2281AES Economics and Natural Resources

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2281AESEconomics and Natural Resources

• Module 10 Economic Valuation of Environmental
  Costs and Benefits Hedonic or Property
  Valuation Technique
• Lisa Alder

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Sources

• EMS and Land Valuation The potential for land
  valuation to drive the adoption of Environmental
  Management Systems in Agriculture, A report for
  the Rural Industries Research and Development
  Corporation by Catherine Nind, Department of
  Agriculture, Western Australia, May 2002, RIRDC
  Publication No. 02/040
• Techniques to Value Environmental Resourcesan
  Introductory Handbook, Published as a joint
  exercise by the Commonwealth Department of the
  Environment, Sport and Territories, The
  Commonwealth Department of Finance, and the
  Resource Assessment Commission, Australian
  Government Publishing Service, 1995

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Case Studies

• Streeting, Mark (1990) A Survey of the Hedonic
  Pricing Technique, Resource Assessment
  Commission, Research Paper No.1, Australian
  Government Publishing Service, Canberra.
• King, D.A. and Sinden, J.A. (1988) 'Influence of
  Soil Conservation on Farm Land Values', Land
  Economics, vol.64, no.3, pp.242-255.

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Theory

• Hedonics is based on the hypothesis that any
  product represents a bundle of characteristics
  that define quality.
• Rosen (1974), first explored goods valued for
  their utility-generating attributes.
• Rosen suggests there are competitive implicit
  markets that define implicit prices for embodied
  product attributes, and that consumers evaluate
  product attributes (e.g. features of a car,
  indicators of air or water quality) when making a
  purchasing decision.
• The observed market price is the sum of implicit
  prices paid for each quality attribute.

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Identification Problem

• Rosen recognized an identification problem for
  supply and demand functions derived from hedonic
  price functions, because implicit prices are
  equilibrium prices jointly determined by supply
  and demand conditions.
• Implicit prices may reflect not only consumer
  preferences but also factors that determine
  production.
• In order to solve the identification problem it
  is necessary to separate supply and demand
  conditions.
• Arguea and Hsiao (1993) argue that the
  identification problem is essentially a data
  issue that can be avoided by pooling
  cross-section and time-series data specific to a
  particular side of the market.

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The concept

• The price paid for a property directly reflects
  the benefits of the characteristics of the
  property.
• Environmental characteristics (clean air, peace,
  quiet and beauty) are traded in the property
  market.
• The property-value technique derives the value
  for a particular characteristic from the price
  paid for the property.
• Data are collected on prices paid and
  characteristics of the property.
• The amount of the price attributable to the
  characteristics is then identified through
  statistical analysis.
• In essence, if two houses differ in only one
  characteristic, the difference in price is the
  value of that characteristic.

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Hedonic Pricing

• Is a property valuation technique used to
  identify how much of a propertys value is due to
  differences in its attributes
• Is used to infer how much people are willing to
  pay for an improvement in environmental quality
  (see Pearce and Turner, 1990).
• Environment is just one element of market value
  as there are many factors that influence what
  people will pay for a (rural) property.

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Hedonic pricing

• Used to estimate economic values for ecosystem or
  environmental services that directly affect
  market prices.
• Most commonly applied to variations in housing
  prices that reflect the value of local
  environmental attributes such as amount of open
  space, views to forested hills etc.

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Factors that influence what people will pay
(rural property).

• Price affects the ability to generate income.
• Location A property in a reliable area will
  command a better price than in a marginal area.
• Climatic factors such as rainfall, temperature,
  frost risk, windiness and sunshine/cloud cover
  will also influence the price of a rural
  property.
• Enterprise preference Planned land use has some
  effect on land purchase. For example, a wheatbelt
  farmer who wants to continue to grow a cereal
  crop will value central wheatbelt light soil more
  highly than heavy soil.
• Proximity Closeness to markets or delivery
  points, and if the land is adjoining a buyers
  farm are considered.
• Size Small parcels of land can attract higher
  prices as this is affordable
• Current economic climate. (Source Herbert,
  1993)

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Hedonics for biodiversity valuation

• Can be used to estimate values based on actual
  choices eg property markets.
• It is versatile, and can be adapted to consider
  several possible interactions between market
  goods and environmental quality.
• However, outside influences, like taxes, interest
  rates, or other factors can affect the market.

