IRR > market rate of interest/accounting rate of interest which in most cases implies NPV >0. In summary each of these criteria has its strengths and weaknesses but NPV is probably the most useful and the recommendation here is to stick firmly to NPV as a measure of performance.

Stage seven: Sensitivity Analysis
The NPV test described above tells us about the relative efficiency of a given project given the data input to the calculations. If this data changes the clearly the results of the NPV test will change too. But why should data be changed? An essential final stage of any ex-ante CBA is to conduct sensitivity analysis. This means recalculating NPV when the values of certain key parameters are changed.

These parameters will include:
i the discount rate. ii physical quantities and qualities of inputs. iii shadow prices of these inputs. iv physical quantities and qualities of outputs. v shadow prices of these outputs, and vi project life span. The NPV decision will often depend crucially on the choice of discount rate: this will certainly be so for projects with long-term effects such as woodland planting, toxic waste disposal and research and development of alternative energy sources.

8.0 VALUATION TECHNIQUES FOR NON- MARKET GOODS
8.1 INTRODUCTION PREVIEW OF MAJOR PROBLEM AREAS WITH CBA APPLICATION The application of CBA to environmental management is fraught with problems.

The valuation of non-market goods such as wildlife, clean air and landscape.
Ecosystem complexity: 3. Discounting and the discount rate: 4. Institutional capture: 5. Uncertainty and irreversibility.

However methodologies/techniques have been developed to estimate values of non-market goods and services. The existence of such techniques offers a methodology which aims explicitly to take all natural resource values into account. These methods are Contingent valuation Travel cost Hedonic pricing Avoided cost Dose response approach

It is important to understand that it is not natural resource good/service per se that is being measured but people’s preferences for the good/service-valuation are anthropocentric. Valuation of non-market goods therefore relates to preferences held by people and the economic value of something is established by an actual or hypothetical exchange transaction.

Willingness to pay (WTP) Vs Willingness to Accept (WTA)
A number of approaches are available for determining the economic values of non-markets goods. First the question arises of which measure of welfare change – WTP or WTA should be used. WTA measures substantially exceed those based on WTP.

The difference between WTP and WTA appears to reflect a real difference in individuals valuation of experiments, and appears to reflect a real difference in individual valuation of a policy change depending on how the policy is framed or the individual’s reference point.

In particular the decision whether to use WTP or WTA for
benefits estimation is important - losses associated with changes in the status quo-or the reference point-would weigh much more heavily than corresponding gains. Individual tend to view compensation for a loss as two separate events (1) a loss (which they greatly dislike): and (2) a money payment which is perceived as a gain from their new (lower) reference point. Policy measure that mitigate or reduce losses may thus be more desirable than those that allow the damage to occur and then compensate the individuals affected.

Valuation techniques There are five broad ways to try to address this question. First one could be experiment: This method is more of experimental aspect, involves setting out of an experiment to determine how much people are willing to give up in order to get something. Though it is more theoretical and hard to implement.

A second approach is simply to ask people how much they would be willing to give up (i.e. how much they would be willing to pay) to have a particular good/service (e.g. a specified environmental quality improvement happen). This is known as the contingent valuation method and is a “stated preference” technique. It is also termed the direct approach to valuation because people are directly asked to state or reveal their preferences.

Cont. There are several practical difficulties with this approach - intentions people indicate ex-ante (before the change) and their behaviour ex-post (after the change). surrogate markets. To use this technique economists try to find a good or service that is sold in markets and is related to the non-market good.

Surrogate markets techniques are termed indirect valuation approaches.
Cont. The surrogate market techniques include the travel cost model, the hedonic wage model and the avertive behaviour model. All of these surrogate market methods rely on the behavioral trail left by individuals as they make actual decisions that affect their lives. Surrogate markets techniques are termed indirect valuation approaches.

Benefit transfer approach.
Cont. The conventional markets or damage functions approach. The techniques include dose-response and replacement costs. Benefit transfer approach.

8.2 CONTINGENT VALUATION METHOD (CVM)
It is a stated preference approach also referred to as direct approach. Based on some form of questionnaire. In contingent valuation (CV) studies, People are asked directly to state, or reveal what they are willing to pay. The situation the respondent is asked to value is hypothetical (hence contingent.

There are three basic parts to most CV survey instruments:
First, a hypothetical description (scenario) of the terms under which the good or service is to be offered is presented to the respondent. Second, these questions take the form of asking how much an individual is willing to pay or accept for some change in provision. Third, questions on socio-economic and demographic characteristics of the respondent.

Value of elicitation The simplest is to ask respondent a direct question about how much she/he would be willing to pay for the good or service - knows as continuous or open-ended questions. Alternatively, a respondent can be asked a specified amount. These are known as discrete or dichotomous choice questions.

Reliability of responses
The few reliability tests that have been conducted to date have found a high correlation between the individuals WTP in the test and retest experiments, indicating that the contingent valuation method appears to be a reliable measurement approach.

Bias The problem of strategic bias has long worried economists.
Hypothetical bias-caused by the hypothetical nature of the CV market. Perhaps most controversy has centered on the so-called ‘embedding effect’. Many studies have found that individuals CV responses often do not vary significantly with changes in the scope and coverage of the good being valued. Respondents appear not to discriminate. e.g. Small lake vs big lake, class of goods

Analysis of WTP responses
There are three ways in which CVM information is typically analyzed to check the consistency of responses and to calculate the required valuation estimates. Firstly, summary statistics such as means, medians and so on can be used to calculate estimates of a good’s total value for a particular population.

