Environmental Economics II

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Environmental Economics II

• Dr. Anil Markandya
• hssam_at_bath.ac.uk 01225 386954 Room 3E 4.31b

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Valuing the Environment

• Environmental Valuation
• Enable environmental impacts to be included in
  Cost-Benefit-Analysis (CBA)
• To take account of environmental damage in
  measuring economic performance
• To take account of environmental benefits of
  public programs

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Categories of environmental benefits

• Use Value (UV)
• Existence Value (EV)
• Option Value (OV)(Option Price Expected Use
  Value OV.
• Quasi Option Value (QOV)
• Bequest Value (BV)
• Total Economic Value (TEV)
• TEV UVEVOVQOVBV

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Non-market valuation techniques

• Stated Preferences
• Contingent Valuation
• Choice Modelling
• Revealed Preferences
• Travel Cost Model
• Hedonic Pricing

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The Contingent Valuation Method

• Stated preference technique
• Questionnaire based
• Direct method
• Valuation of a hypothetical scenario
• It is called contingent valuation because the
  valuation is contingent on the hypothetical
  scenario put to respondents
• Non Use Values Use Values
• Willingness To Pay (WTP) question

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Stated Preference Techniques CVM
An interview is used to create the hypothetical
market within these questions are asked. The
hypothetical market comprises two key parts a
statement of the proposed change and an
institutional mechanism through which the
proposed change is to be provided/avoided and
financed. The challenge in conducting a CV is to
make the market as realistic as possible. The
process of directly questioning a sample group to
ascertain their valuation of a change can be
divided into six stages. These are (each with a
number of steps) definition of survey
objectives design of the questionnaire surveyi
ng the sample population creating a database
and performing an exploratory data
analysis estimating WTP values and reporting
the survey results.
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CVM Stage 1 - Project Definition - Theoretical
Model
CV study should begin with a basic theoretical
model two purposes Identifies the information
required from questionnaire Generates
predictions allowing results to be checked Number
of sources of information that can be used to
construct the model, including predictions of
economic theory and existing literature,
discussion/meetings with focus groups/affected
parties. Participants discuss understanding of
the context of the good/service in question, the
good/service itself, its value, who should
provide it, how it should be paid for, whether
they would contribute, etc. The information from
the focus groups is particularly valuable in
designing the CV survey.
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CVM Stage 1 - Project Definition - Sample Design
For a site-specific resource, the sample may be
drawn from Visitors to the site (on-site
sample) does not elicit information on the WTP
of non-users interviews must be kept short
procedure is needed to select among visitors
to a site Households within a certain radius of
the site (off-site sample) geographical
boundaries need to be defined a larger sample
required, many households may not visit the
site It is also important to carefully select
the size of the sample A larger means more
confidence that the sample mean WTP/WTA is a
reliable estimate of the true mean WTP/WTA.
(Balance precision and cost)
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CVM Stage 2 - Questionnaire Design - Background
Questions
General background Questions on general
characteristics of the respondents information
for checking the validity of the valuation
results Respondents tastes and socio-economic
characteristics (is the sample
representative?). Personal details - should ,
come at the end of the questionnaire Respondents
knowledge of the commodity in question, e.g.
background questions concerning the respondents
visits to a recreation site should cover such
issues as attitudes towards environmental
issues proximity of their home to the site
frequency of visits duration of trip
reason for visit, etc. These questions should be
asked at the beginning of the interview as they
are relatively straightforward to answer, and
will help to build-up the respondents confidence.
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CVM Stage 2 - Questionnaire Design - Preparation
Questions
To avoid bias, interviewer must make sure the
respondent is aware of budget constraints (you
cannot spend more than you have!) their right to
refuse to pay for the good If the event of a
negative response, the reason must be recorded a
zero valuation is implied if the respondent
may not be able to pay anything or the
respondent may not be willing to pay anything. a
protest bid is implied if the respondent may
find it too difficult to establish a monetary
valuation the respondent may disapprove of the
concept of expressing environmental resources in
monetary terms or may be hostile towards the
institutional context.
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Format of WTP question