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When to use it

• Are differences between property values due to
  differences in their environments?
• How much of a property's value is due to a
  particular environmental characteristic?
• What compensation should be paid to landholders
  who preserve woodland?
• Monetary values needed for the benefits (soil
  conservation) and costs (land degradation).

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Prerequisites for the Application of Hedonics

• the existence of equilibrium in the market under
  study.
• adequate sample sizes.

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Hedonic Estimate using Dummy Variables

• This is a standard hedonic approach to constant
  quality price indexing.
• The model is based on cross sectional data.
• The model estimates log of price as the dependent
  variable against an array of dummy variables for
  each quarter and an array of property attributes.

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Using Proxies (Hedonic Pricing)

• This method assumes that the value of parts of
  the environment can be found by considering the
  prices of market substitutes.
• For example a lake that is used for fishing,
  boating and swimming might be valued by what
  people spend on private fishing, boating and
  swimming facilities.
• Another market substitute commonly used is
  property values. The idea is that houses in a
  polluted area will be worth less than houses in a
  non-polluted area and part of the difference in
  house prices will reflect the value the market
  puts on clean air.
• Differences in property values will also arise
  for other reasons such as quality of
  accommodation and accessibility to the central
  business district or public transport routes.
• The analyst has to work out what part of the
  difference is due to the environmental
  differences and infer from that how much people
  are willing to pay for improved environmental
  quality.

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Environmental uses

• Other proxies might include differences in water
  rates, where higher rates are levied to cover
  better waste-water treatment of effluent going
  into a river. The extra cost to ratepayers is a
  proxy for the value of a cleaner river.
• The value of time environmentalists spend
  fighting to protect an area can also be used as a
  proxy for what they think its worth. Working out
  what their time is worth is also tricky. If
  someone earns more money in their job, does that
  mean their spare time is worth more?

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Strengths

• the ability to derive money values
• the use of actual market prices
• the use of actual changes in environmental
  characteristics.

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Weaknesses

• need for a competitive property market in which
  to collect data
• buyers and sellers must bargain to arrive at a
  final price
• buyers and sellers must be aware of the
  environmental characteristics
• These characteristics must be bought and sold as
  part of the properties.

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Theoretical validity

• technique is also restricted to cases where the
  environmental effects affect price.
• technique applies willingness to pay/accept and
  opportunity cost.
• users of these techniques have refined the
  procedures and interpretations, but these
  techniques require careful and skilled
  management.

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Market validity

• uses actual prices and costs from actual
  exchanges in market places.
• Apart from the proxy-good technique, the
  surrogate is directly and causally related to the
  environmental effect of interest.
• As with travel-cost, property-value and
  wage-differential techniques are all supported by
  market tests

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Non-Market Valuation

• Noise - Changes in noise level can lead to
  changes in enjoyment of an environment. When the
  noise levels are sufficiently high, they will
  impose costs on individuals and decrease house
  and land values.
• Abelson (1979) related the land value associated
  with houses in the Marrickville and Rockdale
  suburbs of Sydney to noise level and other
  characteristics such as house size. The average
  unimproved land value of a house block at the
  time was 10 000 in Marrickville and 14 000 in
  Rockdale.
• Land size - and shape of the block were the most
  important determinants of land value
• environmental factors - including road access,
  quality of view and noise, were also significant
  determinants
• E.g. a one unit increase in aircraft noise,
  decreased land values by between 540 and 840
  (Marrickville) and 300 (Rockdale).