Secondly, cross tabulations between WTP and socio-economic and other variables are considered.
Thirdly multivariate statistical techniques are used to estimate a valuation function that relates respondents’ answers to hypothesized determinants of WTP such as socio-economic variables and the prices of substitute good and services.

Conclusion on CVM The US National Oceanic and Atmospheric Administration (NOAA) panel has offered a set of guidelines it believes should be followed if CV is to provide information about non–use values of sufficient quality to be usable as the basis for claims for legal compensation for environmental damage.

Cont. The use of these guidelines within the profession is now being extended to cover all CV studies. CV is likely to be most reliable for valuing environmental gains, particularly when familiar goods are considered such as local recreational amenities. Finally it should be remembered that CVM is the only technique with the potential for measuring existence value.

INDIRECT VALUATION TECHNIQUES/APPROACHES
Indirect valuation approaches seek to elicit environmental preferences from actual observed market-based information. In the surrogate market variant of indirect valuation, these markets are for private goods to which environmental commodities are related either by being complements to or substitutes for the private goods in question.

Cont. These techniques are therefore often preferred by policy makers because they rely on actual choices rather than the hypothetical choices involved in the direct valuation approaches.

8.3 THE TRAVEL COST METHOD 8.3.1 Introduction The Travel Cost Method (TCM) can claim to be the oldest of the non-market valuation techniques. TCM is predominantly used in outdoor recreation modeling, with fishing, hunting, boating and forest visits among the most popular applications.

The Basic Method The TCM seeks to place a value on non-market goods by using consumption behaviour in related markets. Specifically the costs of consuming the services of the good are used as proxy for price. These consumption costs will include travel cost, entry fees, on-site expenditures and outlay on capital equipment necessary for consumption. The method assumes weak complementarity between the good and consumption expenditure. The TCM cannot estimate non-user values.

Travel costs (c) depend for a given site “j “ on several variables:
Cont. Travel costs (c) depend for a given site “j “ on several variables: Cij = C (DCij, TCij, Fi) i= 1 ..n., j = 1..m (eq.1) Here, DC are distance costs for each individual “i” dependent on how far he/she has to travel to visit the site and the cost per mile of traveling. TC are time cost; these depend on how long it takes to get to the site and the value of an individual’s time. F is the fee, if any which is charged for entrance to site j. Travel costs (C) are included in a trip generating function (TGF) which predicts how many visits (V) will be undertaken by any individual i to site j.

Cont. Also included in the TGF for an individual would be socio-economic characteristics such as income, education and age level as well as variable giving information on the type of trip. Vzj = V(Czj, Popz, Sz); z = 1 ……Z) …… Eq2 Once a TGF has been estimated using multiple regression, a demand relationship is estimated by simulating what would happen to visit per annum (individual TCM) or visits from each zone in the zonal model as the “fee” is increased. In this way a demand curve is traced out for each site.

The reader should not that these fee/visit combinations are all predictions based on the observed relationship between travel cost and visits. The key assumption behind the demand curve is that as the travel costs defined in equation (eq. 1) increase the number of visit fall.

8.3.3 Problems with the travel cost method
The basic problems are: The choice of dependent variable Multipurpose trips Holiday – makers vs residents Calculation of distance costs The value of time Statistical problems

Cont. Choice of Dependent Variable Two basic options exist for choosing the dependent variable. These are (1) visits from a given zone; and (2) visits made by a given individual. Option 2 is usually implemented by collecting data on visits as visits per capita, V/Pop. There is no consensus in the literature as to which option is preferable on theoretical grounds.

Multi-purpose Trips A convention is followed in travel cost analyses which distinguishes “meanderers” from purposeful visitors”. The former describes those for whom a visit to the site in question is only part of the purpose for their journey. The latter term describes those for whom a visit to the sites is the sole purpose of their trip.

Holiday – makes and Residents
Cont. Holiday – makes and Residents A similar problem occurs here to that discussed under (ii) above. Suppose that our sample of visitors to a place contains people who visit as residents. Their valuations could be measured by looking at these daily travel costs. However the argument could be put forward that part of the reason for their visit to that site was the existence of sites in the area. If this is true then some of their travel costs from their permanent residence should be allocated to the site valuation exercise. But how much?

Calculation of Distance costs
This involves setting a price per mile which requires choosing between two options: (1) use petrol costs only as an estimate of marginal cost or; (2) use “full cost of motoring” figure to include an allowance for depreciation, insurance etc. Consumer’s surplus figures will depend on the choice.

The value of Time Principal among the inputs are visits, equipment and time. Time is expended both in traveling to a site and whilst recreating on the site. As a scarce commodity time clearly has an implicit (or shadow) price. Much attention in the recreation demand literature focuses on how this price should be estimated.

(vi) Statistical Problems
Cont. (vi) Statistical Problems The dependent variable is truncated. Truncated means that as only visitors to the site are recorded there is no information on the determinants of the decision to visit the site. Also visits are only recorded during the sampling period and may thus incorrectly describe the preferences of those visiting at other times of year – OLS (Ordinary Least Square) estimates of demand parameters will be biased.

8.3.4 Conclusions The travel cost model is now well established as a technique for valuating the non-market benefits of outdoor recreation resources. However as noted above there are many problems associated with the technique and as with hedonic pricing, applications are limited. Only recreational resources which necessitate significant expenditure for their enjoyment can have user values estimated. However current research does not tell us how close travel cost estimates come to “true” user value.

