Valuation 8: Defensive expenditures HPF

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Valuation 8 Defensive expenditures (HPF)

• Revealed preference methods
• Defensive expenditures
• Damage costs
• Defensive expenditures A simple model
• An example Urban ozone

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Last week

• Contingent choice modelling and its variants
• Steps and design stages for choice modelling
• Some econometrics
• Application to green product choice

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Revealed preference methods

• People make choices within markets prices paid
  and quantities purchased
• Derive values people place on environmental
  amenities and disamenities from purchase
  decisions
• Stated preference methods intended behaviour
  non-use values
• Four commonly used methods TCM, HPM, defensive
  expenditures and damage costs

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Revealed preference methods -2
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The Household production function approach

• A household combines an environmental good/bad
  with market goods to produce and experience
  that directly provides utility
• To enjoy a national park people must visit the
  park and this costs money
• To defend against an environmental bad such as
  traffic noise money is spent on insulation
• The household production function (HPF) approach
  involves investigating changes in the consumption
  of commodities that are substitutes or
  complements for the environmental good of interest

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Defensive expenditures

• Measures the demand for environmental bads
• A rational consumer buys self-protection up to
  the point where the marginal cost of additional
  measures exceeds the marginal benefits from the
  reduction
• Averting inputs include air filters, water
  purifiers, noise insulation and other defensive
  or self-protection inputs these are substitutes
• In all these cases an individual combines
  quantities of a public bad with a quantity of a
  market good to produce what actually gives utility

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Excurse Damage costs

• The method estimates the resource cost associated
  with environmental change, rather than WTP
• Does not include any estimate of consumer surplus
  or marginal prices
• In the health context cost of illness approach
• This is the sum of direct and indirect costs
  associated with illness, injury, or death
• Direct costs (out-of pocket expenses)
• Diagnose, treat, rehabilitate, or support ill or
  injured persons
• Indirect costs (the value of output that is not
  produced)
• Mainly foregone earnings

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Defensive expenditure A simple model

• Noise pollution (P) from a nearby road
• higher Ps are worse
• The individual is only interested in the level of
  quiet within the house (Q)
• higher Q is better
• The homeowner buys noise insulation and other
  equipment to reduce the level of noise within the
  house
• Defensive expenditure D(Q,P) to achieve Q for a
  given P

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The homeowners problem

• The homeowners problem to choose between
  conventional goods (X) and Q is
• Outdoor noise does not enter the utility
  function, it is outside of the control of the
  individual

X
Y
D(Q,P)
X
U1U(X,Q)
U0U(X,Q)
YXD(Q,P)
Q
Q
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A simple model (2)

• Suppose the level of noise (P) increases slightly
• consumer has to spend more to achieve same noise
  level
• If income increases
• The level of utility is the same
• Compensating surplus
• What happens if income is not adjusted?
• Lower level of utility
• Substitution effects Q drops
• Defensive expenditure lt true marginal WTP

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The effect of a change in pollution
X
P2 gt P1
YXD(Q,P2)
YXD(Q,P1)
U1
U2
Q
Q2
Q1
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Algebraically

• Suppose we change P slightly by DP
• The consumer adjusts the choice of Q and X
• Defensive expenditure changes by DD and indoor
  noise levels by DQ
• DDD(QDQ, P DP)-D(Q,P)
• D(QDQ, P DP)-D(Q, P DP) D(Q, P
  DP)-D(Q,P)
• DQDQDPDP
• DQD(QDQ, P DP)-D(Q, P DP)/ DQ
• DPD(Q, P DP)-D(Q,P)/ DP
• The marginal WTP to avoid a change in P
• DD/DP DQ(DQ/DP)DP
• Generally DD/DP ltDP

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An example Urban ozone

• Significant extension to previous model
• pollution level enters directly into the utility
  function
• Study by Dickie and Gerking (1991)
• Estimate the demand for ozone pollution for two
  cities in the metropolitan area of Los Angeles
• Burbank and Glendora
• Compare the results to out-of-pocket medical
  expenses (damage costs) associated with elevated
  ozone in each of the two cities

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Burbank and Glendora

• Suppose

Burbank
Glendora
New Standard
Old Standard
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The basis of the analysis

• Both cities have a significant amount of air
  pollution
• What is the WTP for an average resident of each
  city to reduce the maximum ozone level during a
  year to either 12 or 9 pphm?
• The analysis is based on peoples willingness to
  purchase health care to compensate for the
  health-related damage from ozone pollution
• Ozone causes coughing and other breathing
  difficulties

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The modelling approach

• Utility is a function of market goods (X), health
  (H) and exposure to air pollution (A)
• Defensive expenditure (M) depends on health (H),
  air pollution (A) and the individuals health
  status (R)
• We write this as a health production function
  which tells us how much health will result if M
  is spent on medical care
• The budget constraint is defined on the basis of
  time available to generate income

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The modelling approach (2)

• The indirect utility function giving maximum
  utility attainable is
• If we could observe utility we could
  statistically estimate the equation
• Dickie and Gerking compensate this by observing
  whether people visit a doctor
• If they do, there must be a utility gain from
  visiting
• and V1 (Mgt0) gt V0 (M0)
• They use a random probability model and estimate
  the probability to visit a doctor
• The binary choice problem is
• Mgt0 if V1 - V0 gt 0 and M0 if V1 - V0 0

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The data

• Sample of 256 residents of the two cities
• All are household heads with full-time jobs
• Married white males with compromised respiratory
  functions are oversampled
• Respondents were asked about
• long-term health status
• contacts with the medical care delivery system
• socio-economic/demographic and work environmental
  characteristics
• typical out-of-pocket expenses incurred for a
  visit to their doctor
• commuting and waiting time required to see their
  doctor
• Each contact with a respondent was matched to
  daily measures of ambient air pollution
  concentrations

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The results
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Conclusion

• Estimates are lower bounds
• As expected, out-of-pocket medical expenses are
  much lower
• Earlier studies on defensive expenditures found
  much smaller values
• 0.04 to 4.00 per year per person
• Other regions
• Lower ozone levels
• No oversampling of respiratory impaired
• CV studies found similar values
• The broad range of WTP estimates poses an awkward
  situation for policy makers