Measuring the Benefits of

Environmental Protection

Introduction

Market benefits

Nonmarket benefits

Nonmarket benefits are determined by inferring how much people would be willing to pay or accept for these benefits if a market for them did exist

Use, Option, and Existence Value

The nonmarket benefits of environmental protection: Use: value in useOption: a resource has option value if the

future benefits are uncertain and resource depletion is irreversible

Existence: obtaining value from the existence of a species

Total Value = Use + Option + Existence

Measuring Benefits: Consumer Surplus The benefit measure for pollution

reduction is the increase in consumer surplus due to such a reduction

Consumer surplus is the difference between what one is willing to pay and what one actually has to pay for a service or a project

Consumer Surplus from Preservation

Measuring Benefits: WTP and WTA There are two ways to determine

surplus: Willingness-to-pay (WTP) for improved

qualityWillingness-to-accept (WTA) compensation

in exchange for degraded quality In theory, because income differences

are small, WTA should be only a bit higher than WTP

Problems with WTA and WTP WTA values are typically 2 to 7 times as

high as WTP valuesThis difference persists even in tests

specifically designed to control for inflated WTA figures

Problems with WTA and WTP

Explaining WTP/WTA Disparities:1. Prospect theory: people may adopt the

status quo as their reference point and demand higher compensation to allow environmental degradation than they are willing to pay to make improvements

If prospect theory is correct, it would reshape our marginal benefit curve for pollution reduction

Prospect Theory and Marginal Benefits of Cleanup

Explaining WTP/WTA Disparities: Substitution

2. The degree of substitutability between environmental quality and other consumption goods

Do environmental goods really have no good substitutes?

WTP/WTA Disparities: Which to Use?

The standard practice is to use WTP because WTA estimates may be less reliable

But if we think of common property as belonging to “the people” then WTA may be the best measurement

With either WTA or WTP, the use of consumer surplus as our benefit measure automatically leads to higher benefits for clean-up in wealthier communities.

Risk: Assessment and Perception

Step 1 in measuring the benefits of pollution reduction: assess the risks

Information on health risks come from two sources:Epidemiological: studying past cases of

human exposure Animal studies from laboratories

Risk Comparisons: peanut butter?!

Risk: PCBs Epidemiological studies have shown that

PCBs cause developmental abnormalities such as low birth weights and less developed cognitive and motor weights; there is also limited evidence of a link between exposure to PCBs and certain cancers

In animal studies PCBs have been found to generate cancers

These studies have led the EPA to label PCBs as “probable human carcinogens”

Making Predictions

Translating information from high-dose animal studies to low dose human exposure often generates a much higher estimated risk of cancer in humans than other models

Because of this researchers often adopt a “conservative” modeling stance

Perceived Risk

Individuals may perceive risk differently than the actual risk for a few reasons:Voluntary vs involuntary riskLack of knowledgeDistrust of ExpertsPeople are risk averse

Risk Aversion An individual is risk averse if they prefer a

“sure thing” to a gamble with a higher expected payoff:

E.g.. If I prefer $50 for sure versus a 50% chance for $110, I am risk averse.

Risk aversion implies that people will dislike exposure to catastrophic events occuring w/ low probability more than unpleasant events occurring w/ high probability– even if they have the same average cost.

Why is nuclear waste at the bottom?

Measuring Benefits: Contingent Valuation

Contingent valuation (CV Analysis):Survey methods used by economists to

determine the benefits of environmental protection; the survey responses are “contingent” upon the questions asked

Basically, ask people their WTP and/or WTA

The CV Method of Measuring Consumer Surplus

Sources of Error in CVs

Hypothetical BiasHypothetical questions hypothetical responses

Free-ridingMay lead understatement of true WTP

Strategic BiasPeople might inflate their WTP to achieve greater

clean-up if they believe they will not have to pay their WTP

Embedding BiasAnswers are strongly affected by the context provided

about the issue at stake: MAIN PROBLEM!

CV: useful or useless?

