The economic valuation of environmental costs and benefits Market pricing and nonmarket valuation

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The economic valuation of environmental costs and
benefits Market pricing and nonmarket valuation
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Lecture outline

• Review of last week
• Defining property rights for water
• Market pricing
• Overview of nonmarket valuation
• Difference between revealed preference and stated
  preference approaches to valuation

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Review of last lecture

• Assumptions of market pricing
• Private property and non-attenuated property
  rights
• Definitions of property rights
• Externalities and Coasean bargaining
• Common pool resources and public goods
• Other property rights regimes

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Water

• Water supplies are inherently risky. Climate
  variability, variable water demands and the
  increasing economic and environmental values of
  water are significant sources of uncertainty in
  rural catchments.
• Water has many competing uses in irrigation,
  urban uses, recreational uses, habitat, ecosystem
  services etc

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Property rights for water

• Green (2000) characterized the point of view that
  it is a simple matter to define non-attenuated
  property rights for water and achieve allocative
  efficiency as the Panglossian approach.
• However, it is rarely that simple.
• For example, there are also distributional issues
  with the allocation of new property rights.

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Property rights for water

• Time-span of entitlements
• Method of accommodating the stochastic nature of
  water availability
• The time and place of delivery
• Return flows and the attendant obligations upon
  the owner
• The conditions of transferring entitlements

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Alternative property rights regimes

• Volume sharing
• Capacity sharing
• Systems of priority rights
• Prior appropriation
• General and high security water entitlements

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Reservoir Inflows
Reservoir Inflows
User 1 share
User 2 share
Reservoir Releases
User 2 Releases
User 1 Releases
Capacity sharing
Volume sharing
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Environmental concerns

• Changes in perceived costs and benefits have
  altered the legal foundations of property rights
  regimes for water.
• Historically, in the western US, the doctrine of
  prior appropriation only considered consumptive
  uses of water.
• However, courts have now recognised instream flow
  requirements as a legitimate property right
  because of a no-injury requirement in water
  law.

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• VRN NRMW 4576CLOSING DATE 02/10/2006
• Position Description
• Policy Officer (Economic Social Assessment)
• TYPE OF VACANCY Permanent (2 positions)
• WORK UNIT/REGION Water Economics, Water
  Planning, Water and Sustainable Landscapes
• LOCATION Brisbane
• CLASSIFICATION PO3
• SALARY RANGE 55,072 - 60,138 per annum plus
  Superannuation
• CONTACT OFFICER Bill Park Weir
• CONTACT PHONE [phone]
• PURPOSE OF POSITION_To undertake economic and
  social assessments to support the development and
  implementation of water planning processes
  relating to the allocation, management and use of
  the States water resources, including Water
  Resource Plans and Resource Operation Plans.

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Market pricing

• Consumers surplus
• Producerssurplus
• Price as a measure of resource scarcity

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Price
Pm
S
R
Pe
D
PL
O
Qe
Quantity
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Consumers surplus
Price
Pm
R
Pe
D
O
Qe
Quantity
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Consumers surplus
Price
Pm
R
Pe
D
O
Qe
Quantity
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Consumers surplus
Price
Pm
R
Pe
D
O
Qe
Quantity
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Consumers surplus
Price
Pm
R
Pe
D
O
Qe
Quantity
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Producers surplus
Price
S
R
Pe
PL
O
Qe
Quantity
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Producers surplus
Price
S
R
Pe
PL
O
Qe
Quantity
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Producers surplus
Price
S
R
Pe
PL
O
Qe
Quantity
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Producers surplus
Price
S
R
Pe
PL
O
Qe
Quantity
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Price as a measure of resource scarcity
Price
Pm
SMPCMSC
R
Pe
DMPBMSB
PL
O
Qe
Quantity
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MSC MPC MEC
per unit
S MPC
P
R
Pe
D MPB
Q
Quantity (units)
Qe
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Nonmarket valuation

• Attempt to measure the benefits of environmental
  improvement or the preservation of the services
  of the natural environment.
• Because environmental damage costs are
  externalities their monetary values cannot be
  easily obtained via markets.

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Valuation

• Economists use willingness to pay to measure
  benefit.
• Willingness to pay is measured by the demand
  price at the margin.

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P1
Pe
D
Q
25
10
26

A
t1
B
C
t2
D MDC
Q1
Q
Q2
Air quality measured in terms of reduced sulphur
emissions per unit time
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WTP versus WTA

• Decision-makers judge outcomes according to some
  reference point.
• Decision-making experiments provide evidence that
  people care whether choices are framed as gains
  or losses.
• This may be relevant to the initial allocation of
  property rights over externalities.
• The framing of decisions as gains or losses or as
  purchasing decisions or political decisions is
  relevant to nonmarket valuation.

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Sir Humphrey demonstrates to Bernard Woolley how
public surveys can reach opposite conclusions
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• H.A. Mr. Woolley, are you worried about the rise
  in crime among teenagers?
• B.W. Yes.
• H.A. Do you think there is lack of discipline
  and vigorous training in our Comprehensive
  Schools?
• B.W. Yes.
• H.A. Do you think young people welcome some
  structure and leadership in their lives?
• B.W. Yes.
• H.A. Do they respond to a challenge?
• B.W. Yes.
• H.A. Might you be in favour of reintroducing
  National Service?
• B.W. Er, I might be.
• H.A. Yes or no?
• B.W. Yes.
• H.A. Of course, after all you've said you can't
  say no to that.