8.4 THE HEDONIC PRICING METHOD
8.4.1 Introduction Hedonic pricing (HP) derives from the characteristics theory of value. The method identifies environmental service flows as elements of a vector of characteristics describing a marketed good typically housing. HP seeks to find a relationship between levels of environmental servies (such as noise levels or total suspended particulate levels) and the prices of the marketed goods (houses).

The characteristics theory of value
The characteristics theory of value sometimes referred to as the Lancaster Rosen approach states that any given unit within a commodity class can be described by a vector of characteristics z. Weak complementarily is also assumed. That is if the level of purchases of the private good (here housing h) is zero then the marginal willingness to pay for or marginal demand price of environmental quality is also zero. Thus HP is incapable of estimating non-user values.

8.4.2 How the method works The first step n any HP study is to decide which natural resource good/service variable is of interest and then to ascertain whether sufficiently desegregated spatial data were available along with data on house prices and housing characteristics. Once this has been verified the typical HP exercise proceeds in two stages: estimation of a hedonic price function and estimation of a demand curve for some element of environmental quality.

Stage one : Estimation of Hedonic price Function
In this stage the relationship between the environmental/natural resource variable of interest and a related marketed good is estimated. For example house price (Ph) within a city might depend on: site characteristics (SI) such as the number of rooms the size of garden and whether a garage is provided or not neighborhood characteristics (Nj) such as ethnic composition crime rate and number of schools in the area; and environmental quality variables (Qk) such as air quality and noise level. The following hedonic price equation can be estimated using ordinary least squares (OLS): Ph=P)Si,NjQk)[I= 1…..m, = 1…n,k=…..1] Eq1

This equation (Eq1) allows implicit prices for each
characteristic to be calculated. The implicit price of a given environmental characteristic is obtained from equation (1) by partially differentiating (Eq1) with respect to the characteristic of interest. For example for Q the implicit price would be : δPh/ δQ1 = P(SI, Nj, Qk) Eq2 This implicit price δP/ δQ is called the rent differential r and is a measure of the value of a marginal change in the environmental quality variable Q1. A perfectly functioning market has perfect information flows. Also all individuals trading in the market are able to adjust their buying behaviour moving along the rent differential

Cont. Curve δP/ δQ1 until marginal value to each an improvement in environmental quality is equal to the marginal cost of that improvement defined by the implicitly price. Stage two: Estimating a Demand Curve Stage two of the Hp process involves estimating a demand curve for environmental quality using the information gained from stage one. Equation (2) will be an inverse demand curve3 for Q1 only if all individuals affected by noise pollution are identical. The procedure for estimating a demand curve for Q depends on the assumptions about the supply side of the market. The case likely to be of most interest is a short-run situation

Cont. where there are only a fixed number of houses in any air quality class. House-buyers must then bid for this fixed supply of heterogeneous units. If this is the case an demand curve for Q can be obtained by regressing implicit price r against Q socio-economic variables available which represent preferences. Estimating such a demand curve for within a city with these areas indexed by i” gives the inverse demand curve: R = P(QI,Yi,Ai)

8.4.3 Problems with the HP method
Omitted variable bias As was remarked is section the analyst must decide with factors to include as independent variables in the hedonic price equation (and indeed in the demand curve). The selection process can give rise to problems. If a variable which has a significant on house prices. And which is correlated with some or all of the included variables. Is omitted from the hedonic price equation. This will influence the coefficients of the estimated variables. This lead to biases estimated for these coefficients and for the implicit prices (for a recent application( See Atkinson and Crocker 1992).

(ii) Multi-Collinearity
Several of this independent variables included in the hedonic price equation may be closely correlated with each other. For example. If a house is sited near a quarry as dust levels increases so do noise levels. Such multi-collinearity can result in a number of problems. These include imprecise coefficient estimates (high standard errors). And intuitively wrong signs on variables. Even though the R2 may be high (Maddala, 1979). Multi-collinearity can also bring about considerable instability in parameter estimates and if serious can reduce the confidence attached to model predictions (stewart 1984).

Choice of Functional Form
What Functional form should be chosen for the hedonic price equation? However economic theory does not suggest which non-linear form is to be preferred. Garrod and Allinson (1991) have argued that there is unlikely to be one Universally preferred functional form and that even for a given data set criteria for functional form selection may be conflicting. Market Segmentation Housing markets are often segmented on grounds such as ethnic composition rental versus owner-occupied and price bracket. Failing to recognize such segmentation in a HP study when it is present in reality will result in biased

Cont. coefficients in the hedonic price functions; Segmentation implies that demand parameters vary across segments. Expected versus actual characteristics levels In using the HP approach to value environmental attributes current levels of environmental quality are assumed to influence house prices. However house prices can also be influenced by expected changes in quality levels. For instance the prospect of a by-pass in a busy residential zone can keep prices higher than in the absence of such expectations.

Restrictive assumptions
HP gives an accurate estimate of the value of environmental quality only if (continuing the house price/air quality example); (i) All buyers in the housing market are perfectly informed of air quality levels at every possible housing location (ii) all buyers in the market are able to move to utility maximizing positions (otherwise marginal cot is not Equivalent to marginal WTP) (iii) The housing market is in Equilibrium the vector of implicit prices is such that the market clears at all times. Furthermore the assumption of Weak complementarily implies that only those Environmental improvements that have an impact on the property market will be measured.

Conclusion As has been pointed out in the proceeding section there are many problems associated with the HP technique. Perhaps the most important of these are the assumptions made about the related market (the housing market in this chapter) However the method does make use of data on actual behaviour unlike the contingent valuation method. Although this chapter on HP has concentrated on house prices and environmental quality levels the technique is applicable to other goods. HP can be used to estimate the implicit price of any observable a characteristic of any good so long as the weak complementarily assumption holds.

