Economic valuation ofenvironmental services

M RafiqBased on

Ahmad Hassan’s book

According to the current paradigm in economics ‘The ecosystem is viewed as external to society, providing goods and services, unoccupied territory in which to expand, and assimilative capacity to handle by-products.... Economics seeks to integrate this externalized environment into its own paradigm through the concept of ‘valuation.’ This approach sounds reasonable on the surface. Society should place a monetary value on the goods and services provided by the ecosystem and also on the effects of human activity on the ability of the ecosystem to provide these goods and services. Values for these ‘externalities’ can then be inserted into the economic model. Within the economic model, these externalities would provide the self-regulation needed to manage society’s use of the environment. (O’Neill and Kahn 2000: 333)

Introduction • Attempt to measure the benefits of environmental

improvement or preservation of NRs.• Measuring damages avoided by taking actions.• Flood control, Air Cleaning, reduced emissions etc.• Benefits are inferred from assessment of reduced

Environmental damages.• However, these damages are external cost.• Observing monetary value from market prices is

difficult.• How it is done???

Valuation of benefits: the methodological issue

• WTP is the standard measure of Benefits.• Demand price at the margin.

Continue..• Individual make choice by comparing WTP with the

Price.• WTP reflects or must reflect individual preferences

for a certain good.• How this is related with social choice mechanism??

Continue..• What is the total benefit of reducing sulfur

emission?• What are the interpretations??• Maximum amount of money people are WTP?• Minimum amount of money section of a society

needed in order to voluntarily reduce emissions?• WTP and WTA.• These concepts are similar, provided, society value

gains and losses equally.

Continue..• economic valuation of benefit is based on the

concept of willingness to pay, the shaded area measures people’s ‘preferences’ for changes in the state of their environment (Pearce 1993)

• Three important point 1. Environmental benefits are based on human

preferences alone and all aspects of environmental damages can be monetized.

2. Estimation is not time specific and may neglect uncertainty involved in estimation. (Krutilla, 1967)

Ozone lyre depletion, acid rain, climate change

Continue…• 3. Change in the human welfare resulting due to

change in the environmental quality is being measured.

• Movement from point A to B in the previous graph.• Standard economic approach precludes attempt

like Costanza et al. 1997 to put an annualized figure of $33 trillion of benefits of the total environmental flow to the human economy.

Why it is not making sense???

Continue..• Benefits should be based on individual WTP,

however, for most of the environmental goods there is no information on actual WTP why??

• there is no information on the price or there are no markets for environmental goods.

• Various techniques for direct and indirect elicitation of WTP.

• Revealed preference; direct and indirect• Stated preference; direct and indirect

Valuation methodsRevealed Preference Stated Preferences

A. Environment as an input into a production process

Direct techniques

Market price based approach Contingent Valuation

Productivity changes

Health Production Function

B. Environment as a characteristics of aMarket based good

Indirect techniques

Travel Cost Method (TCM) Contingent ranking

Hedonic property price approach Contingent referendum

Hedonic wage method Choice Experiment

Practical method for measuring benefits• There is no single technique for estimation• The choice depends upon the damage being done

to the eco-system.• Morbidity, mortality, agricultural productivity,• Irreversible loss to ecosystem• Do you know about some of the studies conducted

by SANDEE and EPSEA??

1. Market pricing method• it is used when environmental preservation causes

changes in the output or input.• Expected increase in the fish harvest due to

pollution control technology.• Increase in the crop yield due to legislation for

tougher air pollution control standards.• Increase tourist revenue to law enacting

preservation of wilderness.• These inputs or output have market prices-scarcity• Shadow prices can also be used• Prices of the same goods in the private sector

Continue..• Thus, where environmental improvement is directly associated with changes in the quantity or price of marketed outputs or inputs, the benefit directly attributable to the environmental improvement in question can be measured by changes in the consumers’ and producers’ surpluses.

Continue..• Dixon and Hufschmidt (1986) estimated the loss of

fishery resources owing to Tokyo costal development using market prices of fish.

• One more approach is called ‘Opportunity Cost (OC)scenario.

• The opportunity cost approach simply looks at the land use that produces the highest alternative return.

• Forest conservation and development program in Madagascar, Kremen et al. (2000) used the OC method this way. The case study specifically dealt with preserving a 33,000 ha area of tropical forest (Masoala National Park and the surrounding buffer zone).

• Forest concession instead of a PA

The Replacement Cost Approach• Measuring benefits of avoiding the damages due

to environmental preservation • Approximation by using market prices of what is

the cost to restore or replace the damage.

• For example, govt. passing a legislation enacting a cut in the sulfur and nitrates emission can be reinforced with a monetary estimate of cost of replacing infrastructure in the wake of an acid rain

• Savings realized by avoiding damages.

Continue…• How it is linked with people’s WTP??

• Reduction in the restoration, replacement of assets due to improvement in the environment closely reflects it (Pearce 1993).

• However, in some case the loss can be irreparable

• See Dixon and Hufschmidt (1986) • Cost of recovery and replacing an eroded soil from

an agriculture Project in Korea

Hedonic pricing approachesA. Hedonic property model• A revealed preference method.• Decomposes the item into constituents

characteristics• Obtain the estimates of the contributory value of

each characteristics.• Two houses, similar characteristics except that one

is closer to landfill• Implicitly reveal WTP-Irfan’s study-SANDEE• Environment is a complement to a market product

Hedonic pricing approaches B. Hedonic wage model

• See Madheshwaran (2004)

• Rafiq(2011)

-SANDEE

The HPF• Becker(1965) did earlier work• In HPF the benefits of environmental quality

improvement- by the expenses of households on good- substitute or compliments.

• Market goods don’t provide utility rather household combines time and environmental good or bad to it to produce final utility yielding good.

• Environmental commodities-effects can be modified using market goods.

• Examples include sound proofing, water filter, air filter

A. Defensive expenditure• In the case of a bad like noise, air congestion,

contamination of water, the market good is used to improve them.

• In each of these cases, we observe individual WTPto avert or defend them selves against specific damages.• Defensive or aversive expenditure for

environmental qualities (quietness, clean water, clean air).

• Health production function

B. Travel Cost Method• A variation of HPF• Valuation of environmental services from

recreation sites.• Proxy values from the surrogate market of tourism• WTP for environment is derived from the expenses

on travel expenses to a particular site.• Method originated in 1950’s –Harold Hotelling• V=f(pv, q, y)• ITCM, ZTCM• Ali Dehlvi- keenghar lake

compliments• The important relationship b/w X and Q can that of weak

complimentarity and perfect substitute If X & Q are compliments then an increase in Q enhancement the enjoyment of X, other things being equal.

• Q is an exogenous determinant of X• Visits made to a lake X=f(P,Q,M)• Integrating conditions are met one can integrate the system of

demand function to obtain the expenditure function h=h(P,Q,U0)• The integration further requires weak complimentarity; two

neceassary conditions• i)at certain price P* the demand for X will be zero• ii)changes in Q will have no effect when price of X is greater then P*• Travel cost

substitutes• If X & Q are perfect substitutes then the

expenditure on X can be used as the value of Q

• Defensive expenditure