Revealed-preference methods

1. Revealed-preference methods Outline • Hedonic pricing method • Travel cost method • Davao study

2. Readings • Lesser et al., pp. 276-281, 296-304 • Choe, Whittington, Lauria

3. Hedonic pricing method • Measures how the characteristics of a marketed asset, including environmental attributes, affect its price • Typically applied to housing: “hedonic property method” • Earliest application: Ridker (1967) • Has also been applied to agricultural land • Can also be applied to wages: “hedonic wage method” • Job selection might reflect regional amenities or occupational health risks

4. Common observations • Houses near airports tend to sell for lower prices • So do houses downwind from oil refineries and slaughterhouses • Houses with panoramic views tend to sell for higher prices Hence, although there are no markets for noise, smell, or view, such environmental characteristics can affect house prices

5. Hedonic property method:basic idea • Housing is made up of several characteristics, including environmental quality, that determine its value • The price of a house is the sum of the products of the implicit prices of those characteristics times the amounts of the characteristics in the house • Statistical methods can be used to decompose house price into these implicit prices, as long as the characteristics vary within the sample of houses

6. Revealed preference method • Synonym: “indirect” method • Analyze “behavioral trail” left by individuals’ actual decisions, not what individuals say they would do (“stated preferences”) under hypothetical conditions • Implications: cannot use revealed preference methods to value new goods, or changes outside range of current conditions

7. Surrogate markets • Housing market is not really a market for houses, but rather a surrogate market for the characteristics of houses • Similarly, demand for parks is not really demand for parks per se, but rather demand for different environmental services provided by parks (travel cost method)

8. Types of values that hedonic property method can estimate • Use values • Among non-use values, perhaps option values, but not others (e.g., existence)

9. Typical applications • Ambient environmental quality: air, water, noise, odor pollution • Proximity to noxious sites: dumps, incinerators, airports • Natural hazards: floods, earthquakes, landslides, radon • Proximity to desirable amenities: beaches, parks, vistas, cultural sites

10. Hedonic price function • Relationship between price and attributes: PH = 0 + 1A1 + 2A2 +  PH = price of house A1 = airport noise A2 = size of house  = error term 0, 1, 2 = coefficients • Econometric methods (multivariate regression) can be used to estimate the coefficients

11. For the linear function PH = 0 + 1A1 + 2A2 + , the implicit price for amenity A1 is just the coefficient 1: PH/A1 = 1

12. Example: Housing and air pollution in U.S.

13. Travel cost method: basic idea • The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it

14. Travel cost method: basic idea • The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it • Visitors who live at different distances from the site thus face different implicit prices

15. Travel cost method: basic idea • The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it • Visitors who live at different distances from the site thus face different implicit prices • We can estimate a demand curve for the site by relating the number of visits to the total travel cost

16. Entry fee vs. Implicit price • Parks often have no entry fee, or fee hasn’t varied over time or across users • Cannot estimate a demand curve if there’s no price variation • Analyze demand as a function of implicit price: total cost of visiting park, not just entry fee

17. History of TCM • One of oldest and most frequently used valuation methods • Concept is due to Harold Hotelling, in response to request from National Park Service in the late 1940s • Operationalized by Marion Clawson in the 1950s • Refined by Jack Knetsch in the 1960s

18. Recreational applications • National parks and other protected areas • Sporting sites (hunting, fishing) • Archaeological sites • Cultural sites (museums)

19. Other applications • Collection of fuelwood • Collection of water In principle, can be applied to any good whose consumption involves travel-related costs

20. Related terminology • Revealed preference method: TCM is a prime example of this category of valuation methods, which infer WTP or WTA from observed (not hypothetical) behavior

21. Related terminology • Revealed preference method: TCM is a prime example of this category of valuation methods, which infer WTP or WTA from observed (not hypothetical) behavior • Surrogate market method: demand for transportation services is surrogate for demand for environmental amenities at destination

22. Types of travel cost models • Zonal: average data on visitors; a given site • Individual: data on individual visitors; a given site • Multi-site (ditto): data on individual visitors; a set of sites • Hedonic: average or individual data on visitors; characteristics of a given site