8.5 PRODUCTION FUNCTION APPROACHES
These methods are concerned with approaches which link environmental quality/good changes to changes in production relationships. An increase in the level of a pollutant in the well (nitrates say) will cause the household either to cut its water consumption or more likely to increase its purchases of water treatment equipment. Alternatively the household may spend time and energy boiling water if the pollutant is a pathogen. Firms also combine environmental attributes with purchased inputs to produce commodities. For example a farm combines air quality (Q1) and water quality (Q2) with

Cont. Purchased inputs to produce soybeans. The production function for a representative farm might look like. X = f(L, K,I,Q,Q1,Q2) Where L and K are labour and capital inputs, I is a vector of purchased inputs such as fertilizers and pesticides and X is the output of soybeans. If we assume that δX/ δQ1 is positive then a decrease in air quality will ceteris paribus reduce output levels. All the approaches outlined in this chapter share the characteristics that changes in expenditures are due to the need to substitute other inputs for change in environmental quality/good. We consider two such approaches avoided cost and dose-response methods. Linking the two is the evaluation of human morbidity and mortality a crucial

Cont. Crucial issue which often determines project approval and environmental standards. 8.5.1 The avoided cost approach How it works When a change in good (or environmental quality) occurs households are able to react. In the case of decreasing quality expenditures will be made to mitigate the effects of the household from welfare reductions. The value of an improvement in good/environmental quality can be inferred directly from reductions in expenditures on defensive activities; that is from reductions in averting expenditure (AE).

Cont. An example is an increase in aircraft noise due to a new airport. In the absence of intervention households will engage in averting behaviour such as moving away from The area (an impact measurable via hedonic pricing) or noise proofing their home. In theory the benefits of a policy to reduce aircraft noise (by insisting on quieter jets. For instance) could be obtained from avoiding the costs of AE. However. Such a procedure would almost certainly produce an underestimate of the benefits of such a policy to households.

Cont. Finally. AE may generate benefits other than pollution avoidance. Double glazing not only cuts noise levels but also reduces heat losses and thus saves on energy bills. This would make AE an overestimate of the cost of increased noise levels.

An Application A contentious area where the AE approach has been utilized is in valuing human morbidity and mortality. The main alternative to using AE is to measure the (net or gross) productivity of an individual and then discount lifetime earnings (output) over the expected life span( Leave and Seskin 1977). However there are several problems with this approach: (i) as people get older their economic value declines (ii) the unemployed and parents at home can be attributed zero economic value and (iii) the customary measure of value in economics revealed preference is ignored. Moreover the value of life under this" human capital”

Cont. Approach is highly dependent on the discount rate used. Under the related “net output” approach the present value of consumption is deducted from the present value of output implying that the retired have negative values!. The AE route might appear more attractive since it measures how much people actually pay to reduce the risk of being injured, sick or dying, However AE will measure the reduction in these risks only if both the marginal cost of AE and the effect of such expenditure on risk reduction are known.

Cont. Examples include the expenditure on car seat belts in the UK (before they became compulsory) and spending on smoke detectors. The AE approach has also been used to estimate the benefits of reduced morbidity e.g. a study of the value of reduced risks of skin cancer. Both figures for the value of a life as revealed by individuals seem very low if compared to estimates from hedonic wage studies or from contingent valuation.

8.5.1.3 Why do AE measures give such relatively small value
First, the actual marginal cost of AE may be difficult to measure. For example the financial expenditure on seat belts would underestimate the actual marginal cost since it fails to allow for the wearer’s discomfort and inconvenience. Second, the value of risk function may be subject to sharp Discontinuities. An individual’s WTP to go from a 0.9 to 0.8 risk of death may be $ 1 million while their WTP to go from certain death to a 0.9 probability may be infinite!

Finally some authors (Moore and Viscusi 1988) recognize
that an altruistic value exists for human life people are WTP something to reduce the probability of others being killed. Dose – response function Dose-response methods seek a relationship between good/environmental quality variables and the output level of a marketed commodity. Output may be defined either in quantity terms (for example cubic metres of wood produced from a forest) or in quality terms (damage to building s from acid deposition. The most common examples relate to air quality impacts on agricultural production

The technique takes natural science information on the
physical effects of pollution and uses this in an econometric equation Thus the method can be split into two parts: (i) The derivation of the pollutant dose and receptor response function and (ii) the choice of economic model and its application. The example of iar pollution effects on agricultural crops is used. Valuation of Agricultural Crop Yield Changes Various methods have been applied to evaluate the benefits from reducing crop losses caused by air pollution. Three main categories of economic approach can be defined: traditional models optimization models and econometric models.

The Traditional Model The “traditional" type model is a simple method of approximating a monetary value fro crop yield changes. The model multiplies estimates of a physical crop change based on current acreage in production by the current price of the crop. This implies a simple response assumption that resource use and prices and thus consumer surplus remain constant. Optimization Models There are two types of optimization model: Linear Programming (LP) models and Quadratic Programming (QP) models. Both require extensive data sets and are normally established as computer programms due to their complexity

Limitations of DRF Large quantities of reliable data are usually demanded. Difficult to isolate other factors that are cause of e.g. pollution from the acute “dose” that we try to quantify. Identification of damage threshold levels – the level of pollution that the environment can handle before it begins to cause damage is not easily specified. Conclusions Dose response models offer a means of measuring the economic costs of a number of important pollutants including Acid depositions and troposphere ozone. But controversies over the appropriate way in which to model responses

(apart from a recognition for the obvious inferiority
Cont. (apart from a recognition for the obvious inferiority of the “traditional” model) mean that widely varying estimates of economic damages can emerge. 8.5.3 Overall conclusions This chapter has looked at ways of valuing environmental effects/goods using production function-based approaches. The notion of a household production function leads to an averting expenditure measure; this can be an overestimate or underestimate of welfare effected depending on the reference level of utility and the degree of substitutability.