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Revealed preference techniques for biodiversity
valuation

• Mitigatory or preventative expenditure approaches
  
• Replacement cost
• Production function technique or
  change-in-productivity technique
• Travel cost method
• Hedonic pricing

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Replacement cost

• To measure the cost of land degradation to shire
  councils, monetary values can be estimated for
  the benefits of conservation and flood protection
  and the costs of land degradation (eg. cost of
  damaged roads).

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Non-Use Benefits

• This approach does not strictly estimate the
  value of biodiversity benefits.
• It is a surrogate approach, because it estimates
  costs associated with providing substitutes or
  avoiding loss.
• not ideal for fully valuing biodiversity, but can
  be useful for providing an initial estimate.

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Revealed preference techniques

• When market data are available for goods and
  services that are in some specific way related to
  the biodiversity value in question, such as the
  relationship between the costs of travel and the
  number of people visiting a national park and
  these data can be used to infer values.
• This approach is called revealed preference and
  a number of different techniques have been
  developed.

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Usage

• Other than the travel cost technique, these
  methods are not used much for biodiversity
  valuation in Australia.
• Of the most promising techniques for valuing
  biodiversity the hedonic pricing technique and
  the production function method have had very
  little application.
• The usefulness of these techniques could be
  improved by better biophysical knowledge (for the
  production function method) and better market
  data collection and analysis (the hedonic pricing
  technique).

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Case Studies

• Increase in soil conservation were found to be
  associated with increase in the value of farms in
  Manilla Shire, New South Wales (King and Sinden
  1988).
• The increase in value were attributed to
  conservation's role in improving aesthetics,
  maintaining farm access and improving long-term
  sustainability of output.
• Retention of woodland on farms may enhance the
  naturalness of the environment, aesthetic quality
  and biodiversity but it may also lower farm land
  value.

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Higher or Lower Values?

• Reynolds (1978) estimated the loss in property
  value for increase in area retained and for
  increments in naturalness, aesthetic and
  biodiversity for a region of northern New South
  Wales. These losses are one measure of the cost
  of preservation of woodland.
• Extension of a water supply pipeline to farms in
  Western Australia would benefit farm households
  as well as farm production activities. Coelli et
  al.(1991) valued these benefits as the increase
  in property value.

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• A South Australian study used Hedonic Pricing in
  an attempt to establish Statewide and regional
  models of market values for rural properties with
  remnant vegetation and to determine the effect of
  covenants on market values since the introduction
  of the Native Vegetation Act 1984 (Marano, 1998).
• Results suggested that remnant native vegetation
  does not have a significant effect on property
  prices.
• Hedonic pricing, using estimates of unimproved
  capital value rather than actual sales, was used
  (Reynolds, 1978) to relate the naturalness and
  scenic quality of vegetation with rural property
  values in NSW. It was found that land value
  decreased with increases in vegetation cover.
• Contingent valuation, where people are asked what
  they are willing to pay for a benefit and/or what
  they are willing to receive as compensation, was
  used in a recent study to assess the non-market
  values of remnant native vegetation in NSW and
  Victoria (Lockwood and Walpole, 1999). Results
  indicated that participants would be willing to
  pay to conserve native vegetation in these areas.

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Validity of Hedonics

• Is doubted because of perceived biases in the
  questioning (Pearce and Turner, 1990) and
  practical difficulties of implemention (Common,
  1995).
• Lally (1998) recommends the use of a values jury
  to determine non-use values (a proxy system to
  determine value and participants are asked to
  consider the responses as representatives of the
  community) and use value (public amenity),
  inclusive of market value.
• Until a more concise way of measuring non-use
  value is established, these methods will remain
  unused by most valuation practitioners Lally
  (1998) .
• These methods will continue to be discussed and
  developed amongst the valuation industry and
  economists (Lally, 1998), but are unlikely to be
  used in the near future.
• This is because the non-market valuation is not
  based on easily accessible and objective data
  (Lally, 1999).
• More objective data may eventually be obtained
  through the emerging markets for environmental
  services.