Measuring Benefits: Methods *Hedonic housing price method *Travel cost method

1. Measuring Benefits: Methods *Hedonic housing price method *Travel cost method How much pollution is too much?

2. Revealed preference methods • Hedonic pricing models and travel cost measure the actual result of what people do. • Stated preference models (contingent valuation) examine what people say.

3. Hedonic Pricing Models – Housing Market • What determines the value of a house? • Site characteristics: number of bedrooms, age of house, garage, etc. • Neighborhood characteristics: distance from downtown, distance from MTSU, quality of neighborhood schools, etc. • Environmental characteristics: noise levels, air quality, proximity to disamenities (i.e. landfills), proximity to amenities (parks, lakes, scenic views).

4. Hedonic Pricing Models • Consider two houses which are identical in every way (i.e. same size, same age, etc.) except their distance to Percy Priest Lake. • House A (1/4 mile from the lake) sells for $190,000. • House B (1/2 mile from the lake) sells for $185,000. • Value of moving an extra ¼ mile closer to the lake is equal to $5000. • The value of the amenity is capitalized in the value of the house.

5. Hedonic Pricing Models • The problem is that houses are never identical. • Consequently, the researcher must use statistical methods to control for all the factors that can affect the value of a house. House price (p) Environmental factor (air quality, for example) All other factors (X)

6. Process for an Hedonic Pricing Study • Collect data on house characteristics and prices. • Use a regression equation to estimate the portion of the housing price attributable to particular characteristics. • Total House Price = (A1 x Number of Square Feet) + (A2 x # of Bathrooms )+ …… +( A10 x Air Quality). • A1, A2,…, A10 are coefficients estimated by the researcher. • Coefficient A10 is the contribution of air quality to the price of the house; this is the MWTP for air quality improvements. • This is the method by which we can control for all other attributes which may affect the price of housing.

7. Hedonic Pricing Models Hypothesis: an improvement in air quality is capitalized in higher housing prices. Housing Prices ΔP Q1 Q2 Air Quality

8. Case Study 1: Air quality and home prices in Las Vegas • Sample of 15,000+ home sales Jan-Nov 1999. • P = f( X, Q, W, Z) • P is the market value of home, • X is the set of characteristics associated with home, • Q comprises the market factors, • W is the neighborhood characteristics, and • Z represents the environmental attributes. Helen R. Neill, David M. Hassenzahl, and Djeto D. Assane, “Estimating the Effect of Air Quality: Spatial versus Traditional Hedonic Price Models”, Southern Economic Journal April 2007.

9. Case Study 1: Air quality and home prices in Las Vegas • Environmental variables: • Carbon monoxide (CO) • Particulate matter (PM) • Collected daily at 18 stations; researchers used monthly averages. • Station monitoring devices geocoded and linked to sales by nearest Census tract.

10. Case Study 1: Air quality and home prices in Las Vegas • Results: air quality matters • 1% rise in CO associated with a 1.7% lower home price. • 1% rise in PM associated with a 2.2% lower home price.

11. Case Study 2: Water quality and home prices in Chesapeake Bay • What impact does fecal coliform bacteria have on property values? • If water quality improves, how much would property values rise? • P = f( X, W, FECAL) • P is the market value of home, • X is the set of characteristics associated with home, • W is development density, distance to wetlands, forests, and cities, and • FECAL represents water quality. Christopher Leggett and Nancy Bockstael, “Evidence of the Effects of Water Quality on Residential Land Prices”, Journal of Environmental Economics and Management, 2000.

12. Water quality in the Chesapeake

13. Case Study 2: Water quality and home prices in Chesapeake Bay • Results per home: • Change of 100 fecal coliform counts per 100mL produces a change of 1.5% in property prices. • Low of $5,000 to high of $9,800 depending on the model. • 100 counts per 100 mL is a large change (mean is 103 counts per 100 mL; beaches are closed at 200 counts per 100mL). • Actual range along coastline is 4 to 2300 counts per 100 mL.

14. Case Study 2: Water quality and home prices in Chesapeake Bay • Benefits estimation: • Example for Saltworks Creek inlet near Annapolis consisting of 41 homes. • Range in inlet is 50 to 240 counts per 100 mL. • Improving water quality by -100 counts per 100 mL would increase property values by roughly $230,000 or about 2% of assessed value.

15. Case Study 2: Water quality and home prices in Chesapeake Bay • Benefits estimation: • For entire Anne Arundel County, what are the benefits of reducing fecal coliform count to the state standard (200 counts per 100 mL)? • Estimated at $12 million (+/- $4 million). • Does not include: benefits to near-shore property owners, recreation benefits, or nonuse benefits.

