Valuation of NonMarket Goods

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Valuation of Non-Market Goods

• Lecture 5

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Outline

• Project Evaluation
• The Need for Values of Non-Market Goods
• Cost benefit analysis
• Concepts of economic value
• Valuation Technique Contingent Valuation
• Survey evidence
• Valuation Technique Inference from Market
  Behaviour
• Travel Costs method
• Avertive behavior
• Hedonic Pricing

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Valuation of a Private Project

• Step 1 Evaluate Monetary Costs and Benefits
• Year Benefits Costs Net Revenue
• 0 B0 C0 R0 B0 - C0
• 1 B1 C1 R1 B1 - C1
• 2 B2 C2 R2 B2 - C2

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• Step 2 Add them up!
• R0 R1 R2 R3 ?????????????????????

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• Step 2 Add them up!
• You have to remember that money tomorrow is worth
  less than money today.
• If I invest 100 today I get back 100 x (1.02)
  102 next year if the interest rate is 2.
• Thus 102 in a years time is worth 102/1.02
  100 today
• Similarly, R1 in a years time is worth
• R1 / (1interest rate) today.

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Present Discounted Value

• PDV R0 R1 R2 R3
• (1r)1 (1r)2 (1r)3

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Decision Rule

• Undertake the project if
• PDV gt0
• Or NPVgt0

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Basically need to do the same thing for Public
Projects but

• 1. Many more costs and benefits need to find
  them all not just how they affect a company.
• 2. Its hard to evaluated costs and benefits.
  Often cannot use prices.
• Need to find ways of valuing these things.
• Decision rule is again undertake project if PDV
  gt0!!

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Example

• Building a Road
• Costs
• Materials 100m in first year.
• Labour 15m in first year.
• Maintenance 10m per year.
• At a 5 social discount rate 10m per year is
• (1.05/.05)10m 210m
• Total Discounted costs 325m 21010015

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Building a Road

• Benefits
• Driving time saved 500,000 hours per year.
• Lives Saved 5 lives per year.
• Suppose we assess this as being worth y per year.
  Then the road should go ahead if
• y(1.05)/.05gt325m!

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Cost Benefit Analysis

• This is the name for evaluation techniques for
  public projects.
• Examples of non-market price problems
• Improved public health?
• Costs are well know
• Benefits (longer lives better health)
• Improved Environmental Quality.
• Costs ?
• Benefits?

Cannot just ignore things you cannot measure.
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Where do the Costs and Benefits come from?

• Personal Use Values
• Direct Use (Consumption of outputs)
• Indirect Use ( Functional benefits) Flood
  control, climate etc.
• Option values (Future direct and indirect use)
• Non-Use Values
• 1. Bequest Values Value of passing assets on
• 2. Existence Value Knowledge of continued
  existence.

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Contingent Valuation

• Direct survey evidence on individuals stated
  valuations.
• How much an individual would be willing to give
  up to have the specified improvement?
• Notes
• Similar tools used for market research, but
  market research can be checked against future
  behaviour.
• Evidence of use and non-use values.
• Controversial in US as it was used in Exxon
  Valdez suit.
• NOAA panel has issued guidelines on its use.

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Contingent Valuation Formats

• Willingness to pay vs. Willingness to Accept.
• WTP What is the most you are willing to pay for
  5 days without air pollution?
• WTA How much would compensate you for .?
• In theory they should be close to equal if they
  were small amounts.
• WTAgtgtgtgtWTP in practice.
• WTP seen as more reliable, less prone to protest.

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Contingent Valuation Formats

• Open Ended vs. Closed Ended Questions .
• Open ended What is the most you would be willing
  to pay for?
• Popular early on and can be easily analysed.
• Closed ended If it cost 20 would you be willing
  to pay this?
• Respondents find these qs easier to answer.
• But requires more complex analysis.

