Class 6

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Class 6

• Environmental Benefit Cost Analysis

Reference source (for the slides 1-18)
http//www.agecon.purdue.edu/staff/shively/courses
/AGEC406/index.htm
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Correcting market failures

• Static efficiency is obtained when net benefits
  for a single periods are maximized.

If private efficiency does not equal social
efficiency, then we have market failure.
Intervention may be justified, and many
approaches are available. What is the best
way to correct the market failure?
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Marginal damage function
Dollar measure of incremental damage from
pollution
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Important cases
1. private benefits social benefits
private costs social costs (no
market failure)
2. private benefits social benefits
private costs NE social costs (positive or
negative externality)
3. private benefits NE social benefits
private costs social costs (positive or
negative externality)
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Case 1
private benefits social benefitsprivate costs
social costs
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Case 2
private benefits social benefits private
costs NE social costs
SMC PMC MD
MD
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Case 3
private benefits NE social benefits private
costs social costs
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Possible interventions
1. Moral suasion
2. Government provision of goods
3. Damage prevention
4. Command and control
5. Economic Incentives
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Deriving values for non-market goods
Two conceptual approaches to valuation
1. Revealed preference
2. Stated preference
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Revealed preference approaches
Hedonic pricing price attributed to
characteristics of a good
Hedonic wages accepted wages reflect tradeoffs
such as risk and living conditions
Travel cost the value of a recreation site
reflects the cost people willingly pay to get to
it
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Stated preference approach
Contingent valuation use a survey to measure
willingness to pay regarding actual or
hypothetical changes in the environment
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Example 1 Hedonic wage
Construction work is risky, and the riskiest jobs
have wage premia.
What if workers are willing to accept a 1/1000
annual risk of death to take a job that pays
1200 more per year?
What is the value of one statistical life?
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Calculating the hedonic wage
Workers are willing to accept a 1/1000 annual
risk of death to take a job that pays 1200 more
per year.
1,200 1000 1,200,0001000 people have a
collective willingness to accept 1.2 million to
be exposed to the death of one individual.
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Example 2 Travel cost model
5 people
1 recreation siteA,B,C,D,E
B
A
D
C
E
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Visitation data
Individual Cost visits A 0
50 B 25 45 C 50 40 D 125
25 E 250 0
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Construct a demand curve
Individual Cost visits

E
250
E 250 0 D 125
25 C 50 40 B
25 45 A 0
50
TravelCost

D
P 250 -5Q

C

B
A

0
50
0
Number of visits
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Demand curve can be used to find
1. consumer surplus (TB)
2. impact of increased fees
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Putting a Monetary Value on Environmental Goods

• Is one value better than no value?
• Is some number better than no number?

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Example Brasil Water Sanitation Example

• A study in Brasil used a valuation approach that
  focused on asking people either directly what
  they are willing to pay, or less directly what
  their choices would be if they were faced with
  certain prices for the service in question.
• The question if you are required to pay X,
  would yu connect to the new suppy or use an
  alternative supply?

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Example Korup National Park in Cameroon

• Africas oldest rainforest. Over 1000 species of
  plant, 1300 animal species (60 occur in nowhere
  else and 170 are currently listed as endangered).
• WWF initiated a programme for conservation

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Korup Project Benefits and Costs

• Cost of conservation Project
• Resource costs -4475
• Foregone forest costs
• Timber -353
• Forest products -223
• Total costs -5051
• Benefits of Conservation Project
• Direct use benefits
• Use of forest products 354
• Tourism 680
• Indirect use benefits
• Protection of fisheries 1770
• Flood control 265
• Soil productivity 130
• Total benefits 3199
• Net benefits -1852
• Net benefits when the discount rate is 6 319
  

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Valuing Benefits for Risk Management

• The difficulties in estimating physical damages
• If they can be estimated, the next step is to try
  to place a monetary value on them.
• The complexities of assigning monetary value

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Types of Values

• 1. Use value
• 2. Option value
• 3. Non use value
• Total WTP

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• Use Value Use value reflects the willingness to
  pay for direct use of the environmental resource.
  
• to use something simply requires one of the
  senses to be active (sight, sound, touch, taste
  or smell).
• Hearing noise pollution, seeing a grizzly bear,
  eating freshly caught fish, consuming water for
  drinking or swimming, taking in a vista while
  hiking and touching your feet to the trail,
  smelling flowers or smelling foul air.
• All of these constitute some kind of use of
  natural resources and the environment.
  Distinguishing between active use (consumptive)
  and passive use (nonconsumptive)

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• Option Value Option value is the willingness to
  pay for the future ability to use the
  environment.
• This is the value people place on having the
  option to use or ensuring something exists for
  potential future use.
• Do you plan to go to Yellowstone National Park
  next summer? NO??
• Would you ever like to go? Yes??
• Place a value on the park to ensure it will still
  exist when one does want to go.

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• Nonuse Value Nonuse value represents an
  individuals willingness to pay to preserve a
  resource that he or she will never use.
• These values are often called existence values.
  This is a very different category of value and,
  of course, represents the most problematic as
  well as controversial to monetize.
• These are less tangible values, but can be quite
  large.

