Valuation Methodsfocus on conventional market approaches

Session Objectives:

• Identify key steps in valuing the environment

• Use selected methods to analyze environmental issues

Agenda

• Explain major valuation methods

• Exercises

• Discussions

Concepts of Techniques

• Doze response• Human capital• Replacement cost• Prevention cost

• Travel cost• Hedonic pricing• Benefit transfer• Contingent valuation

Dose-Response Method

• Dose - cause of an environmental impact such as pollution

• Response - resulting environmental impact

• Impact shows up in changes in quantity or price of marketed inputs or outputs

• Measures the value of impact in terms of changes in total surplus (consumer plus producer surplus)

Changes in Total SurplusP

Q

D

S

S’

Consumer Surplus

Producer Surplus

Application of D-R Method

• Often used if causal relationships are known (effects of pollution on health, physical effects on materials/building, aquatic ecosystems, vegetation, and soil erosion)

• Physical dose-response function multiplied by a unit “price” or value per unit of physical damage to give a “monetary function”.

Illustration of D-R Method

• Doze-response:1 ton of untreated water > loss of fish catch 50 kg per fishing season

• Average market price = $5• Total discharge of untreated water 200 tons• Value of damage caused by untreated water:

200 x 5 = $1,000

• If the response leads to a change in existing market price, use a predicted new price

Limitations

• A dose may lead to responses from different input & output sectors - difficult to predict the new price

• A response may be due to different types of doses - difficult to isolate the effects

• The method cannot estimate non-use values

• Mostly used in estimating pollution-related damages only.

Human Capital Method

• A sub-set of the Dose-Response method

• Assess the health effect of an environmental change

• Estimate the loss of working days or statistical life for the affected population

• Estimate the total present value of forgone income

Replacement Cost

• Estimate the cost of replacing or restoring a damaged environmental asset to its original state or an established standard

• A measure of the cost of damage or benefit of restoration (WTP for restoration)?

• Applicable if there is an environmental standard that must be met

• Efficient if the standard meets MB=MC

Prevention Cost

• Get data on an environmental change & related preventive measures

• Observe people’s expenditures on associated preventive measures

• Reflect the value people attach to environmental quality, or benefits of reduced environmental damage

• Assume prevention is technically possible

Prevention Cost: Illustration

• Environmental change: soil erosion• Associated preventive measure: plant trees• For reducing soil erosion by 1m3, plant 2 trees• Cost of planting a tree = $5• Value per 1m3 of soil erosion = $10• Observed soil erosion = 500m3

• Total prevention cost: 500 x 10 = $5,000

Travel Cost

• Estimate recreational (use) value of natural resources and their quality changes

• Value expressed in terms of the costs of travel and time

• Costs estimated through surveys

• There are many different models

• Expensive to carry out travel cost studies

Travel Cost: Illustration I

City Population

(Pop)

Total VisitsPer year

(V)

Travel CostPer visit

(TC)

VisitationRate

(V/Pop)

A 1000 450 $1 0.45

B 2000 600 $2 0.15

C 3000 700 $3 0.35

D 4000 200 $4 0.05

Travel Cost: Illustration II

• Postulate a linear relationship:– V/Pop = a - b x TC (for each city)

• Regression analysis (Ordinary Least Square) gives the equation:– V/Pop = 0.5 - 0.1TC (for each city)

Travel Cost: Illustration I

City Travel Costper visit

PredictedAnnual Visits

per capita

Per CapitaConsumers'

Surplus

TotalConsumers'

Surplus

A $1 0.40 0.80 800

B $2 0.30 0.45 1800

C $3 0.20 0.20 400

D $4 0.10 0.05 200

Travel Cost: Illustration IV

Travel cost per visit

5

4

3

2

1

01 0.2 0.3 0.4 0.5

Per capita visit

1

2

3

4

Hedonic Pricing

• Different prices of the same product may reflect different environmental quality of the product (such as a house)

• Isolate the price differences attributable only to different environmental quality (such as air quality) using econometric techniques

• The difference is the value of the difference in environmental quality (benefit of improvement)

• Can be applied to different wages due to different job-related environmental risks

Benefit Transfer

• Find previous studies that have estimated economic benefits of a similar environmental change

• Transfer those estimates to the site of interest with adjustments to account for differences in social, economic, and environmental characteristics between the previous sites and the new site

• It is an inexpensive approach, still in its infancy

Contingency Valuation

• A hypothetical scenario of the specific terms under which the good/service is to be offered

• Give the description to respondents & ask them their WTP for environmental improvement or WTA to avoid deterioration under the specific terms

• Ask questions on socio-economic and demographic characteristics for econometric analysis

• Not easy to do!