Environmental Economics Lecture 5

1. Environmental EconomicsLecture 5 Valuing the Environmental Dr. Mahmoud Arafa E-Mail: mahmoudara@gmail.com Facebook Account: www.facebook.com/mahmoud.one

4. This Lecture Focus on • How can we calculate the cost and benefits of environmental outcomes? • Can we put a value on ecological system, or on human health and life? • How can we weight the interests of future generations?

5. Why Cost-Benefit Analysis (CBA)? Environmental policy tools that work through market mechanisms (taxes, subsidies, transferable permits) – leave the final decisions on resource use and goods production up to firms and individuals.

6. Why Cost-Benefit Analysis? In some cases, however, governments must make specific decisionsthat have both economicandenvironmentalimplications. In such cases, decision makers use Cost-Benefit Analysis(CBA) to balance the positive and the negativeconsequences of a proposed action (Ex. construction of large Dam).

7. CBA for An Dam Construction

8. How can we evaluate whether or not to build the dam? How can we put a dollar value on the social and ecological losses that will result?

9. Estimating ValueFor Dam Construction Case Economists use various techniques to estimate different kinds of values.

10. Types of value

11. The term value is used in many ways in studies on the economic valuation of goods and services, including use values and non-use values. It is important to clarify the meanings of the different types of values, as the term can have distinct meanings. The working definitions and discussions of non-market values.

12. Use values Use value refers to the benefit a user obtains, either directly or indirectly, from participating in an activity. Consumptive use can be described as participation in activities that utilize and possibly deplete the forest resources (e.g. hunting, fishing and tree cutting); while non-consumptive uses are those uses or activities that do not affect the resource (e.g. bird-watching in a national park, appreciating a view at a look-out).

13. Non-use values Non-use values do not involve any actual physical consumption of the forest goods and services. Examples of non-use values include increases in productivity, wellbeing, health, longevity (long life), and feelings of peace and tranquility and a decrease in stress levels. They are further classified as existence, option, quasi-option, bequestand vicariousvalues

14. Existence values are those benefits that are derived from the knowledge that non-timber amenities and resources will continue to exist regardless of the fact that the amenity or the resource may never be used, seen or visited.

15. Option value relates to the willingness to pay for an option to have the resources or services available in future when there is uncertainty attached to its supply. In simple terms, the option value has been defined as “the value of the opportunity for obtaining better information by delaying a decision that may cause irreversible changes” .

16. Quasi option valueis slightly complicated, it relates to the willingness to pay to avoid an irreversible development given an expectation that knowledge about the impact is in the offing. If you choose not to decide, You still have made a choice Quasi-option value = Value of the development opportunity including delay option - Expected net present value .

17. Bequest value is the value assigned to preserving a resource for use by future generations. In a forestry context, a bequest value could occur if an individual is willing and able to pay for the preservation of a forest resource so that his children and grandchildren find the resource in an intact state

18. Vicarious value deals with the value placed on a resource that may have never been used or planned to be used, but benefitmay be derived from mere pictures, descriptions and other representations of the resource. Vicarious values may include the information that certain rare species of animals like spottedowls, pine Martens, peregrinefalcons, etc.

19. VALUATION METHODS The methods adopted for the economic valuation of forest goods and services generally include • direct methods, which determine the value a person is willing to pay for the products or goods through a resource survey instrument. • Indirect methods are also used to determine the value of forest goods and services.

20. VALUATION METHODS

21. Indirect valuation techniques The travel cost method is an indirect valuation technique that was designed to model recreation behavior. This method calculates a value based on the fact that the price paid to travel to the site is the ultimate value of that site. It should be considered that no fees may be imposed on the use of the resource.

22. The travel cost method The costs associated with travelling to the resource (fuel, mechanical maintenance of vehicle, time spent travelling there) become the variables to be used to determine the value of a resource. The weakness of this method is that, it only deals with single destination trips and assumes that travel is a means, rather than an end in itself

23. Hedonic Pricing Method The hedonic pricing method is used to estimate economic values for ecosystem or environmental services that directly affect market prices.  It is most commonly applied to variations in housing prices that reflect the value of local environmental attributes.

24. Hedonic Pricing Method It can be used to estimate economic benefits or costs associated with: • environmental quality, including air pollution, water pollution, or noise • environmental amenities, such as aesthetic views or proximity to recreational sites

25. Hedonic Pricing Method The basic premise of the hedonic pricing method is that the price of a marketed good is related to its characteristics, or the services it provides.  For example, the price of a car reflects the characteristics of that car—transportation, comfort, style, luxury, fuel economy, etc.

