Economic V aluation of ENVIRONMENTAL & NATURAL RESOURCES

Econ 231: Natural Resources and Environmental Economics SCHOOL OF APPLIED ECONOMICS Economic Valuation of ENVIRONMENTAL & NATURAL RESOURCES

Introduction • Environmental valuation is concerned with putting values to natural resources. • It would provide a means for comparing the importance of recreation with that of other uses of the same resources, • the value of the recreation to be provided by a proposed recreation site would provide one measure of the desirability of making the necessary investment in the project

Introduction • the value of the recreation would provide a ceiling to any fees that might be charged for its use • Thus, we need to impute values that reflect the true social costs and benefits of recreational activities using some techniques of valuation of environmental resources. If the economic costs and benefits of outdoor recreation sites are not estimated using accepted environmental valuation techniques, conservation benefits could not be nearly approximated.

Definition of the total economic value of an environmental resource

Definition of the total economic value of an environmental resource The major contribution of environmental economists has been in the area of the valuation of environmental goods and services, i.e. methods for measuring the demand curves for goods for which there are no markets (nonmarket valuation)

Basic Valuation Principles • Value of a resource = marginal opportunity cost = highest amount that someone is willing to pay for it in an alternative use • Value of a benefit = amount that someone is willing to pay for it • Willingness to pay (WTP) values

Valuation of benefits and cost • Based on WTP values • 3 ways • Observe prices in various markets • Observe individual expenditures of money and time • Ask people what they are willing to pay for goods

Valuation Methods (Non-Marketed Goods and Services) Valuation Methods are divided into two: • Revealed Preference Methods-seek to recover estimates of individuals’ willingness to pay by observing their behavior in related markets. • Direct Proxy involves cost or price that approximate values negative/positive externalities i.e., Opportunity Cost, Productivity Loss and cost of illness

Valuation Methods (Non-Marketed Goods and Services) • Indirect Proxy assumed that non marketed good or service affects preferences of consumers about other marketed goods or services. Common methods: • Travel Cost Method (TCM) • Hedonic Pricing Method (HPM)

Valuation Methods (Non-Marketed Goods and Services) • Stated Preference Methods-seek to recover estimates of individuals’ willingness to pay based on people’s responses to hypothetical questions for a change in environmental services. Method: • Contingent Valuation Method (CVM) • Contingent Choice Methods (CCM) • Contingent Ranking Method (CRM)

Examples:Revealed Preference : Travel Cost MethodStated Preference: Contingent Valuation Method

Travel Cost Method • TCM is the oldest technique of valuation of environmental resources. • TCM is one of the techniques used to value non-market environmental goods using households' consumption characteristics in related markets. • TCM is often used to assess the value of parks, lakes and similar public areas which host a good deal of recreational activity; it is predominantly used in outdoor recreation modeling with several recreational activities.

Travel Cost Method • The fundamental insight that drives this model is that if a consumer wants to use the recreational services of a site he/she has to visit it. • The travel cost to reach the site is considered as the implicit or the surrogate price of the visit, and changes in the travel cost will cause a variation in the quantity of visits. • Observation of these visitations across individuals will permit the estimation of demand functions and the derivation of the welfare measure.

Willingness to Pay (WTP) P’ PhP Consumer Surpluses Demand (WTP) P0 Total Consumer Expenditure Quantity Q0 Q’

TCM Concept TC* PhP Consumer Surpluses Demand (WTP) TC1 Total Consumer Expenditure V1 V* Quantity

TCM Hypothesis • The demand for visit to the site can be estimated based on the number of trips that the people make at different levels of travel cost. • Although people cannot be observed through buying units of environmental good, the cost of the travel is the price paid for the recreational enjoinment.

Key attributes /assumptions of TCM: • Admission fees (often low or non-existent) to recreation areas are an inadequate measure of the value of a visit to recreation site and the cost of round-trip travel is a proxy measure of WTP to visit a recreation site; • Recreation site users will react to changes in gate fees in the same manner that they react to changes in travel cost.

Key attributes /assumptions of TCM: • The basic method assumes the case of a pure visitor, i.e., the trip to the site is for the sole purpose of visiting the site. • TCM uses the costs of travel and the value of travel time as a proxy for WTP for outdoor recreation sites.

Key attributes /assumptions of TCM: Key attributes /assumptions of TCM: • Specifically, the total sum of expenditure of services obtained from a site visit consists of the following 4 elements. • Direct travel expenses (e.g. money expenditure on fuel transport, hotels, etc.). • Time cost of travel (opportunity cost of travel time) • Cost of time spent at the site (opportunity cost of on-site time). • Entrance fee (if any).

Step by Step procedure for TCM • Sample selection and survey (P observations) Random sampling is appropriate but seasonality must be considered to obtain representative sample a. Sampling b. Survey Questionnaire

Step by Step procedure for TCM 2. Elaboration of variables and statistical description of data Descriptive statistics allow to get a first idea of the nature of the data collected.

Step by Step procedure for TCM 3. Choice of the functional form for the individual demand curve. V = f (TC, X) Appropriate statistical tests need to be conducted to select a better specification among the available functional forms.

Choice of the functional form for the individual demand curve. Linear Model: Log-Linear Model: Log-log Model: Linear-log Model: Appropriate statistical tests need to be conducted to select a better specification among the available functional forms.

Choice of the functional form for the individual demand curve. Criteria for selecting the best functional form? • Consistency of results to economic theories • The significance of the variables at 5% level of alpha (to be significant P-value 0.05) • The coefficient of determination ( should be the highest (measures the variation of Visits (V) about its mean that can be explained by TC and Xs) • Standard error ( should be the smallest

Step by Step procedure for TCM Step by Step procedure for TCM 4. Estimation of the demand function of the recreational service V = f (TC, X) Individuals with the same (modeled) features behave in the same way

Step by Step procedure for TCM Step by Step procedure for TCM 5. Calculation of Consumer Surplus Formulas of CS depend on the specific functional form selected for the demand in the previous step

Step by Step procedure for TCM Step by Step procedure for TCM 5. Calculation of Consumer Surplus Suppose the best functional form is double-log model: / let: so, x=c/ where: x=visit rate, y=ave. travel cost of visitors

Step by Step procedure for TCM Step by Step procedure for TCM 5. Calculation of Consumer Surplus x=c/ dy where: highest actual travel expenditure of the respondents average travel expenditure of the respondents

Step by Step procedure for TCM 6. Aggregation of sample CS and further elaboration of CS Sample CS per visit must be multiplied by the total annual number of visits Annual Economic Value= CS * Total number of visits

Economic V aluation of ENVIRONMENTAL & NATURAL RESOURCES