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Environmental & Ecological Economics for Development

Environmental & Ecological Economics for Development. Lecture 2: Valuation of the Environment. Outline. Economic values for the environment Contingent Valuation (CVM) Hedonic Pricing (HP) Travel Cost Method (TCM) Production Function Approach (PFA). 1. Values for the environment.

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Environmental & Ecological Economics for Development

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  1. Environmental & Ecological Economics for Development Lecture 2: Valuation of the Environment

  2. Outline • Economic values for the environment • Contingent Valuation (CVM) • Hedonic Pricing (HP) • Travel Cost Method (TCM) • Production Function Approach (PFA)

  3. 1. Values for the environment • Pricing/charging of un-priced environmental goods & services • Valuing environmental impacts in cost-benefit analysis • Controversial basis of methods • Subject to lobbying and manipulation

  4. Demand curves – substitution and income effects Price of X2 rises from Px21 to Px21 leading to a fall in consumption of X2 which can be decomposed into a substitution and an income effect. Welfare evaluation requires that we remove the income effect so that we arrive at a “compensated” demand curve

  5. Economic valuation - demand and consumer surplus

  6. Categories of Goods

  7. Demand for private & public goods

  8. Economic valuation methods

  9. 1. Economic value of the environment • Use values: direct use of environmental resources • e.g., fertility of soil, fish from the sea, timber from forest, water from stream, etc. • Option values: the value people place on future ability to use environment; the willingness to preserve the environment even if one is not currently using it • future use by descendants or by others – altruism • Existence values:willingness to pay for preserving or improving resources that people will never use; unrelated to any actual or potential use • existence of environment, even without human beings, is intrinsically important • non-human rights

  10. 1. Economic value of the environment (cont) Four categories of environmental services –use and option values (e.g., forest) • Input for production: timber, honey, medicinal plants • Waste sink: absorbs CO2, dumping area • Amenity service: recreation • Life-support service: soil cover, plants & animals, rainfall

  11. 1.Economic value of the environment (cont) • Non-use/existence value: willingness to pay for preserving or improving resources that people will never use; unrelated to any actual or potential use • existence of environment, even without human beings, is intrinsically important • non-humans rights

  12. 1. Economic value of the environment (cont’d) • Direct & indirect approaches to measure values • Direct: asking individuals questions about the value of environmental services; captures both use and non-use values; e.g., CVM • Indirect: estimates from the observed behaviour of individuals in relation to marketed commodities; to estimate only use-values, e.g., HP, TCM, PFA

  13. 2. Contingent Valuation Method (CVM) Directly asking people about their • willingness-to-pay (WTP) for availability of an environment service and/or • willingness-to-accept (WTA) compensation for loss of an environmental service

  14. 2. Contingent Valuation Method (CVM) (cont) • Six stages in CVM • Set-up a hypothetical ‘market’ • Obtain bids • Estimate mean WTP or WTA • Estimate bid curves • Aggregate data • Evaluate the CVM exercise Use preserving a community forest as example

  15. 2. Contingent Valuation Method (CVM) (cont) • Set-up a hypothetical market • Create a reason for payment • “the forest cannot be preserved without the management by the forestry department which entails costs” • How are funds to be raised • Income taxes? Property tax? Fees? Contributions? User fees? etc.

  16. 2. Contingent Valuation Method (CVM) (cont) • Obtain bids • Survey instrument administered asking individuals to state their maximum WTP or minimum WTA

  17. 2. Contingent Valuation Method (CVM) (cont) • The bids can be obtained through • Bidding game: higher and higher amounts suggested • Close-ended referendum: yes/no reply to a single payment • Payment card: a range of values on a card • Open-ended question: no value suggested

  18. 2. Contingent Valuation Method (CVM) (cont) • Estimate mean WTP or WTA • Mean/median of the bids are calculated • Protest bids: zero bids for reasons other than attaching zero value; e.g., refuse to attach any value, non-response • Outliers: median preferred if there are ‘problematic’ outliers

  19. 2. Contingent Valuation Method (CVM) (cont) • Estimate bid curves • How are the bids related to the individual characteristics of respondents? WTPi or WTAi = f(Ii, Ei, Ai, Qi, O) Ii = income; Ei = education; Ai = age; Qi = size of forest; O = other relevant factors

  20. 2. Contingent Valuation Method (CVM) (cont) • Estimation of bid curve helps to address issues like, • Do richer people value the forest more than the poor? • Do educated people value the forest more than the uneducated? • Do older people value the forest more than the younger? • How sensitive are people to the stock of forest?

  21. 2. Contingent Valuation Method (CVM) (cont) • Aggregate data • The bid value from the sample has to be scaled-up to the relevant population • Corrections for sampling biases – as in other studies – may be required • If the bids are related to different periods of time  discounting

  22. 2. Contingent Valuation Method (CVM) (cont) • Evaluate the CVM exercise • May include sensitivity analysis • Proportions of protest bids • Understanding of hypothetical ‘market’ by respondents • Comparing with results from other studies • etc.