26. Hedonic Pricing Method Another example would be to consider that the price of a house in a city includes the contribution of certain market goods (e.g., size, and design of the house, number of rooms, etc.) and the neighborhoods environmental conditions (e.g. air quality when near a sewage, noise pollution if near an airport, etc.). Overall hedonic price models is a means to quantify the contributions of the market and non-market aspects of a particular good to its equilibrium market price through sound statistical analysis

27. Direct valuation techniques Contingent valuation is a direct way of capturing consumer surplus by means of eliciting the willingness to pay value for the preservation of a resource or opportunity in a simulated market. This method comprises a number of techniques to elicit valuation responses including a bidding game, the payment card, open-ended Questionsand close-ended questions

28. Another value that can be elicited through contingent valuation is a willingness to accept value. A willingness to accept provides an estimate of the amount of money an individual would like to be compensated for to forgo an opportunity. This value is estimated based on the fact that the payment is equal to the benefits that an individual would enjoy through salvaging that opportunity

29. In economic theory, the willingness to pay and willingness to accept values are similar, but in reality it has been demonstrated beyond doubt that willingness to accept values can be four times higher than willingness to pay

30. Non-use values Figure: presents an example of the total economic value of a tropical forest. Use values Non-use values Use values Use values

31. For more reading …

32. Direct Use Value In Dam Construction example, the direct use value is farmland used for raising crops productivityand quality which can be measured by its market price. Certainly farmers whose land is submerged by the dam waters will suffer losses at least equal to the value of their farms.

33. In a tropical forest example, the direct use value derive from the consumptive or non-consumptive use of the resource. The individual directly enjoys the resource either by consuming it (i.e., logging the forest to obtain fuel wood or fishing for subsistence) or by gaining enjoyment from the resource stock itself (i.e., recreation value of a park or the scenic vista of a coastal area).

34. Indirect Use Value indirect use value: include ways for which forested lands and wetlands benefit nearby communicates by filtering rainfall, preventing flooding , and absorbing potential pollution. Indirect use values are those resulting from the use of a resource’s services. For example, a forest provides watershed protection, and the ozone layer protects the Earth from ultraviolet (UV) radiation. The distinction between direct and indirect use values is not always clear.

35. Non-UseValue Non-use values: How can something be valuable if it is not used? These values are the manifestation of people’s willingness to pay for a resource regardless of their ability to make any use of it now, or in the future. Such values may arise because of altruism (predilection) towards future generations (bequest value) or because of the simple knowledge that something exists (existence value) even if individuals never plan to use it.

36. Non-UseValue In Dam Construction example , Considered the fish species that might be made extinct by building the dam. Even these species have no commercial value, many people might believe that they should be preserved. Some might argue that other species have their own rights to exist, independent of human valuation, or that the existence of many different species mean that we ourselves live in a richer world- Richer in an esthetic and spiritual rather than a monetary sense.

37. Non-UseValue In a tropical forest example, the Non-Use Value Bequest Value ExistenceValue

38. Bequest Value The value of leaving undamaged or improved world for future generations. And for individuals it is why make wills leaving instructions for handling our estates after our deaths.

39. ExistenceValue We not may have a full understanding of ways in which maintaining biological diversity improves the health of ecosystems, so we may be wise to maintain diversity even without obvious benefit. We can therefore say that the endangered fish species have existence value.

40. ExistenceValue existence value need not be revealed in any type of behavior. The contingent valuation method, which directly asks willingness to pay through the use of surveys, is the only way to elicit such values.

41. Option Value Option values derive from the potential future use of a good, if the need arises. The concept is very popular in finance where options are sold for the right to sell a stock-market commodity at a specified price at a specified time in the future. The value of options derives from the fact that present time information is not perfect. Time will tell us if holding the asset is worthwhile, and keeping that option will make it possible to take advantage of any new information.

42. Option Value In the dam example, the flooded farms and forests will be lost forever- the decisionis characterized by irrevocability. And if we not decide to build the dam today, the farms and forests will be preserved, but we could still build the dam ten or twenty years from now.

43. In a tropical forest example, the conservation of a natural area is an option, giving us the possibility of transforming the area in the future, or keeping it, according to the new information gathered on the relative value of the natural area.