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Environmental Economics – Lecture 5

Valuation

Florian K. Diekert February 26, 2015

Perman et al (2011) ch. 11-13

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Preview lecture 5

1. Theory

I Categories of environmental benefitsI WTP and WTA

2. PracticeI Stated preference methods

I The method of “contingent valuation” (CV)I Discussion: (http:

//www.aeaweb.org/articles.php?doi=10.1257/jep.26.4)

I Revealed preferences

I Travel cost methodI Hedonic pricingI Production function based techniques

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Valuation: Theory

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Categories of environmental benefits

In the old edition of the Perman book (2003), there were a lot ofacronyms, summarized in two equations:

EC = UV + EV + OV + QOV

TV = CUV + NCUV + NUV

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Willingness-to-pay & willingness-to-acceptEnvironmental valuation theory 1

Assume that quantity/quality of environmental good e can be treated as an argument in a well-behaved utility function. The individual cannot choose level of e. y is income.

u = u(y, e)

e0 e1

At A, WTP for e improvement = BC is Compensating Surplus, CS

At A, WTA in lieu of e improvement = DA is Equivalent Surplus, ES

e1 e0

At B, WTP to avoid deterioration = BC is Equivalent Surplus, ES

At B, WTA compensation for deterioration = DA, Compensating Surplus, CS

Figure: Slide taken from Perman’s webpage http://personal.strath.ac.uk/r.perman/ppts.htm

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Willingness-to-pay & willingness-to-accept

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Compensating and Equivalent variaton

I Compensating variation is the change in income that wouldcompensate for the price change

I Equivalent variation is the change in income that would beequivalent to the price change

Two necessary conditions for environmental quality changes to beapproximately identified by price changes in demand functions:

I Non-essentialness

I Weak complementarity

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Compensating and Equivalent variaton

I Compensating variation is the change in income that wouldcompensate for the price change

I Equivalent variation is the change in income that would beequivalent to the price change

Two necessary conditions for environmental quality changes to beapproximately identified by price changes in demand functions:

I Non-essentialness

I Weak complementarity

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Valuation: Practice

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Stated preference methods: Contingent Valuation

Excerpt of NOAA-panel recommendation:

I Sample from entire affected population

I Personal interview

I Pre-testing

I Referendum format

I WTP instead of WTA

I Reminder of undamaged substitutes

I ‘No-answer’ option available

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Contingent Valuation: Discussion

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Revealed preference methods

1. Travel cost method

2. Hedonic pricing

3. Production function based techniques

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Revealed preference methods

1. Travel cost method

2. Hedonic pricing

3. Production function based techniques

ECON 4910, L5. Slide 11/ 13

Revealed preference methods

1. Travel cost method

2. Hedonic pricing

3. Production function based techniques

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Review lecture 5

1. TheoryI Categories of environmental benefitsI WTP and WTA

2. Practice

I Stated preference methods (in part. “contingent valuation”)I Revealed preferences: Travel cost method, Hedonic pricing,

Production function based techniques

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Preview next lecture

1. A heuristic definition of cost-benefit analysis

2. Detour: The moral of choosing A over B

3. Cost-benefit analysis in a static and certain world

I Tests for marginal and non-marginal projects

I CBA and social welfare functions

4. Dynamic aspects

5. Accounting for uncertainty, risk, and irreversibility