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• H.A. On the other hand, the surveys can reach
  opposite conclusions.
• H.A. Mr. Woolley, are you worried about the
  danger of war?
• B.W. Yes.
• H.A. Are you unhappy about the growth of
  armaments?
• B.W. Yes.
• H.A. Do you think there's a danger in giving
  young people guns and teaching them how to kill?
• B.W. Yes.
• H.A. Do you think it's wrong to force people to
  take arms against their will?
• B.W. Yes.
• H.A. Would you oppose the reintroduction of
  conscription?
• B.W. Yes.
• H.A. There you are, Bernard. The perfectly
  balanced sample.

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WTP-WTA disparity

• A status quo bias is a preference for the
  current state.
• The endowment effect is the observation that
  people often demand much more to give up an item
  than they are willing to pay to acquire it.
• These are both examples of loss-aversion, the
  idea that people weigh losses more heavily than
  gains.

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Prospect theory
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Examples

• Lottery ticket versus cash endowment effect
• Opportunities to learn, inappropriate application
  of a sensible bargaining habit in understating
  WTP and overstating WTA.
• WTP for a lifesaving medicine versus WTA to
  participate in a medical trial.
• Moral component
• Insecticide with a health risk

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Economic valuation of benefits

• Since economic valuation of benefit is based on
  willingness to pay, the area Q1ABQ2 measures
  peoples preferences for changes in the state
  of their environment.
• Economists are measuring not the value of the
  environment but the preferences of people for an
  environmental good or bad.

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Economic valuation of benefits

• Valuation of the environment is based on human
  preferences alone
• The estimation of benefit is not time-specific
• It is assumed the changes in the environmental
  quality are reasonably small
• Precludes the work of Costanza and associates to
  measure the total annual value of the flow of
  environmental services 33 trillion

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Dasgupta et al. (2000 342)

• The standard approach is meaningful because it
  presumes that humanity will survive in the
  incremental change and be there to experience and
  assess the change.
• If crucial environmental services were to cease ,
  life would not exist. Who would be there to
  receive 33 trillion of annual benefits if
  humanity were to exchange its very existence for
  them?

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Dasgupta et al. (2000 342)

• Almost paradoxically, perhaps, the total value of
  the worlds ecosystem services has no meaning
  and, therefore, is of no use, even though the
  value of incremental changes to those ecosystems
  not only has meaning it also has use.

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Nonmarket valuation

• Exxon Valdez
• Discussions of public policies will be one-sided
  and, in that sense biased, if the only money
  figures on the table are the policies costs.

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Nonmarket measures of WTP

• Economic benefits should be measured on the basis
  of individuals willingness to pay.
• However, the actual measurement of willingness
  to pay requires information on prices, which is
  difficult to obtain from markets because of
  market failures.
• Therefore, alternative techniques are used to
  directly and indirectly elicit willingness to pay
  for environmental assets.

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Critical assessment of the economic approach to
environmental valuation

• Environmental values should not be reducible to a
  single one-dimensional standard expressed only in
  monetary terms
• High levels of uncertainty make the measurement
  and the very concept of total value meaningless
• Survey techniques used to elicit willingness to
  pay confuse preferences with beliefs.
• Important ecological connections may be missed
  when valuing components of a system separately

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Environmental values should not be reducible to
simple monetary terms

• It would be misleading to ignore intangibles in
  an effort to obtain a single dollar-value
  estimate for benefits.
• There are irreplaceable and priceless
  environmental assets whose values cannot be
  captured either through the market or survey
  methods.
• However, it is important to note that to describe
  an environmental asset as priceless cannot mean
  that such a resource has an infinite value.

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High levels of uncertainty

• Uncertainty compounds the difficulty of
  estimating environmental damage
• Irreversibility
• Precautionary principle and intergenerational
  equity

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Survey techniques may confuse preferences with
beliefs

• Peoples preferences for these kinds of resources
  include aspects of their feelings that are not
  purely economic. These feelings may be based on
  aesthetic, cultural, ethical, moral, and
  political considerations.
• It is possible that some people may prefer not to
  sell publicly owned resources at any price.

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Important ecological connections may be missed

• Valuation may fail to account for primary values
  system characteristics upon which all ecological
  functions are contingent (Pearce, 1993).
• All elements of a natural system are mutually
  interrelated.
• Assessing the total value of a particular natural
  environment as the sum of the values of its parts
  or individual attributes does not account for the
  whole.

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Revealed preference versus stated preference
techniques

• Revealed preference techniques
• Travel cost
• Hedonic pricing
• Cost of replacement
• Stated preference techniques
• Contingent valuation

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Travel cost

• Valuation of environmental services from
  recreational sites, such as national parks.
• This method measures the benefit (WTP) for a
  recreational experience by examining household
  expenditures on the cost of travel to a desired
  recreational site.
• Lumpinee Park in Bangkok

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Hedonic pricing

• Valuation of environmental amenities associated
  with property values.
• This method is based on the idea that
  environmental features can increase land and
  house values if they are viewed as attractive or
  desirable, or they can reduce values if they are
  viewed as nuisances or dangerous, and therefore
  undesirable.

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Cost of replacement

• This approach is used as a measure of benefit
  when the damage that has been avoided as a result
  of improved environmental conditions can be
  approximated by the market value of what it cost
  to restore or replace the damage in question.
• Replacing lost services rests on the assumption
  that the public is willing to accept a one-to-one
  tradeoff between a unit of services lost due to
  damage and a unit of service gained due to
  restoration.

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Contingent valuation

• What is your willingness to pay?
• Source Russell (2001, p. 328)