Cont. When the ex ante welfare level is the reference one and when AE is an imperfect substitute then AE measures underestimate the benefits of reducing pollution AE also seems to produce relatively low values for human life when compared to hedonic wage and contingent valuation results. Dose response models offer a means of measuring the economic costs of a number of important pollutants including acid deposition sand troposphere ozone. But controversies over the appropriate way in which to model responses (apart from recognition of the obvious inferiority of the “traditional” model) mean that widely varying estimates of economic damages can emerge.

8.6 HOW GOOD ARE THE VALUATION METHODS?
How much faith (credibility) can be placed in the value estimates generated by such methods? Are the results acceptable for inclusion in the CBA procedure? There are a number of ways of evaluating such “credibility” Credibility can be considered from within the structure of CBA where the basic premises are accepted. Three main factors might be considered as determining credibility: (i) How repeatable are the results generated by a methodology? (ii) How valid are these results? (iii) What esteem does the method hold within the academic community

Cont. 8.6.2 Repeatability If a method is applied to the same data set over a number of trials and if the results are statistically the same the method has passed a Repeatability test The aim of repeatability is to replicate the results. 8.6.3 Esteem Esteem or the degree to which valuation methods are held in high regard by academics is difficult to judge. (i) use of academic journals – studies using the methods have been published/ (ii) Methods are adopted for teaching environmental/natural economics (iii) recognized by government and NGOs.

8.6.4 Validity Three definitions of validity can be identified as useful with regard to non-market good valuation construct validity theoretical validity and convergent validity. Construct Validity Construct validity refers to how well a valuation method explains the values generated. On CVM, the ordering and embedding effects cause some doubts on the credibility of applying CVM to public goods. Theoretical Validity This means that results generated by the methods should be consistent with economic theory. Considering CVM WTP and WTA bids are clearly theoretically justified. CVM is therefore producing theoretically correct results.

Cont. Convergent Validity Convergent validity relates to the extent to which different methods for valuing a given good/service produce similar results. If a CVM study gives a result similar to a hedonic price or travel cost study then at least the analysis is converging on one answer. 8.6.5 Conclusion Three measures of validity have been suggested each of which can be used to assess the worth of non-market valuation technology. The CBA outcome is but one piece of relevant information in taking a decision.

9. INTRODUCTION TO HISTORICAL DEVELOPMENT OF ENVIRONMENTAL ECONOMICS
This course tries to provide a link between society, economics and environment as a natural resource

Environmental economics is a subfield of economics concerned with environmental issues. According to the National Bureau of Economic Research, Environmental Economics undertakes theoretical and empirical studies of the economic effects of national or local environmental policies.

Central to environmental economics is the concept of market failure
Central to environmental economics is the concept of market failure. Market failure means that markets fail to allocate resources efficiently. A market failure occurs when the market does not allocate scarce resources to generate the greatest social welfare. Common forms of market failure include externalities, non excludability and non rivalry.

Externality: the basic idea is that an externality exists when a person makes a choice that affects other people that are not accounted for in the market price. For instance, a firm emitting pollution will typically not take into account the costs that its pollution imposes on others.

Common property and non-exclusion: When it is too costly to exclude people from accessing a rival environmental resource, market allocation is likely to be inefficient.

Public goods and non-rivalry: Public goods are another type of market failure, in which the market price does not capture the social benefits of its provision. For example, protection from the risks of climate change is a public good since its provision is both non-rival and non-excludable

10. SUSTAINABLE ECONOMIC DEVELOPMENT THEORIES
10.1 Introduction The world economy inextricably linked to the environment because societies must extract, process, and consume natural resources. “Sustainable development “is development that lasts into the foreseeable future.

Scheme of sustainable development: at the confluence of three constituent parts (3 pillars of sustainable development)

Environment as: A supplier of resources. A sink of waste products.
A supplier of amenity, and educational and spiritual values.

PRODUCTION ENERGY AND MATERIALS CONSUMPTION WASTE SINK AMENITY

Describes a process in which the natural
resource base is not allowed to deteriorate. It emphasises the hitherto unappreciated role of environmental quality and environmental inputs in the process of raising the real income and the quality of life. Could be interpreted as per capital levels of welfare that remains constant or increase over time. – suitable interventions that reduce the rate at which natural assets are depleted.

A concept of sustainability development
In general, economists define sustainable development as a process where social well-being is non-declining overtime. There are three generally recognized notions of sustainability that further refine this concept and make it more accessible for policymaking:

Weak sustainable development
Maintains a non-declining value of the total capital stock (natural plus human-made). However individual components of the total capital stock (K) can decline as long as other sources of capital are enhanced through investment. The problem with this concept is that not all capital is substitutable and some forms of capital and their associated services may be lost permanently.

Strong sustainability
Non-declining value of natural capital is maintained. The emphasis is on preserving the value of natural capital as opposed to total capital. This concept therefore recognizes limited substitution possibilities but allows from having some components decrease in value as long as others are increasing. The problem is that not all natural capitals are homogenous.