• Open Ended
• How much are you willing to pay for public good
  A?
• Bidding Game
• 1) Are you willing to pay X for public good A?
• 2a) If Yes to (1), Are you willing to pay Y for
  public good A? (YgtX)
• 3a) If Yes (2a), Are you willing to pay Z for
  public good A? (ZgtY).
• 4a) if Yes to (3a)
• If No to (Na), WTP questions stop.
• 2b) If No to (1), Are you willing to pay T for
  public good A? (TltX)
• Payment Cards
• choose a WTP point estimate from a list of values

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• Dichotomous or Discrete Choice CV (Referendum
  format)
• Are you willing to pay X for public good A? gt
  STOP
• Dichotomous or Discrete Choice CV with follow-up
  
• 1) Are you willing to pay X for public good A?
  
• 2a) If Yes to 1, Are you willing to pay Y for
  public good A? (YgtX)
• gt STOP
• 2b) If No to 1, Are you willing to pay Z for
  public good A? (ZltX)
• gt STOP

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CVM Stage 2 - Survey Design - Open-ended
Elicitation Format
Respondent simply asked to state maximum WTP for
a specific environmental change The advantages of
the open ended Quick and easy to administer and
analyse Can be performed with a smaller sample
size Avoids anchoring effects - respondents
influenced by suggested starting value. Main
drawbacks Makes strategic bias, more
likely The respondent may need a reference point
to bound value judgement Respondent must be
familiar with the affected commodity in
question.
?
?
?
?
?
?
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CVM Stage 2 - Questionnaire Design -
Dichotomous Choice or Referendum Elicitation
Format
range of values for the max WTP of individuals
pre-set. sample of respondents is divided into
sub-samples. value within the pre-set range is
assigned to each sub-sample (the source of he
so-called anchoring effect). Each respondent
asked whether WTP assigned value for proposed
change Answer not the max WTP only consent or
refusal to pay a given amount Random utility
theory (logit model) are required to estimate the
respondents mean and median WTP values.
Requires large sample. No Incentive to engage in
strategic behaviour. Easier to convey decision
rule - gt50 say yes ? change provided. Realisti
c individuals typically make decisions faced
with fixed prices.
?
?
?
?
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CVM Stage 2 - Survey Design - DC Format An
Example
After describing their illness, the respondent
was given the following valuation question We
are now going to ask you a hypothetical question.
Suppose you were told that, within the next few
days, you would experience a recurrence of the
illness episode that you have just described for
us. What would it be worth to you that is, how
much would you pay to avoid the illness episode
entirely? Remember that you are paying to
eliminate all of your pain and suffering, your
medical expenditure, the time you spent visiting
the doctor or clinic, your missed work, leisure
or daily activities. Bear in mind if you pay to
completely avoid being ill this time, you have to
give up some other use of this money. For
example, you may reduce your expenditures for
entertainment or education. Would you
pay dollars to avoid being sick at all? If NO
Would you pay dollars to avoid being sick at
all? If YES Would you pay dollars to avoid
being sick at all?
300
100
1,000
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CVM Stage 2 - Questionnaire Design - Iterative
Bidding Elicitation Format
suppose you were told that within the next few
days you would have a recurrence of the
respiratory condition that you have just
described. Would you be willing-to-pay 10 to
avoid the illness episode entirely?
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NOAA Panel Guidelines

• Conservative design gt better to underestimate
  WTP
• WTP, rather than Willingness to Accept (WTA)
• Referendum format (i.e. Yes/No Questions)
• Accurate description of the good/scenario gt use
  of focus groups and pretest of the survey
  instrument
• Reminder of substitute commodities
• Yes/No follow ups
• Checks on understanding and acceptance
• Cross tabulations
• Sample size circa 500 is a minimum.