Economists disagree about the reliability of CV analysis. Doing a ‘state of the art’ job can be very expensive○ Analyses of Exxon Valdez oil spill cost $3 million

Such ambitious efforts are relatively rareCVs provide the only available means for

estimating the existence value component of nonmarket benefits, so they are widely used

Measuring Benefits:Travel Cost The travel-cost method measures the

amount of money that people expend to use the resource (parks, rivers, or beaches)

By relating differences in travel cost to differences in consumption, a demand curve for the resource can be derived and consumer surplus estimated

Demand Curve Derived from Travel-Cost Data

Demand Curve Derived from Travel-Cost Data Total Consumer Surplus

= Area A surplus + Area B surplus + Area C surplus

= 1,000 people * (d + e + f)

+ 1,000 people * [(d + e) – 6 * 25]

+ 1,000 people * (d – 50)

Problems With theTravel Cost Method

People have different opportunity costs Some may have alternative recreational

opportunities that others do not The travel cost method has been extended to

address both of these issues

Travel Cost and Beach Values The value of Florida Beaches (Bell and Leeworthy) Survey 826 tourists: days spent at the beach and

expenses incurred to use the beach, meals, travel and access fees, initial travel costs in and out of the state, length of stay, age, income, and other control data.

Hypothesis: holding all the other factors constant, lower beach expenses --> greater number of days at the beach.

Results: a 10% increase in “price” lead to a 1.5% decrease in time on the beach. Average CS per day of $38. Over 2 million tourists: $2.37 billion per year.

Measuring Benefits:Hedonic Regression

Hedonic regression uses the change in price from related (complementary) goods to infer a WTP for a healthier environment

Confusing label! Hedonic=“pertaining to pleasure”

A hedonic regression estimates the pleasure or utility associated with an improved environment

Hedonic Regression 1: Property Values and Pollution PCB contamination in New Bedford

(Mendehslon et al) Compare change in prices for houses sold

before and after contamination became public. Control for all other factors affecting home costs.

Houses closest to the contaminated area: price declines of $9,000; in area of secondary pollution, declines of $7,000. Total damages to home-owners: $36 million

Hedonic Regression 2: The Value of Human Life

The most ethically charged aspect of benefit-cost analysis is its requirement that we put a monetary value on human life

Old approach, still used in court settlements: lifetime earnings. Retired or disabled person is “worth” $0.

Economic Approach: wage-risk studies.

Hedonic Regression 2: The Value of Human Life Isolate the wage premium people are paid to

accept risk jobs--police officer, firefighter, coal miner

With this it is possible to estimate a WTA a reduction in the risk of death, and implicitly, the value of life

Holding all else equal, suppose we observe that police officers receive extra pay of $500/yr. If the excess risk of death is 1/10,000 per year then collectively, 10,000 officers trade one of their lives each year for $500*10,000=$5 million.

Problems:

1. Accurate informationIndividuals might underestimate or

overestimate risk of death

2. Sample selection biasPeople accepting risky jobs are not likely

representative of the “average” person with preference toward risk-aversion

3. Involuntary nature of riskPeople may require more to accept risk

imposed upon them without their consent

The Value of a Life

The value obtained from a hedonic regression is not the value of a specific lifeWe would pay just about anything to save our

own life or that of a loved one!

Instead, this is the amount of money the average individual in a society requires to accept a higher risk of death

Morally OK?

As with any measure of consumer surplus, this method will put a much larger value on life for folks from rich than from poor countries.

USA: $7 millionPakistan: $300,000

Review of Measuring Benefits

1. Is consumer surplus a good measure of benefits, especially for valuing life?

2. Which measure should be used: WTP or WTA?

3. How reliable is the risk assessment? 4. How good are the benefit measures? 5. What discount rate is used to value

future benefits?

WTA and WTP Redux

WTA/WTP: Perfect Substitutes

WTA/WTP: Poor Substitutes

Prospect Theory or Substitutability? One study using candy bars and risk of

salmonella from sandwiches, to determine peoples’ WTA and WTP. Provided support for the “no-good substitutes” explanation for the WTA/WTP discrepancy

Advocates of prospect theory argue people do not become as attached to a candy bar or sandwich as they do to a grove of trees in a local park

Prospect Theory or Substitutability?

People are attached to the status quo because there are no good substitutes for environmental degradation from the status quo

In this sense, the two explanations converge