Some environmental assets are critical and they have no substitute
Some environmental assets are critical and they have no substitute. The challenge is to define the set of critical assets. We must not deplete the stock of natural capital. The environment must be preserved. This does not mean conserving every tree or refusing to mine a tonne of coal. The overall stock of capital must also be preserved although keeping the environment intact will not secure sustainable development.

Environmental sustainability
Non-decline physical service flows from specific resources (not values, and not overall physical stock). (e.g. Sustainable yield in a fishery = constant catch rates). The problem is that it is often difficulty to identify sustainable yields. Many fisheries for example have collapsed due to over capitalization and failure to predict dwindling stock.

This concept of sustainability essentially
recognize the contribution of various types of capital (K) including natural capital (Kn) and social capital (Ks) in maintaining levels of individual and social welfare

Capital stock = km + kh + kn + ks (social)
Where: Km - man made capital e.g. machines, buildings, factories and roads. Kh – Human capital – Stock of skills and knowledge Kn – Nature capital – The stock of natural resources, the capacity of the environment to deal with waste product of human.

10.2 Indicators of sustainability
Ecological indicators 1. Carrying capacity: Maximum population = Resource ⇒ Minimum resources use per capita 2. Sustainability as resilience Diversity ⇒ resilience Resilience = sustainability e.g. growing different types of the crops using different methods. Hence diversity means sustainability

Crop output variability as an indirect measure:
Variations growing big as time goes and output increasing = less resilience. Meaning sustainable development. Economic indicators: NNP = GNP – Depreciation in (km) + depreciation (kn) + appreciation (kh) i.e. education expenditure

10.3 Economic development and Economic growth
Development implies change that leads to improvement or progress. Consequently, defining real development is a normative that is why what constitutes economic development is disputed. It clearly involves change or transformation. An economy that raises its per capital level of real income over time without transforming its social and economic structure is unlikely to be viewed as developing.

Economic development is defined as achieving a
set of social goals. Since these goals change over time, economic development is, to some extent, a process. A society in the process of economic development is likely to experience a combination of three sets of changes. An advance in the utility – which is simply satisfaction or well-being – experienced by individuals in society. A major factor contributing to advances in well-being is real income per capital.

Advances, where needed, in the realms of
education, health, and general quality of life (using the classification of Goulet 1971). Self-esteem and self-respect. As the society is developing it is exhibits a growing sense of independence, which may be independence from domination by others or independence from the state.

Nonetheless, sustainable development and
sustainable growth are linked. A society that does not maintain or improve its real income per capita is unlikely to be developing. If, however, it achieves growth at the expense of other social and political components, its development is being compromised. =

11. NATURAL CAPITAL STOCK AND ENVIRONMENT
11.1 Introduction sustainable development involves trying to avoid creating severe economic and social problems for future generations that might arise from the mismanagement or over utilization of natural capital.

11.2 Why Natural and Social Capital are Important
Key Features of Capital The term capital refers to the stock of materials or information that exists at some point of time. Most commonly to many people, we think of it as the amount of money we have, either tied up in buildings, land, cars or jewellery, or saved in a bank or pension fund.

Each form of capital stock generates a flow
of valuable services that may be used to transform materials or the way they interact to enhance human welfare. Although capital stock and assets take many forms, we have tended to undervalue two critical types, these are : 1.natural capital and 2.social capital.

Natural capital refers to the stocks of plants and
animals, and the ecosystems they make up, the minerals, atmosphere and water. These stocks of capital create 'services' that comprise flows of material, energy and information, which we can combine with manufactured and human capital to produce welfare.

Natural capital is vital: it is difficult to imagine
generating welfare without it. Although it is impossible to give an absolute value to some capital stocks - the atmosphere, for example, has infinite value to us - it is instructive to see how much the services that come from the capital are worth.

Social capital Is an equally fundamental basis for economic
growth. It lowers the costs of working together (the transactions costs) and so facilitates co- operation between people. There are four central aspects of social capital These have close echoes in the features of natural capital, and are trust; norms and sanctions; reciprocity; and connectedness

Trust is important as it lubricates co-operation
and reduces transaction costs. There are two types of trust. The trust we have in individuals whom we know; and the trust we have in those we do not know, but which arises because of our confidence in a known social structure. It takes time to build, but is easily broken. Norms and sanctions are the mutually agreed or handed-down rules of behavior that place group interests above those of individuals.

They give individuals the confidence to invest in
collective or group activities, knowing that others will do so too. Individuals can take responsibility and ensure their rights are not infringed. Mutually-agreed sanctions ensure that those who break the rules know they will be punished. Reciprocity and exchanges increase trust. There are two types of reciprocity:

Specific reciprocity refers to simultaneous
exchanges of items of equal value; and diffuse reciprocity refers to a continuous relationship of exchange that at any given time is unreciprocated but over time is repaid and balanced.

Connectedness, networks, and civic engagement of all types are vital for social capital formation and maintenance. This may be of many types – from guilds and mutual aid societies, to soccer clubs and credit groups, to forest, fishery or pest management groups, to literary societies and mother and toddler groups. Connectedness can be horizontal or vertical, though horizontal bonds and networks are the most vital for effective institutional performance. New platforms for horizontal collaboration and co-operation are commonly needed for the sustainable management of natural resources.

12. ENVIRONMENTAL CONTROL POLICIES
12.1 Introduction Environmental policies statements There are several sectoral and cross-sectoral policies. Some of the cross-sectoral policies include those addressing poverty, demographic dynamics, land tenure, technology, biodiversity, public participation and education.Environmental impacts of actions in one sector are often felt in other sectors.