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Other important aspects for questionnaire
development (1)

• Mail / In Person / On the Phone interview
• In person gt costly, interviewer bias, time
  consuming, more accurate, better option if it is
  difficult to explain the scenario (need
  pictures), only users if on site
• Mail gt low response rate, sampling bias gt who
  takes the survey? Those who are interested in the
  topic?, limited information, relatively
  inexpensive
• Telephone gt relatively inexpensive, limited
  information, not accurate, response rate,
  developing countries?
• Mail Telephone
• Internet
• Computer based instruments

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Other important aspects for questionnaire
development (2)

• Introduction
• Warm-up questions
• Questions on the knowledge of the problem /
  experience with the environmental good gt USE
  values, etc
• Description of the scenario
• WTP question(s)
• Debriefing questions gt why did you vote in
  favour or against the program
• - Use and Non-Use values investigation gt did
  you vote yes, because (a) you will visit the
  national park, (b) even if you will never visit
  the national park, you want future generations to
  visit the park, etc.
• Attitudinal questions
• Socio demographic questions. Ask questions on
  Income at the end of the questionnaire!!! gt we
  dont want to irritate the respondent

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Other important aspects for questionnaire
development (3)

• Identify protest respondents after the WTP
  questions (ask why the respondent voted YY, NN,
  NY, YN)
• Analyze the data for the full sample of
  respondents, then delete those respondents that
  show protest behaviours
• Income. Try to get an answer to the income
  question. In developing countries, sometimes
  researchers (Cropper, Alberini) ask a list of
  expenditures. If you have no information on
  income from some respondents, dont loose those
  observations. Add a dummy equal to 1 for those
  that did not answer the income question, and 0
  otherwise. Set equal to 0 the income of those
  respondents that did not answer the income
  question. In your regression the coefficient of
  the dummy for those that did not answer the
  income question tells if they are statistically
  different from those that reported income. In
  this way you dont loose the observations!
• Clearly define the population of interest
• Consider your budget constraint
• Make sure that your referendum question avoids
  free rider behaviours!

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Payment vehicle

• Whose welfare are we interested in?
• gt Important for sampling plan
• TAX gt One time Tax is incentive compatible
• How do we choose the tax level? Focus groups,
  previous research, pretest, optimal bidding
  design literature, cost of the public program

If Data are not as Shown, use Non- Parameteric
Methods
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CVM Stage 2 - Questionnaire Design - Payment
Vehicle
Valuation question needs a realistic
institutional context - usually an appropriate
payment (or bid) vehicle (instrument). The
payment vehicle is the mechanism through which
the WTP/WTA values are to be raised/distributed. K
ey considerations when selecting a payment
vehicle are familiarity does the respondent
understand the payment vehicle? credibility
does the payment vehicle represent a realistic
situation? empathy is the respondent
favourably or unfavourably disposed towards the
recipient of the funds? feasibility is the
recipient of the funds capable of delivering the
improvement? universality would all the
respondents be affected by the payment vehicle?
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WTP and WTA

• The goal of contingent valuation is to measure
  the compensating or equivalent variation for the
  good in question. Both compensating and
  equivalent variation can be elicited by asking a
  person to report a willingness to pay amount. For
  instance, the person may be asked to report his
  WTP to obtain the good, or to avoid the loss of
  the good. Formally, WTP is defined as the amount
  that must be taken away from the persons income
  while keeping his utility constant
• where V denotes the indirect utility function, y
  is income, p is a vector of prices faced by the
  individual, and q0 and q1 are the alternative
  levels of the good or quality indexes (with
  q1gtq0, indicating that q1 refers to improved
  environmental quality). Z is a vector of
  individual characteristics.
• (Compensating variation is the appropriate
  measure when the person must purchase the good,
  such as an improvement in environmental quality.
  Equivalent variation is appropriate if the person
  faces a potential loss of the good, as he would
  if a proposed policy results in the deterioration
  of environmental quality.)

