CIV324 Week 3

Jan 27, 2012

Monetary valuation of environmental and social
benefits and costs
Next week: How it all comes together! CBA and other multiattribute decision-making tools & individual presentations

Feb 10: Case-study of a CBA for high-speed rail in the QuebecWindsor Corridor & guest lecture. Consumer surplus is back!
Feb 17: Sample problems, wrapping-up evaluation stage

M. Hatzopoulou

Beyond monetary costs and benefits

Internalizing the externalities

Social cost-benefit analysis

Full cost accounting
Social costs accounting
True cost...
Refer to accounting systems that internalize sustainability
factors into the evaluation of project alternatives. Often
this is done by assigning a dollar value to impacts such as:
climate change, air quality, ecosystem health, etc.
Total costs = Private costs (e.g production) +
external costs (e.g. environmental)

Basis for market economies

Market economies are based on voluntary exchange: Agents
(individuals, households, firms, etc.) trade some of their
endowments (e.g. free time, money, competences, skills) for
goods or services (e.g. salary, consumption items) provided by
other agents in the economy
Market prices of goods and services are determined by
demand and supply forces
Ideally, the market price would contain the full value of the
good to consumers and its full cost to producers

Market failures
Ideally, the market price would contain the full value of
the good to consumers and its full cost to producers
In reality this rarely happens
Market failures refer to situations when markets fail to
organize production or allocate goods in an efficient way
Market prices do not reflect the value of the good to
consumers or its cost to producers Too many or too
few goods will be produced (or consumed)
Market failures often occur due to the presence of
externalities

The concept of externality

Often defined as an unintended action caused by an
economic agent and influencing another agent who is not
participating directly in the market transaction
e.g. Car manufacturing plant affects local air quality
but neither car manufacturer nor buyer pay for the
pollution which worsens the QoL of neighbourhood
residents

An externality can refer to a cost or a benefit

Processes and externalities in the

Forest-Wood-Chain

Prokofieva, I., Lucas, B., Jellesmark Thorsen, B., Carlsen, K. 2011.

Monetary values of environmental and social externalities for the
purpose of cost-benefit analysis in the EFORWOOD project.
European Forest Institute, Finland.

External costs of vehicle use

Lemp, J. And Kockelman, K. M. 2008. Quantifying the external

costs of vehicle use: Evidence from Americas top selling lightduty models. Transportation research part D, 13: 491-504

Adapted from: Lemp, J. And Kockelman, K. M. 2008.

External costs of big box retail

External costs of big box retail

Increased costs for host
localities and
neighbourhoods:
Traffic and congestion
costs
Street and road
maintenance costs
Environmental costs
(runoff, storm water)
Depressed property
values in nearby
neighbourhoods

http://2500milesbarbwire.blogspot.com/2009/06/
big-box-mentality.html

Total economic value

An all-encompassing measure of the economic value of
any environmental asset
Relies on the notions of willingness to pay (WTP) and
willingness to accept (WTA):
WTP: maximum amount of money an individual is
willing to give up to have that good
WTA: minimum amount of compensation an
individual requires in order to stop having the good
TEV = SUM (WTP, WTA)project

TEV is often divided into use and non-use value

Stated-preference surveys which capture WTP

values are often used to infer non-use values
Pearce, D., Atkinson, G., and Mourato, S. 2006. CostBenefit Analysis and the Environment. OECD Publishing.