16. Hedonic Pricing Models • Primary strength of HPM: estimates based on observed behavior, not hypothetical scenario. • Primary limitations of HPM: • Estimate use values only. • Estimate values for landowners only. • Main challenge with HPM: omitted variable bias. • Creating the “all else equal” experiment is challenging. • Difficult to obtain data on all things that affect housing prices (e.g. scenery). • Omitted variable bias occurs when “unobserved” factors that affect housing (e.g. scenery) are correlated with environmental quality variables of interest (e.g. pollution).

17. Travel Cost Models • Travel Cost • Typically used to value outdoor recreation. • Process of a simple travel cost study: • Survey visitors to a recreation site and ask questions on the distance traveled to the site, how often they visit, similar sites, income etc. • Estimate a demand curve for the site. • Economic benefits of the site derived from consumer surplus.

18. Origin A Site Origin C Origin B Travel Cost Method Travel cost method example:

19. $ 8 6 2 Trips per capita 2 4 8 Travel Cost Method Calculation of the trip demand curve for a representative individual, assuming that on average, individuals have the same preferences at the three origins Demand curve: q=10-p

20. $ 8 6 2 Trips per capita 2 4 8 Travel Cost Method Consumer surplus is MWTP – travel cost. Example for Origin A: • Travel cost is $8 per person for 2 visits; this is the pink shaded area. • Consumer surplus (net benefits) is the blue shaded area (MWTP – travel cost).

21. Calculating the value (consumer surplus) of the park $ What is the origin A per-person consumer surplus of the park? a What is the origin B per-person consumer surplus of the park? 8 b 6 What is the origin C per-person consumer surplus of the park? c 2 trips 2 4 8 Demand curve: q=10-p Travel Cost Method

22. Calculating the value (consumer surplus) of the park $ What is the origin A per-person consumer surplus of the park? a = (1/2)($10-$8)2=$2 a What is the origin B per-person consumer surplus of the park? b= (1/2)($10-$6)4=$8 8 b 6 What is the origin C per-person consumer surplus of the park? c=(1/2)($10-$2)8=$32 c 2 trips 2 4 8 Demand curve: q=10-p Travel Cost Method

23. Origin A Site Origin C Origin B Travel Cost Method Calculating the aggregate consumer surplus (CS): Aggregate consumer surplus (CS): $112,000

24. Travel Cost Models • Issues with travel cost: • People may have multiple reasons for taking a trip (e.g. visit aunt Sally, visit other parks, etc.). • How to measure costs? gas only?; gas and food?; gas, food and lodging?; what about plane travel? • Value of travel time? • Time is scarce • Using time to travel has an opportunity cost.

25. Travel Cost Method The above trip demand curve ignores the costs of travel time. Suppose that when the time costs of traveling are considered, the total travel cost per trip is $16, $12, and $4 for origins A, B, C, respectively. How does this change the calculation of the net benefit of the park? • Per-person CS for A : (1/2)($20-$16)2 = $4 • Per-person CS for B : (1/2)($20-$12)4 = $16 • Per-person CS for C : (1/2)($20-$4)8 = $64 • Total CS : ($4*4000) + ($16*1000) + ($64*3000) = $224,000 • Ignoring cost of travel time underestimates MWTP for a trip.

26. Origin Population # of Visits Visits per capita Trip Cost C 3000 24000 8 2 A 4000 8000 2 8 1000 4000 6 B 4 Travel Cost Method A. An example of how NOT to apply the travel cost method… Net benefit of a recreation site is equal to total expenditures… Trip cost x visits/capita x population = $64,000 Site A $24,000 Site B $48,000 Site C Total: $136,000 What is wrong with this approach??

27. $ 8 6 aa bb 2 cc Trips 2 4 8 Travel Cost Method Wrong way to estimate: adds up costs, not net benefits.

28. Case Study 3: benefit of Florida beaches • Survey of tourists to Florida beaches • Collected data on spending: lodging, food, travel, access fees, other beach expenses. • Also data for age, income, length of stay, perceptions. • Hypothesis: the lower the cost of visiting the beach, the longer the stay in days.

29. Case Study 3: Benefit of Florida beaches • Days on beach = f(cost of visit, other factors). • Found a 10% rise in cost cut time at the beach just 1.5% (inelastic demand). • Average daily expense: $85. • Average consumer surplus per day: $38. • 70 million tourist days per year. • Total consumer surplus: $2.4 billion. • Did not account for value of tourists’ time.

30. Non-Market Valuation Methods • Strengths of various methods: • Contingent valuation: • Can directly value changes in any good. • Can estimate use and non-use values. • Directly identifies WTP/WTA for a specified change in environmental quality. • Hedonic pricing / travel cost: • Value estimates based on observed behavior, not hypothetical questions.

31. Non-Market Valuation Methods • Challenges / weaknesses of various methods: • Contingent valuation: • Hypothetical bias. • People not understanding valuation scenario. • Hedonic pricing: • Setting up the “all else equal” scenario is empirically challenging. • Only measures use values for landowners. • Travel cost: • Incorporating cost of travel time is difficult. • Only measures use value for recreationists.