5. WHAT ARE THE KEY BENEFIT/COST MEASUREMENT METHODS FOR NATURAL RESOURCE & ENVIRONMENTAL ISSUES?

1. 5.WHAT ARE THE KEY BENEFIT/COST MEASUREMENT METHODS FOR NATURAL RESOURCE & ENVIRONMENTAL ISSUES? SPRING 2002 Larry D. Sanders Dept. of Ag Economics Oklahoma State University

2. INTRODUCTION • Purpose: to understand alternative ways to measure value of natural resource/environmental management options • Learning Objectives: 1. To understand how Benefit Cost Analysis (BCA) operationalizes utilitarian concepts of ethical social policy making with money as a common measure. 2. BCA includes time & future generations by searching for present value of net benefits. 3. There are several methods to apply BCA to nonmarket goods, although ethical values & cultural considerations are not likely to be quantified.

3. Overview of Benefit/Cost Analysis (BCA) • BCA provides a method to compare an array of alternative public policy choices • If B>C for a given policy, it says that for every $1 of project expense, more than a $1 of benefits would be generated by the project • If there are several alternative projects to resolve a problem, the project with the greatest net benefits would be preferred, assuming to ethical/cultural reasons to the contrary

4. Overview of BCA (continued) • For BCA to work: • “apples & oranges” measured by money • nonmarket goods/services measured by money • proxy measures are sought if no market exists • Alternatives to BCA: • public vote (democracy) • those in power decide • use a noneconomic decision rule (social, cultural, religious, etc.)

5. BCA (continued) • Mix BCA w/others • BCA used to guide/educate public/decision makers • Integrated environmental assessment • economics plus ecological/social/political/ethical factors

6. BCA compared to others • BCA • may be scientific, objective, & equitably applied • requires time/resources to conduct/evaluate • ethical questions • nonmarket goods problematic • interdependencies problematic • Noneconomic • may be “easy” to do • ethical questions (majority rule; future generations, etc) • subject to manipulation

7. Efficiency is central to economic assessment... • Minimize waste (of resource, profits, time) • Ecosystem must be valued in monetary terms to be included in efficient solution • “Efficient policy option” selects alternative which generates most social utility relative to status quo • Kaldor-Hicks: PDV = or > status quo • Pareto Criterion: no other policy can make some better off without making anyone worse off • B/C ratio: policy w/greatest benefit per $ of cost & B/C > 1

8. Cost-Benefit Analysis & Economic Measures • Project evaluation, typically over time • Choice of Discount Rate Key • Higher rate lowers future value of b, c • Risk-free real market rate of interest may be preferred social discount rate (sdr) • Choice for sdr < individual r suggests society values future > individuals value future • Potential for Abuse • Assumptions & who decides are critical • May run counter to Native American Ethic, “Deep Ecology”, Leopold land ethic, etc.

9. Dynamic Efficiency • Rapid development of resource drives price down • Future price rapidly increases • Hi future P suggests incentive to reduce current production, thus raising current P & potentially reducing future P • Dynamic Efficiency: maximum present discounted value (PDV)

10. “Optimal” Environmental Quality Level • Opportunity Costs to reduce externality increase as pollution levels approach zero • Marginal Abatement Cost Function (MAC) • Damage (real & perceived) to physical/natural environment • Marginal Damage Function (MD) • Optimal Level: MD = MAC • Economics provides analytical tools; society provides the goals (sometimes thru market, sometimes thru public action)

11. Marginal Damage/Marginal Abatement Marginal Damage Function=MD Damages & Costs ($) Marginal Abatement Cost Function = MAC Pollution Level Total Damage Total Abatement Cost

12. Economic Incentives to Improve Natural Resource/Environmental Quality • Marketable Pollution Permits • Trade permits in market to equate MC across polluters • Initial distribution • history, auction, lottery • equity & geographic concerns • Bonding Systems • Liability Systems • Pollution Subsidies

13. Natural Resource/Environmental Valuation • Determined by people & willingness to make trade-offs • Producer & Consumer Surplus • Nonmarket valuation--use & non-use value

14. Non-market Valuation Techniques • Direct--hypothetical questions on willingness to pay/sell (wtp/wts) • Contingent Valuation Method (CVM) • open/closed-ended w/specific mechanism • Conjoint Analysis • preferences among bundles of characteristics • Indirect (revealed preference)--people’s decisions reveal preferences & value • Hedonic Pricing/Wages • Travel Cost Method (TCM)

15. Economic Returns--Rent Applications (cont.) • Land Values: In theory, current market value = present value of expected future land rents = worth of current investment held at acceptable interest rate • Discounting determines present worth of expected rental returns; negative premium on waiting • Present Value = Future Value / (1+rate) • Future Value = Present Value x (1+ rate) • “rate”: appropriate discount rate • social discount rate? • Risk-free real market rate of interest? t t