1)
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• Willingness to accept (WTA) is defined as the
  amount of money that must be given to an
  individual experiencing a deterioration in
  environmental quality to keep his utility
  constant
• Where q2 indicates a deterioration in quality
  compared to the status quo, q0.
• In equations (1) and (2), utility is allowed to
  depend on a vector of individual characteristics
  influencing the tradeoff that the individual is
  prepared to make between income and environmental
  quality. An important consequence of equations
  (1) and (2) is that WTP or WTA should, therefore,
  depend on (i) the initial and final level of the
  good in question (ii) respondent income (iii)
  all prices faced by the respondent, including
  those of substitute goods or activities and (iv)
  other respondent characteristics.
• Internal validity of the WTP responses can be
  checked by regressing WTP on variables (i)-(iv),
  and showing that WTP correlates in predictable
  ways with socio-economic variables.

2)
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Dichotomous-Choice Contingent Valuation

• When dichotomous choice questions are used, the
  researcher does not observe WTP directly at
  best, he can infer that the respondents WTP
  amount is greater than the bid value (if the
  respondent is in favor of the program) or less
  than the bid amount (if the respondent votes
  against the plan), and form broad intervals
  around the respondents WTP. To estimate the
  usual welfare statistics, it is necessary to fit
  binary data models.
• The simplest such models assume that an
  individuals response to the WTP question is
  motivated by an underlying, and unobserved, WTP
  amount, which is normally (logistically)
  distributed. Formally, let WTP be the unobserved
  WTP
• Where ? is both mean and median WTP, ? is a
  zero-mean normal (logistic) error with mean zero.
  The model is completed by specifying the mapping
  from the latent variable to the observables
• 4) WTPi1 iff WTPigtB and WTPi0 iff WTPiB
• where B is the bid that was assigned to
  respondent i, WTP 1 means that the response is
  a yes, and WTP 0 means that the response to
  the payment question is a no.

3)
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• Because we observe discrete outcomes, we must
  derive the probabilities of yes and no
  responses. When attention is restricted to a
  normal latent WTP, the probability of a yes
  response is, therefore
• Because ?/? is a standard normal variate,
• where ?(?) is the standard normal cdf. If we
  define aµ/s and
• ß-1/s, the probability of a yes response can be
  rewritten as
• 6)
• Equation (6) is the contribution to the
  likelihood by a yes observation (or a one) in a
  probit model with the intercept and one
  regressorthe bid. As long as ? is identified and
  estimablewhich requires that the bid amount be
  varied to the respondents in the survey, so that
  it becomes a legitimate regressor in the probit
  modelmean/median WTP is estimated as
• 7)

5)

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• while the standard deviation of WTP is estimated
  as
• 8)
• The same formulae produce estimates of
  mean/median WTP and of the scale parameter of WTP
  from the logit coefficient if WTP is assumed to
  be a logistic variate.
• A standard probit routine will automatically
  produce standard errors for and , but not
  for and .
• To obtain the covariance matrix of and ,
  you can use the delta method (Cameron, 1991).
• First calculate the covariance matrix of and
  produced by the probit routine V
• 9)
• where , and , with ?(?) the standard
  normal probability density function (pdf).
• Next, compute the matrix G
• 10) G

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• Finally calculate the matrix product V1GVG,
  with V1 the covariance matrix of and . Nb
  This can be done in LIMDEP.
• If WTP is assumed to be a logistic variate, the
  steps required for the delta method are the same,
  except that w(z) in expression (9) is equal to
  ?exp(zi) / 1 exp(zi)?.
• in some studies, depending on the frequencies of
  the yes and no responses to the payment
  questions, formula (7) produces a negative
  mean/median WTP figure.
• Perhaps a better way to avoid this problem is to
  work with a WTP distribution that is defined only
  over the positive semi-axis. The Weibull and the
  lognormal are examples of such distributions.
• The cdf for a Weibull with parameters ? (?gt0) and
  ? is
• Mean WTP is where ?(?) is the gamma
  function
• Median WTP is
• The log likelihood function becomes
• 11)
• where F is the cdf of the Weibull

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• median WTP is generally regarded as a robust, and
  conservative, welfare statistic associated with
  the good or proposed policy. It is usually
  estimated more precisely than mean WTP, and is
  interpreted as the value at which 50 of the
  respondents would vote in support of the program,
  and hence the cost at which the majority of the
  population would be in support of it.

