5. WHAT ARE THE KEY BENEFIT/COST MEASUREMENT METHODS FOR NATURAL RESOURCE

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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
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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.

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Overview of Benefit/Cost Analysis (BCA)

• BCA provides a method to compare an array of
  alternative public policy choices
• If BgtC 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

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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.)

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BCA (continued)

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

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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

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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 gt 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 gt 1

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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 lt individual r suggests society
  values future gt individuals value future
• Potential for Abuse
• Assumptions who decides are critical
• May run counter to Native American Ethic, Deep
  Ecology, Leopold land ethic, etc.

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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)

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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)

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Marginal Damage/Marginal Abatement
Marginal Damage FunctionMD
Damages Costs ()
Marginal Abatement Cost Function MAC
Pollution Level
Total Damage
Total Abatement Cost
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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

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Natural Resource/Environmental Valuation

• Determined by people willingness to make
  trade-offs
• Producer Consumer Surplus
• Nonmarket valuation--use non-use value

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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)--peoples
  decisions reveal preferences value
• Hedonic Pricing/Wages
• Travel Cost Method (TCM)

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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 / (1rate)
• Future Value Present Value x (1 rate)
• rate appropriate discount rate
• social discount rate?
• Risk-free real market rate of interest?

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