23. Features that are common across TCM models • Typically implemented using cross-sectional data • Econometric-based • Two-stage procedure to obtain estimates of consumer surplus

24. Davao study: individual TCM • Asked each household (i) annual number of visits it made to Times Beach before and after health advisory (Vi0, Vi*)

25. Calculated prices of visits to Times Beach (pi) and substitute sites (sij) as sum of: • Roundtrip travel costs • E.g., bus fare • Costs of roundtrip travel time • Assumed cost per hour equaled half of hourly wage rate • There’s no entry fee • If there were, it should be included, too

26. Pooled data across households and estimated demand functions (“trip generating functions”) that relate annual number of visits to pi, sij, household income (yi), and other socioeconomic characteristics (hi): Vi0 = b00 + b10pi + b20sij + b30yi + b40hi + i Vi* = b0* + b1*pi + b2*sij + b3*yi + b4*hi + i • What do we expect the signs of the coefficients to be?

28. For each household, calculated difference in consumer surplus between the two demand functions • This can be interpreted as the household’s WTP for restoring Times Beach • Do we interpret it as compensating variation, equivalent variation, or something else?

29. Calculating consumer surplus • For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as Vi = ci + b1pi where ci = b0 + b2sij + b3yi + b4hi

30. Calculating consumer surplus • For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as Vi = ci + b1pi where ci = b0 + b2sij + b3yi + b4hi • Solve for pi: pi = –ci/b1 – Vi/b1 • Can interpret intercept, –ci/b1 , as choke price: price that causes number of visits to drop to zero: Vi = 0

31. Calculating consumer surplus • For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as Vi = ci + b1pi where ci = b0 + b2sij + b3yi + b4hi • Solve for pi: pi = –ci/b1 – Vi/b1 • Can interpret intercept, –ci/b1 , as choke price: price that causes number of visits to drop to zero: Vi = 0 • Calculate consumer surplus by applying the formula, MCS = ½(–ci/b1 – pi)Vi

32. WTP: TCM vs. CVM • TCM: 36 pesos/month

33. WTP: TCM vs. CVM • TCM: 36 pesos/month • CVM (Scenario 1, mean for households that used beach before advisory): 37 pesos/month

34. WTP: TCM vs. CVM • TCM: 36 pesos/month • CVM (Scenario 1, mean for households that used beach before advisory): 37 pesos/month • Looks good, but: • CVM yields WTP for well-defined reference utility level ; TCM yields Marshallian WTP • CVM measures use and non-use values; TCM measures only use values • CVM measures WTP for cleaning up river and sea; TCM measures WTP just for Times Beach

35. Time costs • Time has an opportunity cost (OC), both while traveling and while on site • Time-related costs are often the largest portion of total travel costs

36. OC of time and the wage rate • Does OC of time equal the pre-tax wage rate?

37. OC of time and the wage rate • Does OC of time equal the pre-tax wage rate? • No: taxes drive a wedge between OC of time and gross compensation • How about post-tax wage?

38. OC of time and the wage rate • Does OC of time equal the pre-tax wage rate? • No: taxes drive a wedge between OC of time and gross compensation • How about post-tax wage? • Overstates OC of time if work involves nonpecuniary costs (stress) • Is time fungible between work and travel?

39. OC of time and the wage rate • Does OC of time equal the pre-tax wage rate? • No: taxes drive a wedge between OC of time and gross compensation • How about post-tax wage? • Overstates OC of time if work involves nonpecuniary costs (stress) • Is time fungible between work and travel? • Can work while traveling (laptops), or might not be able to work if not traveling (institutional constraints)

40. OC of time and the wage rate • Does OC of time equal the pre-tax wage rate? • No: taxes drive a wedge between OC of time and gross compensation • How about post-tax wage? • Overstates OC of time if work involves nonpecuniary costs (stress) • Is time fungible between work and travel? • Can work while traveling (laptops), or might not be able to work if not traveling (institutional constraints) • People might enjoy travel itself Usual assumption: OC of time equals 25-50% of pre-tax wage