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The Double Bounded Dichotomous Choice model

• Double bounded models increase efficiency in
  three ways
• YN and NY answers bound WTP
• NN and YY answers further constrain WTP
• The number of observation is increased
• The log likelihood function becomes
• where WTPH and WTPL are the lower and upper bound
  of the interval around WTP defined above, F(?) is
  the cdf of WTP, and ? denotes the vector of
  parameters that index the distribution of WTP.
  (Notice that for respondents who give two yes
  responses, the upper bound of WTP may be
  infinity, or the respondents income for
  respondents who give two no responses, the
  lower bound is either zero (if the distribution
  of WTP admits only non-negative values) or
  negative infinity (if the distribution of WTP is
  a normal or a logistic.))

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Non parametric models for contingent valuation
the Turnbull estimator

• Consider only the first bid answer
• For bids indexed j1,,M, calculate FjNj/(NjYj)
  where Nj is the number of No responses to tj and
  Yj is the number of Yes responses to the same
  bid, Tj NjYj
• Beginning with j1, compare Fj and Fj1.
  Intuitively, of Nos should increase with the
  increase in the bid
• If Fj1gtFj then continue
• If Fj1Fj then pool cells j and j1 into one
  cell with boundaries (tj,tj2, and calculate
  Fj(NjNj1)/(TjTj1)Nj/Tj. That is,
  eliminate bid tj1 and pool responses to bid tj1
  with responses to bid tj.
• Continue until cells are pooled sufficiently to
  allow for a monotonically increasing CDF
• Set FM11, F00
• Calculate the PDF as the step difference in the
  final CDF
• fj1Fj1-FJ for each offered price. These
  represent consistent estimates of the probability
  that WTP falls between price j and price j1.

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1. Multiply each offered price (tj) by the
   probability that WTP falls between it and the
   next highest price (tj1)
2. Sum the quantities from step (9) over all prices
   to get an estimate of the lower bound on WTP
3. Calculate the variance of the lower bound as
   

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Unrestricted Turnbull Turnbull
tj Nj Tj Fj Fj fj
5 20 54 0.370 0.343 0.343
10 15 48 0.313 Pooled back Pooled back
25 46 81 0.568 0.568 0.225
50 55 95 0.579 0.579 0.011
100 106 133 0.797 0.797 0.218
200 82 94 0.872 0.872 0.075
300 72 81 0.889 0.889 0.017
300 - - 1 1 0.111
ELB(WTP)00.34350.225250.011500.2181000.0
75 2000.0173000.11156.50 V(ELB(WTP))(0.343
0.657/102)(5-0)2(0.5680.432/81)(25-5)2 (0.5
790.421/95)(50-25)2(0.797-0.203/133)(100-50)2
(0.8720.128/94)(200-100)2(0.8890.111/81)(30
0-200)229.52
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Literature for this lecture

• Haab-McConnell Valuing environmental and natural
  resources chapters 1-5
• Perman et al. Chapter 12
• A good book for the CV Mitchell-Carson Using
  surveys to value public goods the contingent
  valuation method Resources for the Future,
  Washington, DC, 1989.
• Read the paper Alberini, Rosato, Longo, Zanatta
  Information and Willingness to Pay in a
  Contingent Valuation Study The Value of S.
  Erasmo in the Lagoon of Venice.
• Ill post the slides and the paper on my website
  http//people.bath.ac.uk/al224/