GES 400 H Selected Topics in Geography: Computer Aided Negotiation Economic Issues in River Basins

1. GES 400 H Selected Topics in Geography: Computer Aided Negotiation Economic Issues in River Basins John J. Boland, Ph.D., P.E. Professor Emeritus The Johns Hopkins University 24 Sep 08

2. Objectives • At the end of this lecture, you should: • Recognize some economic issues associated with recreational uses of rivers • Be able to articulate the difference between market and non-market values, and to recognize the non-market values associated with recreation • Be able to list the principal advantages and weaknesses of methods used to measure non-market recreation benefits 0:10

3. Example Problem • A state is considering a capital project for the next fiscal year. The project is described as follows: • “Fish populations in several tributary streams have been depleted because of past pollution (now corrected). At the present time, fishing is banned in the affected stream reaches to avoid extinction of harvestable species. The state proposes to stock the streams with immature fish raised in a state hatchery. It is expected that the program, conducted in the summer of 2010, will permit sport fishing to resume in the summer of 2013, and to continue indefinitely thereafter.” 1:05

4. Benefits and Costs • What are the costs of carrying out this project? • How can we measure the costs? • What are the benefits that will result if this project is successfully implemented? • How can we measure the benefits? • From the point of view of society as a whole, why do we care about benefits and costs? 2:15

5. More Information • Up to a point, the larger numbers of immature fish restocked, the larger the resulting population and the more fishing-days can be sustained. • The more fish placed in the stream, the greater the cost of restocking and the risk of overstocking • The more fishing-days each year, the greater the benefit from the state's investment. • The state proposes limiting the number of annual fishing days to a sustainable level by issuing a fixed number of no-cost licenses, assuming each licensee will fish for an average of 25 days/year. • The state wishes to design the project so that the benefits are at least equal to the costs. 5:05

6. Sustainability • What does it mean for this project to be sustainable? • With respect to --- • fish population • social welfare (economics)‏ • anything else? 8:00

7. The Question • How many licenses should the state issue each year (so that the benefits are at least equal to the costs)? • Issuing too few licenses will deprive some of the opportunity to fish and will result in lower benefits, possibly less than the project costs (no economic sustainability)‏ • Issuing too many licenses may result in depleting the restocked fish population (no fish population sustainability)‏ • The state wishes to find the optimum number of licenses, considering all of these factors 9:00

8. The Analysis • This problem requires economic analysis because: • We need to know the cost of restocking the streams as a function of the anticipated fishing pressure, resulting from the number of licensees • We need to know the economic benefits obtained from fishing each year, as a function of the number of licensees • In order to evaluate benefits, we must measure the value of a non-market good – fishing • Costs and benefits must be adjusted to reflect the same monetary measure (e.g., 2008 dollars)‏ • Future benefits must be reduced to present value for comparison to costs 9:20

9. What's Next • We will learn how economists measure costs and benefits • In particular, we will learn how non-market benefits are measured • Several methods will be discussed • They all have pros and cons • We will see how costs and benefits occurring at different times are adjusted and compared • The result will be the optimum number of licenses that the state should issue 11:00

10. Measuring Costs • The costs of implementing a project generally consist of construction costs, operating costs, maintenance costs, and possibly future removal costs. These costs are typically engineering estimates and relatively uncontroversial (compared to benefits). • But there may be external effects (either positive or negative) associated with constructing and operating a project. These are measured using methods similar to those described for benefits. 11:10

11. Measuring Benefits • Measuring the benefits of public sector projects, especially water resource projects, presents many challenges. Resulting measurements often prove controversial, making this a particularly difficult area for planners. • What is sought is a monetary measure of benefits, even though many water resource benefits are not associated with a cash flow. Even where there is a cash flow, it may not properly represent the value of the output to society. 11:55

12. Market vs. Non-Market Goods • Market good • Can be bought and sold in a market – the good has a price – consumption of the good involves a cash flow (consumers pay producers)‏ • Examples – bread, cable TV, computers • Non-market good • Is not offered in the market – no price – consumers may use the good but they don't pay for it, so there is no cash flow • Examples – clean air, visual amenity, fishing 12:40