 FYI. Side note on the TEV

The TEV relates to preferences of individual human
beings (recall, WTP and WTA)
Critics of CBA reject the notion that individual
preferences should be the basis for valuing
environmental assets
They prefer the notion of intrinsic value
Intrinsic value is independent of human preferences
TEV cannot encompass intrinsic values

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Travel cost method
Hedonic pricing
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Revealed Preference (RP) models

Basis of RP methods is the valuation of non-market
impacts by observing actual market behaviour (or
purchases made)
Infer the value of a non-market good (e.g. air quality)
from observations of expenditures on some related
market good (e.g. house)
RP are based on actual decisions made by individuals or
households (vs. SP which ask people about decisions they
would make under hypothetical situations)

Hedonic Price Method

The price of a good is a function of a bundle of
characteristics e.g. the price of a house is a function of
the number of rooms, house location, local environment
Assume that people prefer quiet areas; since there is no
market for noise, there is no direct evidence of the
price of quiet
But people who value quiet will purchase a house in a
quiet area; a measure of the value of quiet is the
premium that is paid for a quieter house compared with
a noisier but otherwise identical one

Hedonic Price Method (2)

Concerned with unbundling the
contributions of each significant determinant
of house price in order to infer the WTP for
each characteristic
Involves collecting large amounts of data on
prices and characteristics of properties in an
area, and applying statistical techniques to
estimate an hedonic price function
HPM models of the property market have been
used to identify the value of nonmarket goods
(or bads) such as road traffic and aircraft noise,
air pollution, water quality, proximity to landfill
sites, etc.

Example of a Hedonic Price Model

ln pi 0 Acc Acc1i Area ln Areai Age ln Agei House1hi
p i:
Acc1i:
Pi:
Areai:
Agei:
1hi:

Price of dwelling unit i [100,000$]

Accessibility to jobs for the Zone to which i belongs.
Population of Zone i
Area of dwelling unit i
Age of dwelling unit i + 1 year
1 if dwelling unit i is a house, 0 otherwise
The coefficients of the model were estimated as an
Ordinary Least Squares (OLS) regression
0
Acc
Area
Age
House

Estimate
-3.592
0.05211
0.9423
-0.06481
0.1672

Std. Error
0.03080
0.001029
0.006296
0.002007
0.01811

t value
-116.6
50.62
149.7
-32.29
9.234

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Travel Cost Method (TCM)

Adopted to value geographical areas and locations used for
recreational purposes (e.g. Beaches, lakes, natural reserves).
The recreational area itself does not have a market price but many
of the factors employed in the generation of the recreational
experience have market prices
TCM derives from the observation that the value of the recreational
area can be measured with reference to:
The number of trips that an individual takes to visit the area
The cost per trip
Information is usually collected through surveys carried out at the
recreational site

Travel Cost Method (2)

The cost per trip is divided into 2 components:
Costs in return fares or gasoline expenses, wear and tear and
depreciation of the vehicle
Cost of time spent travelling (value of time)
Cost of time spent travelling
Time spent travelling could be spent in some other activity (e.g.
working)
One possible value for the price of time to an individual is their
wage rate: If individuals can choose the number of hours they
spend working then they will choose to work up to the point at
which an extra hour spent at work is worth the same to them as
an hour spent at leisure. At the margin, therefore, leisure time
will be valued at the wage rate.

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Averting Behaviour
Individuals might be able to avoid exposure to non-market
bads via the purchase of a market good

These financial outlays are known as defensive expenditures

The value of each of these purchases represents an implicit
price for the non-market good or bad in question
e.g. Households installing double-glazed windows to decrease
exposure to road traffic noise.
If noise levels decrease as a result of a local authoritys
implementation of traffic calming measures then households
will spend less on these defensive outlays changes in
expenditures on this substitute good provide a good measure
of households valuations of traffic calming policies

Complications in the practical applications

of averting behaviour
Defensive expenditures typically represent a lower bound
estimate of the value of the non-market bad
In the double-glazing case, greater indoor tranquillity may be
achieved, but gardens will still be exposed to road traffic
noise, so double-glazing will not help homeowners avoid the
costs of road traffic noise completely
Many defensive expenditures create joint products. The
double-glazing case creates energy conservation. It is the net
cost of the expenditure that is, the cost after taking account of
the value of energy savings which is the correct measure
difficult to infer!