This is why environmental goals, objectives and
Cont… This is why environmental goals, objectives and actions cannot be understood and framed in isolation from the development and policy sectors in which they emanate. Sectoral policies include those focusing on agriculture, livestock, water and sanitation, health, transport, energy, mining, human settlements, industry, fisheries, tourism, wildlife and forestry.

Wildlife resources shall be protected and
Cont… Wildlife resources shall be protected and utilized in sustainable manner on the basis of careful assessment of natural heritage of in flora, and fauna fragile ecosystem, sites under pressure and endangered species, with participation of, and benefits to, the local communities. Environmentally adverse impacts of development projects in wildlife conservation areas (e.g tourist hotels, rail construction) will be minimized by EIA studies.

In forestry, the main objective is the development
Cont… In forestry, the main objective is the development of sustainable regimes for soil conservation and forest protection, taking into account the close links between desertification, deforestation, freshwater availability, climate change and biological diversity.

12.2 Instruments for environmental policy.
The environment is both a natural and cultural heritage. Achievements of environmental policy objectives suggest the use of the most effective policy and economic instruments. Such instruments must ensure that the exploitation of natural resources, the direction of investment and the orientation of technological development are all in harmony and enhance both the current and future potential to satisfy human needs and aspirations. The following area considered priority policy instruments:

12.2.1 Environmental Impact Assessment
Although it is important to tackle immediate environmental problems, precautionary, preventive approaches are the most effective approaches. Finding the right balance between natural process and unavoidable human interventions.

Cont… It is in the context of an EIA regime that
policy guidance on choices to maximise long-term benefits of development and environmental objectives can be revealed and decided upon. The aim is to integrate environmental considerations in the decision making process to avoid unnecessary damage to the environment.

12.2.2 Environmental legislation
Environmental law is an essential component of effective environmental management and improvement in the quality of life. The environmental laws aim at setting demands, impose duties and limits and create obligations for the individual for private and public bodies and in a way that it can make clear contribution to fit human activities into laws that govern the patterns of our air, water, soils and plant and animal life.

environmental law must be understood and
Cont… It is recognized that for effectiveness, environmental law must be understood and appreciated by the people to whom it is aimed. Therefore other instruments like public education and awareness are essential and complementarily policy instruments. Furthermore, environmental standards and procedure have to be in place before or as a result of legislation for this instrument to be effective.

12.2.3 Environmental Standards and Indicators
Sustaining life of all forms is a question of balance. There are finite limits to the carrying capacity of ecosystems, that is, to the impacts that they cause, and the environment in general can withstand without dangerous deterioration. The limits vary with each ecological setting and from locality to locality. - how much food, water, energy and raw materials are exploited, and wastes disposed.

Policies that bring human activities into balance with nature's carrying capacity, as well as technologies and practices that enhance that capacity through careful management form a sound basis for sustainable development Environmental standards and indicators are necessary management tools for providing early warning relating to potential environmental problems to carrying or assimilative capacities of environmental media and to habitat quality.

12.2.4 Economic instruments for environmental control
Identify and adopt instruments that integrate environmental and economic policy and that are parsimonious in their use of scarce development and management resources. The search for instruments of environmental management in developing countries and transitional economies is a search for instruments of sustainable development.

Economic instruments meet most of these
conditions and are uniquely suited for the integration of environmental and economic policy and can be design to advocate sustainable development. Economic Instruments for Environmental and Natural Resources Management are economic incentives that are designed to influence the behaviour of economic agents that ensures sustainable use and protection of biophysical resources.

Economic instruments may be classified into seven broad categories:
Property right b) Market creation c) Fiscal instruments d) Charge systems e) Financial instruments f) Liability instruments Performance bonds and deposit refund systems g) Provision of information

Property rights This class of instruments is based on the recognition that excessive resource depletion and environmental degradation arises from misleading price signals which results from absence (or thinness) of markets in the resources and environmental assets. To the extent that the failure of the markets to emerge is due to the lack of well defined, secure, and transferable property rights.

The advantages of secured property right.
With secure property rights, the price of resource commodities such as minerals, oil, and timber would reflect the resource depletion cost and provide the right signals for efficient use and conservation in line with changing relative resource scarcities. Property rights can easily be restricted in some ways to internalise other external costs or to pursue other socially responsible behaviour.

Property rights can easily be restricted in
some ways to internalise other external costs or to pursue other social objectives The assignment of secure, exclusive and transferable property rights goes a long way in correcting the incentive structure and altering the behaviours of resource users to one that more closely conforms to socially responsible behaviour.

The property rights approach to the
internalisation of external cost has a number of limitations, which though important do not overweigh the advantages: One limitation is that the assignment of the property right is a politically contentious issue subject to rent seeking and corruptions and can be used as an instrument to achieve political objectives such as rewards political supporters.

The second limitation is how the property rights
are assigned (distributed) has momentous distributional implications: if granted free of charge, property right holders are given ownership to the entire present value of the infinite stream of rents flowing from the resources While assignment of secure property rights to open access resources is certain to improve efficiency,

management, and conservation, it may also
deprive the poor of access to common resources important for survival, unless they are recipients of the property right. Property rights are particularly applicable to land and soils (land rights, water resources (water rights), minerals (mining minerals) and other natural resources which can be parcelled out and enclosed or their boundaries easily demarcated and defended as the ability to exclude non-owners is critical to the effectiveness of property rights as economic instruments

Market creation As seen above property right in there conventional way are not an appropriate instrument for the protection of the environment, unlike their use in natural resources management.