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Problems in CV studies

• Treatment of Outliers a source of bias
• Strategic responses
• Protest answers (refusal to answer)

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Problems in CV studies

• Treatment of Outliers a source of bias
• Strategic responses
• Protest answers (refusal to answer)
• Embedding Problem
• Tendency for WTP answers to be similar across
  different surveys.
• Part-whole bias some people claim this
  invalidates the whole process

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Problems in CV studies

• Treatment of Outliers a source of bias
• Strategic responses
• Protest answers (refusal to answer)
• Embedding Problem
• Tendency for WTP answers to be similar across
  different surveys.
• Part/whole bias some people claim this
  invalidates the whole process
• Starting Point Bias
• Structure of survey influences all responses and
  the order of magnitudes in responses.
• Yes/No Qs in ascending vs. descending order
  influences answers given.

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Problems in CV studies

• Treatment of Outliers a source of bias
• Strategic responses
• Protest answers (refusal to answer)
• Embedding Problem
• Tendency for WTP answers to be similar across
  different surveys.
• Part whole bias some people claim this
  invalidates the whole process
• Starting Point Bias
• Structure of survey influences all responses and
  the order of magnitudes in responses.
• Yes/No Qs in ascending vs descending order
  influences answers given.
• Instrument Bias
• Proposed financing affects peoples answers.

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NOAA Panel on CV

• Recommendations
• Sample Statistician recommend size and type to
  ensure significance of results.
• Non-responses High rate makes results unreliable.
• Interviews Face to face are best, must test
  effect of interviewer.
• Reporting Data and procedure used must be
  available to all.
• Questionnaire design Piloted pre-tested
• Cross-tabulations Cross checks to assess
  interpretation of data
• Elicitation procedure WTP better than WTA,
  Yes/No Qs
• Accurate Description of issue
• Expenditure implications

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Inference From Market Behaviour

• 1. Travel Costs
• How much does it cost to travel to Alaska how
  many people do it.
• This gives a lower bound

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Inference From Market Behaviour

• 1. Travel Costs
• How much does it cost to travel to Alaska how
  many people do it.
• This gives a lower bound.
• 2. Avertive Behaviour
• What costs to people incur to avoid certain
  risks.
• This gives an upper bound.

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Inference From Market Behaviour

• 1. Travel Costs
• How much does it cost to travel to Alaska how
  many people do it.
• This gives a lower bound
• 2. Avertive Behaviour
• What costs to people incur to avoid certain
  risks.
• This gives an upper bound.
• 3. Hedonic Pricing
• Use differences in market prices to impute a
  value for a hidden variable. (Shadow Pricing)
• Parking near a ball ground.
• House prices

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Values for Life and Time

• Time
• Opportunity Cost if you gave up work then it
  is your wage.
• If you gave up leisure how much would you pay
  to travel quicker?
• Life Mortality
• Implicitly this values health too.
• QALY Quality-Adjusted Life Years
• This is a standard accepted measure.
• You can use CV evidence to assess this life
  insurance contracts etc.

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Examples of Implicit Values of Life

• Legislation imposes costs and achieves a
  reduction in lives lost. You can deduce a value
  of life from these costs
• Legislation Implied 2005() value of Life
• Childproof Lighters 0.1m
• Food labeling 0.4m
• Reflective devices for Lorries 1m
• Rear seatbelts 4.8m
• Asbestos 6m
• Gov Value 7.6m
• Cattle feed regs 185m

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Time and Risk

• How should we assess future costs and benefits?
• This really has a huge affect on very long-lived
  projects.
• Could look at market rates or how individuals
  make these trade offs, but generally they vary
  with the populations characteristics.
• Maybe we should explicitly include future
  generations welfare in the benefits side?
• How rich should we assume they are going to be?
• Should we give them equal weight or less weight?

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Risk?

• Most common route is to discount at a higher
  rate,???
• Risk premium?
• Worst Case Scenario?

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Distributional issues