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• Total Willingness to Pay (TWP) Total Willingness
  to Pay Use Value Option Value Nonuse Value.

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The Concept of Consumer Surplus

• Consumer surplus Difference between what is one
  willing to pay and what one actually pays.
• Willingness to pay for one extra unit of
  pollution reduction
• Divergence between willingness to pay and
  willingness to accept.

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• People are more willing to sacrifice to maintaion
  the existing quality of the environment than they
  are to improve environmental quality.
• Prospect theory
• Risk assessment and perception

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Contingent Valuation

• Asking people their WTP or WTA
• Survey responses are contingent upon the
  questions aske
• Sources of possible errors
• Potential for free riding
• Strategic bias
• Hypothetical nature
• Embedding bias

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CV A Sample Survey

• This research is designed to more closely
  examine some of the trade-offs between industrial
  development, recreation, and the environment in
  the Lake Powell area. In connection with these
  objectives, I would like to ask you a few
  questions to see how you feel about environmental
  quality and its future in this area.
• There are plans to construct a large electric
  generating plant north of Lake Powell. This plant
  is expected to be at least as large as the Navajo
  Plant on the south side of the lake.
• Have you noticed the Navajo Plant or its
  smokestacks? _____ Yes ____No

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• Depending on exactly where and how a new plant is
  constructed, it could have a significant effect
  on the quality of the environment.
• If the plant is built near the lake, it could be
  visible for many miles up and down the lake. If
  air pollution is not strictly controlled,
  visibility in the area may be significantly
  affected.
• These photographs (interviewer shows photographs)
  are designed to show how a new powerplant on the
  north side of the lake might appear.

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• Situation A shows a possible plant site but
  assumes that the powerplant would be built at
  some distant location, not visible from the lake
  area.
• In situation B the powerplant is easily seen from
  the lake, but emits very little smoke visibility
  is virtually unaffected.
• Situation C is intended to show the situation
  with the greatest impact on the environment of
  recreationists in the area. It is easily seen
  from the lake, and the smoke substantially
  reduces visibility.

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• Vacationers, of course, spend considerable
  amounts of money and time and effort to equip
  themselves with vehicles, boats, camping, and
  fishing gear, and for traveling to the
  destination of their choice. It is reasonable to
  assume that the amount of money you are willing
  to spend for a recreational experience depends,
  among other things, on the quality of the
  experience you expect.

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• An improved experience would be expected to be of
  greater value to you than a degraded one. Since
  it does cost money to improve the environment, we
  would like to get an estimate of how much a
  better environment is worth to you.

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• First, lets assume that visitors to the Glen
  Canyon National Recreation Area are to finance
  environmental improvements by paying an entrance
  fee to be admitted into the recreation area. This
  will be the only way to finance such improvements
  in the area. Lets also assume that all visitors
  to the area will pay the same daily fee as you,
  and all the money collected will be used to
  finance the environmental improvements shown in
  the photos.

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• Would you be willing to pay a 1.00 per day fee
  to prevent Situation C from occurring, thus
  preserving Situation A? 2.00 per day? (increment
  by 1.00 per day until a negative response is
  obtained, then decrease the bid by 25 cents per
  day until a positive response is obtained, and
  record the amount.) _________/day

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• Would you be willing to pay a 1.00 per day fee
  to prevent Situation B from occurring, thus
  preserving Situation A? (repeat bidding
  procedure)
• (Answer only if a zero bid was recorded for
  either question above.) Did you bid zero because
  you believe that________ the damage is not
  significant________ it is unfair or immoral to
  expect the victim of the damage to have to pay
  the costs of preventing the damage________ other

http//web.mit.edu/urbanupgrading/urbanenvironment
/tools/contingent-valuation.html
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Travel Cost

• Measure the benefits associated with recreational
  resources

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Example

• A site used mainly for recreational fishing is
  threatened by development in the surrounding
  area.  Pollution and other impacts from this
  development could destroy the fish habitat at the
  site, resulting in a serious decline in, or total
  loss of, the sites ability to provide
  recreational fishing services. 
• Resource agency staff want to determine the value
  of programs or actions to protect fish habitat at
  the site.

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• The first step involved with the TCM is the
  creation of a trip generating function. In an
  actual travel cost study, this stage could not
  take place before a certain amount of thought and
  research concerning the goals and form of the
  study, and a significant amount of data
  collection work.

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Hedonic Regression

• Changes in prices of related goods to infer the
  WTP for healthier environment.

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• Take, for example, the housing market in two
  cities with different levels of air quality.
  Demand 1 represents the dirty air city and demand
  2 represents the clean air city. The price
  differential, dP, is the marginal willingness to
  pay (in higher housing prices) for the difference
  in air quality.

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• These price differentials can be estimated using
  regression methods. Imagine that you collect data
  on housing prices in a local market (these are
  recorded in the courthouse after the sale) and
  the characteristics of the house (square footage,
  lot size, etc.). You are also able to merge in
  other variables such as school district, local
  tax rates, and other neighborhood
  characteristics.

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