  23. 2. Contingent Valuation Method (CVM) (cont) • Some problems in CVM • Strategic bias: respondents may over- or under-state bids to influence possible outcomes • over-state: if respondents think others may provide the resources (NIMBYs) • under-state: if respondents think they are going to provide the resources (the free rider problem)

  24. 2. Contingent Valuation Method (CVM) (cont) • Design bias: the design of the survey may bias respondents’ bids • Choice of bid vehicle: bidding game, close-ended referendum, open ended questions, etc. may give different results • Nature of hypothetical ‘market’: income taxes? property taxes? fees? etc. • Starting point bias: the starting point of the bid may influence the final choice of respondents

  25. 2. Contingent Valuation Method (CVM) (cont’d) • Mental account bias: • respondents may systematically over-state WTP by thinking about a broader problem than the specific environmental problem • respondent may report the “total WTP for preserving all forests” rather than the specific forest

  26. 2. Contingent Valuation Method (CVM) (cont) • Hypothetical market error: do people act the same way in a hypothetical ‘market’ as they do in a real one? • Responsibility considerations: should polluters pay for preserving the environment?

  27. 2. Contingent Valuation Method (CVM) (cont) Some empirical applications • Social forestry in Orissa, India (Kohlin, 2001a) • community forests more beneficial to people living far from forests and those depending on market purchase a. Kohlin, Gunnar. "Contingent Valuation in Project Planning and Evaluation: The Case of Social Forestry in Orissa, India." Environment and Development Economics, 2001, 6(2), pp. 237-58.

  28. 2. Contingent Valuation Method (CVM) (cont) • Wetland in Taiwan (Hammitt, et al., 2001) • estimated households’ WTP to preserve Kuantu wetland • Community forestry in Ethiopia (Mekonnen, 2000) • household size & income, distance, number of trees owned and sex of head significant Hammitt, James K.; Liu, Jin-Tan and Liu, Jin-Long. "Contingent Valuation of a Taiwanese Wetland." Environment and Development Economics, 2001, 6(2), pp. 259-68. Mekonnen, Alemu. "Valuation of Community Forestry in Ethiopia: A Contingent Valuation Study of Rural Households." Environment and Development Economics, 2000, 5(3), pp. 289-308.

  29. 3. Hedonic Pricing (HP) • HP identifies the value of an environmental service by examining how market value of a good (e.g., a house) is affected by environmental damage (e.g., pollution) • How much lower would the price of a house be in a polluted neighbourhood as compared to a similar house in a non-polluted neighbourhood?

  30. 3. Hedonic Pricing (HP) (cont’d) • Estimation of hedonic price function Ph = f(Si, Nj, Ak, Qm) Ph = house price Si = site/property characteristics (rooms, garage, garden, etc.) Nj = neighbourhood characteristics Ak = accessibility (link with other neighbourhoods) Qm= environmental quality

  31. 3. Hedonic Pricing (HP) (cont) • The HP function tells us by how much property price changes for a change in environmental quality – captures WTP • Typically as environmental quality improves, property prices rise but at diminishing rate • Problems in HP: econometric problems, market segmentation (ethnic composition, owner vs. rental), etc.

  32. Pi = f (Qi) House prices, Pi Environmental quality, Qi

  33. 4. Travel Cost Method (TCM) • The cost of using the environmental service as proxy for value of environment • Mainly used in outdoor recreation, fishing, hunting, boating, national park • Travel cost for individual i to site j, Cij Cij = DCij + TCij + Fj, i=1, …, n; j =1, …, m DCij = distance costs TCij= time costs (opportunity cost of labour) Fj = entrance fee

  34. 4. Travel Cost Method (TCM) (cont) • Trip generating function (TGF): predicts how many visits, Vij, by individual i to site j given travel cost and socio-economic characteristics Vij = f(Cij, Ii, Ei, Ai, etc.) Ii = income Ei = education Ai = age • The TGF gives a demand curve for changes in travel cost – WTP for the service

  35. Costs per visit, C C* C1 C2 Vmax V1 V2 No. of visits, Vj

  36. 4. Travel Cost Method (TCM) (cont) • Maximum number of visits when travel cost (fee) is 0 • At C2 & C1, V2 & V1 number of visits – individual still interested to visit (there is WTP for the service); s/he willing to pay as high as C* • Travel costs/fee capture the amounts people are willing to pay (consumer surplus) to visit the environmental service = the value of the environmental service

  37. 4. Travel Cost Method (TCM) (cont) Some problems with TCM: • Multi-purpose trips • Calculating • distance costs (e.g., only petrol, depreciation, etc.) • the value of time (what is the opportunity cost of time for visiting the environmental service?) is complicated • Econometric problems

  38. 5. Production Function Approach (PFA) • Examines how environmental quality affects firm or household production • How much marketed inputs are required to compensate for environmental degradation so that the same level of output is produced?

  39. 5. Production Function Approach (PFA) (cont) • Production function: Qi = f(L, K, I, E) Qi = quantity of output L = labour K = capital I = other inputs E = environmental quality • What are the additional costs in L, K and I if E deteriorates?

  40. 5. Production Function Approach (PFA) (cont) • E.g., fish catch declining with pollution of water • How much more labour, capital (e.g., fishing boats) and other inputs are required to get the same catch as before the pollution? • The additional costs incurred for the additional labour, capital and other inputs measure the value of the water pollution

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