ERE8: ValuationValuation theory
Total economic value
Indirect valuation methods
Hedonic pricing
Travel cost method
Direct valuation methods
ERE8: Valuation
Valuation theory
Total economic value
Indirect valuation methods
Hedonic pricing
Travel cost method
Direct valuation methods
Last week
Renewable resources: Fisheries
Growth rates in biological resources
Steady-state harvest
Perfect market
Open access
Dynamic harvesting
Policy intervention
Economic Value
Neo-classical revolution: Value is relative, value measures demand versus supply, value is based on consumption and production
Basis of valuation: People‘s preferences, what people want
Values depend on context
Supply, demand
Uncertainty: Something that is uncertain is worth less, an uncertain loss is worth more
Uniqueness: Something that is unique is worth more
What to value?
Individuals can derive value from environmental goods from more sources than direct consumption
Types of environmental services:
source of materials input: fossil fuel, wood products, fish, water etc.
life-support services: liveable climatic regime, breathable atmosphere
amenity services: recreation, wildlife observation, scenic view, passive use values
sink for the assimilation of wastes
Why Valuation?
We must make choices about how to manage the human impact on natural systems
Greater use of a particular environmental service or greater protection of a specific natural system results in less of something else (trade-off)
To make the most of scarce resources we must compare what is gained from an activity with what is sacrificed by undertaking that activity
Why? To assess the net impact of changes
Uses of Economic Valuation
Regulation can either seek optimum or not
If an optimum is sought, the marginal external cost function must be estimated, and expressed in money
Find optimum: Marginal benefit equals marginal cost (Cost-Benefit Analysis)
Ex ante, e.g., Pigou tax
Ex post, e.g., evaluation of policy
Demonstrate value of environment
Extend national accounts
Pollution Damage (billions of US$)
0.8 2.9 0.3-0.5 %GDP 26.5 33.9 0.6-1.1 Total n.a. 11.6 0.0 Noise 4.8 3.0 0.1-0.3 Water 21.7 19.3-21.5 0.5-0.8 Air USA* Germany Netherlands * Damage avoided
Total economic value
Total economic value = Use value + Intrinsic value
Total use value = Actual use value + Option value + Quasi-option value
Option value = Value in potential use by self + Value in potential use by others + Value in potential use by future individuals
Quasi-option value = Value of avoiding irreversibilities in the light of expected future knowledge
Intrinsic value = Existence value
Existence Value
Existence value is unrelated to any actual or potential use
Existence value may be related to sympathy, or stewardship
Existence value is not right-based, as rights are absolute, and values are relative
People express, and seem to have existence values
Criterion for Cost-benefit Analysis
„benefits“ and „costs“ are meaningless without a social welfare function
defines good an bad consequences
In economics the criterion is the well-being of the members of society
Well-being is defined as
the individuals‘ preferences and
their max. willingness to pay for gains or (WTP)
their min. willingness to accept compensation for losses (WTA)
Measures of changes in Welfare for an Environmental Good
A B C D E I1 I2 q0 q1 Y0 Y1 Expenditure on private goods, Y Quantity/quality of environmental good q I3
WTP and WTAC
However, people view gains and losses differently
WTP is limited to an individual‘s income, WTAC is unbounded
Confirmed by empirical studies, but not uncontested
Implies that surveys, policies need to be carefully designed
If an individual has the legal right, WTAC is the appropriate concept
It can be difficult to determine property rights (public goods)
Sometimes the current allocation is taken as the legal entitlement
Improvements = WTP and reductions = WTAC
Direct & Indirect Valuation
Direct methods (use and non-use values)
Hypothetical/constructed market
Contingent valuation
Indirect methods (use values)
Surrogate market
Hedonic pricing
Travel cost
Hedonic analysis
The method uses a market good within which the non-market good is implicitly traded
Households are attracted to localities offering preferred combinations of amenities
The value of a piece of land is related to the stream of benefits to be derived from the land
Obvious benefits: agricultural output or shelter
In addition: access to commercial amenities, to environmental facilities, to the workplace and the environmental quality of the neighbourhood
Given that different locations have varied environmental attributes, this will results in differences in property prices or wage rates
Hedonic analysis (2)
In order to live in a location with higher levels of an amenity
Households pay higher house prices
Households accept lower wage rates
Cost differences reflect households’ implicit valuation
Method tries to find a relationship between variations in house prices or wage rates and variations in factors such as proximity to sites to environmental amenities or disamenities
Hedonic analysis (3)
p=property characteristics
n=neighbourhood characteristics
e=environmental characteristics w=worker characteristics
em=employer characteristics
e=environmental characteristics Step 1:
Estimate price differential due to the environment using multiple regression Step 2:
Derive marginal willingness to pay
Drawbacks
Markets are in equilibrium
Rents and house prices have adjusted such that individuals are indifferent across locations
Perfect information, no transaction or moving cost
Assumes that households can buy exactly the amount of dwelling-related characteristics it wants
The housing market is unified and not segmented
Data intensive
Travel Cost Model
Widely used for recreation
Natural areas seldom command a price in the market
Basic premise: time and travel cost expenses represent the „price“ of access to the site
WTP to visit the site
Travel is a complement to recreation
Travel Cost Model – 2
Application of TCM
Reservoir management, water supply, wildlife, forests, outdoor recreation etc.
History: Harold Hotelling 1947
Value of national parks
Variations of the method
Simple zonal travel cost approach
Individual travel cost approach
Random utility approach
Zonal Travel Cost Approach
Gives values of the site as a whole
Based on number of visits from different distances
Travel and time costs increase with distance
Gives information on „quantities“ and „prices“
Construct a demand function of the site
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