13. Market-Based Valuation • Some benefits can be measured by means of market-based methods: • The project output may consist of market goods, which are sold to beneficiaries at observable prices. (hydroelectric energy)‏ • The project output may not be itself a market good, but its provision may affect the demand for an existing market good. (canoeing affects the demand for canoe rentals)‏ • The project output may not be itself a market good, but its provision may affect the cost of producing an existing market good. (flood control may reduce the cost of downstream activities)‏ 14:00

14. Market-Based Valuation • Market goods, or goods with links to market goods, are relatively easy to value • For a market good, the value is consumers' willingness to pay for the good, calculated from the price and the quantity consumed • For goods related to market goods, the value is at least the increment in value created for the market goods, but it might be more 17:00

15. Non-Market Goods • Some outputs may be non-market goods without any close connection to market transactions: • Some can be measured indirectly by revealed preference methods (measurement derived from market behavior involving other weakly complementary goods). • Some can be measured directly by stated preference methods (measurement obtained directly from consumers using survey methods). 17:10

16. Kinds of Value • For certain non-market goods, there may be more than one kind of value: • Use value—experienced by persons who actually use the good • Intrinsic value—experienced by persons who do not necessarily use the good • Option value is experienced by non-users who do not know whether they will use the good in the future, but prefer to retain the option • Existence value is experienced by non-users who do not plan to use the good in the future, but prefer that it be available for others • Bequest value is experienced by non-users who do not plan to use the good in the future, but prefer that it be available for future generations 18:45

17. Non-Market Good Valuation • Indirect methods – Revealed Preference • People's behavior reveals the value that they place on the good • Direct methods – Stated Preference • People are asked to state what value they place on the good 24:40

18. Revealed Preference Methods • Appraisal Method: Expert opinion as to what a good would be worth if it could be traded in the market (based on comparable sales)‏ • Travel Cost Method: Measures value of an in situ resource (e.g., national parks) as demonstrated by willingness of individuals to incur travel expenses. • Hedonic Price Analysis: Value of an environmental good can be deduced from its effect on the value of a weakly complementary market good, such as real estate. 25:20

19. Stated Preference Methods • All Stated Preference Methods use some type of survey, which may be administered in person, by telephone, by mail, or by internet. The survey has the following elements: • Description of the good that is to be valued and the choice situation (hypothetical market) that is to be assumed. • The elicitation (choice) question. This may take a number of forms: “how much would you pay for ____?” “would you pay $____ for ____?” “how would you rank ___ alternatives?” “given a change in the level of the non-market good, how would your behavior change?” 31:15

20. Stated Preference (cont.)‏ • Questions about the respondent: age, gender, socio-economic data, attitudes, beliefs, etc. 33:30

21. Contingent Valuation • Contingent Valuation Method (CVM)‏ • Typical elicitation question: “how much would you pay for ____?” • Results can be extrapolated from sample to population and transformed, in a number of steps, to a population demand curve for the non-market good. • The value of a change in the quantity of a non-market good is the change in the area under the demand curve (change in willingness to pay). 35:00

22. Contingent Referendum • Contingent Referendum Method • Typical elicitation question: “would you be willing to pay $_____ for _____? Yes or No?” • Sample results can be extrapolated to the population. • Using econometric techniques, results can be used to estimate a demand curve. • By comparison to CVM, respondents usually find the elicitation question easier to answer. However, the method requires a larger sample. 35:35

23. Contingent Ranking • Contingent Ranking Method • Elicitation question asks respondents to rank a number of alternative bundles of goods, including the non-market good. • Results can be extrapolated from the sample to the population. • Respondents find this relatively easy; it does not require the assumption of a hypothetical market. Accordingly, this method avoids some kinds of biases. • This method requires a large sample. 37:10

24. Contingent Activity • Contingent Activity Method • Typical elicitation question: “if ___ amount of the non-market good were supplied, how would that affect the number of days you spend _____?” • If the contingent activities can be valued in monetary terms, it is possible to impute the value of the non-market good, to the extent that it enables some valuable activity. • Sample results can be extrapolated to the population. • Limited applicability (e.g., water quality improvement may induce additional recreational activity). 37:45