Cont… Property rights effectively internalise depletion costs (scarcity value) and on-site environmental costs. Any external cost (off-site effects) are internalise through supplementary instruments such as regulations and incentives.

Tradable emission permits.
Are forms of market creation. An aggregate level of allowable emissions is set for each airshed and allocated among polluters either according to the level of output or current level of emissions. Since the aggregate emissions quota is set at or below the level of emissions, an artificial level of scarcity is created and permits acquire positive value (market price).

Industrial producers with a deficit of permits or
Cont… Industrial producers with a deficit of permits or with expansion plans must secure emission permits by reducing emissions from existing plants Alternatively, they may purchase permits from other polluters who are either able to reduce emissions at a lower cost than the industrial producers can or who find it more profitable to sell their permits than use them themselves.

Cont… Thereby the desired reduction of emissions is attained at the minimum possible cost to society and a strong incentive is provided for continued efforts to improve efficiency and to develop cleaner technology

Tradable water share. This is similar to water rights but distinct in that the resource is indivisible in its physical dimension but divisible in its use (analogous to environment). Consider surface irrigation system in the developing countries. Farmers receive irrigation water free of charge. The result is overuse by those with easy access, with consequent waterlogging and salanization of soils and shortage,

Tradable water shares work as follows: The
Cont… And water stress for those further a field or downstream. Tradable water shares work as follows: The irrigation authority issues to farmers and other water users in the command area of a water system percentage shares to the water stored in the system during each season. Each shareholders knows his/her entitlement by multiplying the total amount of water in the system announced by the water authority each season by his/her share.

The institution of tradable water shares does
presume the ability to meter and monitor use, but these requirements are beyond the capability of most water authorities and irrigation departments. Tradable permits can be applied in grazing, land development and hunting etc

Fiscal instruments Fiscal instruments such as taxes and subsidies could be used to bridge the gap between private and social costs/benefits.

Environmental taxes: Can then be used to
effect full-cost pricing (i.e to bridge the gap between private and social costs). To do this, the tax should be set exactly equal to the marginal environmental damage corresponding to the socially optimal level of pollutions. This tax, known as a pigouvian tax, is the embodiment of full- cost pricing.

Environmental taxes can be levied into the
following: a) The pollutant itself (i.e, on effluents, emissions, or solid waste), or b) on final products associated with environmental externalities. Tax pollutant known as pollution charges, are applied directly to the offending substances therefore providing the maximum incentives for the polluter to reduce pollution.

Fiscal instruments include not only taxes but
also subsidies i.e. instead of taxing the polluters to reduce the pollution to the optimal level, polluters can be subsidized to do exactly that.

12.2.4.4 Financial instruments
Financial instruments are distinguished from fiscal instruments because they are often extra-budgetary and financed from foreign aid, external borrowing, debt for natural swaps, and the like. Financial instruments such as revolving funds, green funds and subsidies interest or soft loans for projects with significant positive externalities e.g afforestation as vehicles for internalisation positive externalities.

Liability systems This class of instruments aims to induce social responsible behaviour by establishing legal liability for (a) natural resource damage, (b) environmental damage (c) property damage (d) damage to human health or loss of life (e) non-compliance to environmental laws and regulations (f) non-payment of due taxes and fees or charges.

The difference between liability systems from other instruments (except for enforcement incentives and non-compliance charges) is that the threat of legal action to recover damages is the economic instrument that internalises the external cost in the first instance

Deposit refund system is an economic
cont… Deposit refund system is an economic instrument for encouraging consumers to return containers to appointed centers for proper disposal or recycling. It is also used to encourage consumers to return some used and potentially hazardous products, such as batteries with a high content of mercury or cadmium, to redemption centers for proper disposal.

A surcharge is introduced on the products whose
containers are to be returned to the appointed centers. When a consumer returns the containers he gets back the extra money he paid as surcharge. A performance bond is an economic instrument for environmental management that makes non- compliance with environmental standards costly to producers. The instrument involves producers posting a mandatory bond upon starting a business, and the bond is to be forfeited should it be determined that the producer has caused environmental damage against the regulation

12.2.4.5 Economic instruments for global commons
The scope and role of economic instruments are not limited to the management of domestic environmental problems, but extend to the management of the global commons, such as the conservation of tropical forests, the preservation of biodiversity and protection of the global climate and the ozone layer.

Developed countries need financial resources
Cont… Willingness to pay for conservation could be captured through new innovative trading arrangements between developed and developing countries. Developed countries need financial resources and efficient technologies to pursue sustainable development, in exchange they can offer:

12.2.4.6 Information Provision
A well-functioning market depends to a large extent on well-informed customers and producers. Even for economic instruments to function properly, information is required, and disclosure of information is now seen as an instrument by itself. Non-existence of markets in many cases can be explained by lack of information.

There several forms of information disclosure
Cont… There several forms of information disclosure depending on the degree of interpretation and aggregation of information as well as on the character of the organisation that is responsible for certification i.e labelling, public disclosure, or rating and certification. Such information may be provided through a legal requirement for products to be labelled with information on their environmental impact.

The idea is that consumers who are
environmentally conscious may need such information when making their decisions on whether to buy or not.

THANK YOU FOR LISTENING AND UNDERSTANDING

INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS

Similar presentations

Presentation on theme: "INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS

Similar presentations

Presentation on theme: "INTRODUCTION TO NATURAL RESOURCE AND ENVIRONMENTAL ECONOMICS"— Presentation transcript:

Similar presentations

About project

Feedback