ERE8: Valuation

1. ERE8: Valuation • Valuation theory • Total economic value • Indirect valuation methods • Hedonic pricing • Travel cost method • Direct valuation methods

2. Last week • Renewable resources: Fisheries • Growth rates in biological resources • Steady-state harvest • Perfect market • Open access • Dynamic harvesting • Policy intervention

3. 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

4. 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

5. 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

6. 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

7. Pollution Damage(billions of US$) * Damage avoided

8. 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

9. 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

10. 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)

11. Measures of changes in Welfare for an Environmental Good Expenditure on private goods, Y D E Y1 I3 B Y0 A C I2 I1 q0 q1 Quantity/quality of environmental good q

12. 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

13. 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

14. 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

15. 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

16. Hedonic analysis (3) Step 1: Estimate price differential due to the environment using multiple regression p=property characteristics n=neighbourhood characteristics e=environmental characteristics w=worker characteristics em=employer characteristics e=environmental characteristics Step 2: Derive marginal willingness to pay

17. 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

18. 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

19. 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

20. 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

21. Steps • Define a set of zones surrounding the site • Collect number of visitors from each zone in a certain period • Calculate visitation rates per population • Calculate round-trip distance and travel time • Estimate visitors per period and derive demand function

22. An Example Visits/1000 = 300 – 7.755 * Travel Costs

23. An Entrance Fee of 10 Euro So now we have two points on our demand curve.

25. Drawbacks • Not data intensive, but a number of shortcomings • Assumes that all residents in a zone are the same • Individual data might be used instead • More expensive • Sample selection bias, only visitors are included

26. Other problems • Assumption that people respond to changes in travel costs the same way they would respond to changes in admission price • Opportunity cost of time • Single purpose trip • Substitute sites • Unable to look at most interesting policy questions: changes in quality • Use random utility models instead

27. Constructed Markets • Revealed preference methods can only estimate the use value of the environment, and only if that value affects behaviour in a measurable and interpretable manner • For the rest, we have to use either hypothetical markets or experimental markets (together: constructed) • Experimental markets have delivered little estimates (but a lot of insights), so the contingent valuation method remains – this is a stated preference method

28. Contingent Valuation (2) • Interview people, ask them for their willingness to pay for certain environmental goods and services • Advantage: Applicable to more than direct use value • Disadvantages: Hypothetical, people are unfamiliar with the situation, all sorts of biases may occur, interview design is always hard

29. History • First applications in early 1960s to value outdoor recreation • 1979 the Water Resource Council recommended CV as one of 3 methods to determine project benefits • In the mid 1970s the EPA funded a research program to determine the promise and problems of the method • The Reagan Executive Order 12291 (1981) • All federal regulations on environmental policy should be submitted to a Cost-Benefit Analysis • 1989 governmental decision on legitimacy of non-use values for TEV and equal standing • 1989 Exxon Valdez oil spill • value loss of non-use values for US citizens

30. Design a CV study • Define a market scenario • Choose elicitation method • Design market administration • Design sampling • Design of experiment • Estimate WTP-function

31. Incentive Strategic Compliance Implied value Starting point Range Relational Importance Position Misspecification Theoretical Amenity Context Embedding and warm glow Potential Biases

32. Incentive Biases • The interviewee deliberately gives a false answer • Strategic bias: Influence the outcome • Compliance/sponsor bias: Comply with presumed expectations • Compliance/interview bias: Try to please/impress the interviewer • Protest votes: Interviewees may object to valuation per se, or to being interviewed

33. Implied Value Biases • Starting point bias, in the bidding game • Range bias, in the payment card • Relational bias, if examples of other contributions are mentioned • Importance bias: The fact that the interviewer bothers to ask ... • Position bias, if multiple goods are valued

34. Misspecification Biases -Context • Misspecification of the market scenario • payment vehicle • property right: WTP/WTA • method of provision: like payment vehicle • budget constraint: ability to pay • elicitation: maximum WTP? • instrument: survey may confuse interviewees • question order

35. Other Misspecification Biases • Theoretical • Amenity/symbolic: The perceived good is different than intended • Amenity/part-whole: The interviewee thinks the good is wider or narrower than intended (geographical, issue, policy) • Amenity/metric: Different measurement • Amenity/probability: Different assessments of the chance of delivery

36. Embedding • WTP for same good varies depending on whether it is assessed on its own or embedded as part of a more inclusive package • Kahnemann (1986) • WTP to prevent drop in fish population in all Ontario lakes or small area respectively • Scope effect • Sub-additivity effect • Possible explanations • Substitution and satiation • Purchase of moral satisfaction (warm glow)