25. Other Stated Preference • Combinations of these methods can be used (e.g., a contingent referendum question with a contingent valuation follow-up)‏ • Method can be varied to suit circumstances • Conjoint Analysis, e.g., is a variant of the Contingent Ranking Method. • NOTE: all survey methods, including all of the Stated Preference methods discussed here, are subject to a variety of biases. Every application should be carefully designed to minimize bias. 38:20

26. Biases in Survey Research • Bias is not the same as error, or as uncertainty. In the case of error or uncertainty, there is usually no presumption as to the direction of the error. Biases, however, usually shift results in a particular and predictable direction. • Strategic Bias: Respondents may answer questions so as to increase the likelihood that some valuable good will be provided to them. 38:35

27. Biases (cont.)‏ • Protest Bids: Some respondents may provide zero or non-zero valuations for reasons other than their actual valuation. This may reflect objections to placing a value on a good that respondents expect to receive without cost. Or some may report a high value in order to “send a message” or for other reasons unrelated to their personal valuation. • Value Cue Bias: Instead of reaching their own valuation, respondents may react to some cue given in the course of the survey. 39:15

28. Biases (cont.)‏ • Information Bias: Too much or too little information on the good may have been given in the survey instrument. This is a particular problem where some respondents have access to information from other sources (e.g., newspaper accounts). • Payment Vehicle Bias: The respondent may react to the method proposed for recovering the cost of the non-market good, or to their assumptions when no method is stated. Possible methods include broad-based taxes, local benefit taxes, user fees, etc. 40:55

29. Biases (cont.)‏ • Hypothetical Bias: The hypothetical nature of the survey questions may prompt a respondent to answer carelessly. This effect is typically called a “bias” but it is probably better described as a source of “error,” since the direction of the discrepancy cannot usually be predicted. • Sample Bias: The sample of respondents may be non-random, or the sample may be biased by refusals and/or incomplete responses. 41:40

30. Biases (cont.)‏ • Non-Response Bias: Those who do not respond to the survey, or who decline to be interviewed, are not a random sample of the population. They may include those who place the lowest value on the good. Their exclusion can bias the results. 42:10

31. Fishery Problem • Back to the problem posed at the beginning of the lecture -- • A consultant has estimated the cost of stocking the streams (including hatchery costs) as a function of the expected fishing pressure: • Where: TC = total cost of stocking (2005 $)‏ • P = no. of licenses • Q = fishing-days/year/license (25)‏ • This must be restated in 2008 $, using the Consumer Price Index (why?)‏ 43:10

32. Fishery Problem (cont.)‏ • A previous study estimated the willingness-to-pay (benefit) of anglers on a similar stream, under similar conditions. A sample of anglers were interviewed, using a contingent valuation method. The results were then extrapolated to the larger population of anglers and fitted to a mathematical form, giving the following expression • Where: W = total willingness-to-pay/year • But this result is in 2003 $, so it is escalated to: 44:45

33. Fishery Problem (cont.)‏ • Notice that the cost is a single item, incurred in 2010 and stated in 2008 $, but the benefits are annual amounts, starting in 2013 and continuing indefinitely (stated in 2008 $). • Calculate the equivalent present value of the benefit stream, as of 2010 (same year that costs are incurred). • Both benefits and costs can be stated in 2008 $, or in dollars for any other year, as long as the same year is used for both • Using an inflation free discount rate of 3.0%, the 2010 present value of the benefits is: 46:00

34. Fishery Problem (cont.)‏ • Now we have expressions for total costs and total benefits, both as functions of P and Q. • If Q is assumed to equal 25 days/year, the expressions can be rewritten as functions of P • The decision criterion (benefits at least equal to costs) is satisfied by setting TC = TB • Solving the resulting expression for P gives the optimal number of licenses • Note that this cannot be solved analytically. But the expressions can be set up on a spreadsheet and solved with a solver, or by manual iteration • Solution: optimal number of licenses = 1,380 47:20

35. Fishery Problem (cont.)‏ • Review -- • Solution required: • Mathematical modeling of the cost of restocking the streams • Non-market valuation of fishing (using contingent valuation in this case), allowing mathematical modeling of annual benefits • Both costs and benefits were stated at 2010 present value, but in 2008 $ • Results included - • The minimum cost ($3,781,800) at which the project could be feasible • The number of permits which could be distributed consistent with maintaining sustainable fisheries on these streams 48:20

36. What did we learn?