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Cost of Illness (COI)

Focuses on expenditure on medical services and products
made in response to morbidity and other health effects of
non-market impacts
e.g. costs of the health impacts of air pollution can be
valued by looking at expenditure which affected
individuals make on drugs to counter the resulting
headaches, and other symptoms of some air pollutants

The difference between the COI and defensive expenditure

approaches is that the decision to incur these health care
expenditures is not made by the individual alone, but by
social administrators and ultimately the tax payer
Rely on the development of dose-response functions

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Stated Preference (SP) Models

A range of costs and benefits such as some of the categories
of value of environmental resources cannot be
straightforwardly inferred using RP techniques. Analysts resort
to SP approaches.
SP methods offer a direct survey approach to estimate the
WTP for changes in the provision of (non-market) goods
By means of an appropriately designed questionnaire, a
hypothetical market is described
The contingent valuation method is perhaps the dominant
stated preference method or survey-based technique.
Extensively applied to a range of environmental effects.

Contingent Valuation Questionnaire

At the heart of the CV questionnaire:
The Contingent Scenario: A hypothetical scenario
describing a situation where an increase or decrease
of the non-market good occurs
After the presentation of the hypothetical scenario, the
provision mechanism and the payment mechanism,
respondents are asked questions to determine how much
they would value the good if confronted with the
opportunity to obtain it, under the specified terms and
conditions

Contingent Valuation Questionnaire (2)

Pearce et al., 2006

Contingent Valuation Questionnaire (3)

Pearce et al., 2006

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

SP approaches Choice Modelling (CM)

Widely used in market research and transport literature; new
to environmental valuation
CM is a family of survey-based methodologies for modelling
preferences for goods, where goods are described in terms of
their attributes and of the levels that these attributes take
Respondents are presented with alternative descriptions
of a good, differentiated by their attributes and levels, and
are asked to choose the preferred alternative
By including price as one of the attributes of the good,
WTP can be indirectly recovered from peoples choices

Gaker et al., 2011

Choice modelling alternatives include:

Choice experiments
Choose between 2 or more alternatives
Contingent ranking
Rank a series of alternatives
Contingent rating
Score alternative scenarios on a scale of 1-10
Paired comparisons
Score pairs of scenarios on a similar scale

Choice experiments

The probability that any particular respondent prefers

Option A to alternative options, can be expressed as the
probability that the utility or well-being associated with
Option A exceeds that associated with all other options

Utility of an alternative
Utility or well-being (of the ith respondent for the jth
alternatives in the choice set) depends on the attributes of the
choices and unobserved factors:

Utility of an alternative (2)

Concepts related to choice modelling

(Board)

Different methods to measure the TEV

1. Use Value

2. Non-use value

Revealed preference
techniques
Hedonic pricing
Travel cost method
Averting behaviour
Cost of illness

Stated preference
techniques
Choice models
Contingent valuation

3. Value transfer or benefit transfer

Value Transfer or Benefit Transfer

New primary environmental valuation studies often cannot be
performed prior to all important decisions
Decision-makers are often forced to use the economic
estimates of similar changes in environmental quality from
previous studies
Values from the original valuation study can be transferred:
this procedure is often termed benefit transfer
E.g. Unit value transfer:
(WTP)new study = WTPprev.study x (Inew study/Iprev.study)
I = per capita income
= income elasticity of WTP for the good in question
E WTP, I %WTP / %I

Next weeks debates

Debate 1: Monetary valuation is essential in the project
evaluation phase in order to bring environmental effects to
the forefront of decision-making

AGREE
Participant 1: Martin
Participant 2: Marly
Participant 3: Mark
DISAGREE
Participant 1: Anna
Participant 2: Garth
Participant 3: Jessica

Next weeks debates

Debate 2: Philosophical debate on the preservation of the
environment based on the intrinsic value of natural resources
vs. extrinsic value (i.e. value to humans)

AGREE
Participant 1: Raphael Dumas
Participant 2: Graeme
Participant 3: Rebecca
DISAGREE
Participant 1: Elle
Participant 2: Thomas
Participant 3: Alex