Non-market valuation of the Environment

EANRE Lecture 5
March 5th 2024
Lecture 5
Overview
• Biological growth model
• Defines extent of sustainable limits to physical exploitation of a given
renewable resource

• Economic exploitation model

• Ownership rights and discount rate critical in influencing sustainability of
resource use

• Renewable resource policy

• Effort-based vs Catch-based options
• Policy needs to incorporate externalities
Valuing the Environment

Rationales

• Enable environmental impacts to be included in Cost-Benefit-Analysis (CBA)

• To take account of environmental damage in measuring economic performance

• To take account of environmental benefits of public programmes

4
Valuing the Environment

Why Important?
• Highlights that human welfare determined by both market- and non-market
goods and services
• Allows trade-offs between environment and market-based economic activity to
be quantified
• Project Appraisal
• Policy Appraisal
• Awareness-Raising
• Green National Accounting

5
Financial Analysis vs Economic Analysis

Water companies financial:

• Costs of treatment & supply

• Revenue from supplying water to customers

Economic: Environmental damage from

effluent
• e.g. Southern Water discharging billions of litres of raw
sewage into the sea at Kent and Hampshire from 2010-15.

Financial → Economic

• Southern Water fined £90 million for damage to aquatic

environments
Categories of environmental benefits

• Use Value (UV)

• Existence Value (EV)
• Option Value (OV)(Option Price = Expected Use Value + OV).
• Quasi Option Value (QOV)
• Bequest Value (BV)

Total Economic Value (TEV)

• TEV = UV+EV+OV+QOV+BV
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 Categories of environmental benefits (utility)
Total economic value

Use Non-use

Consumptive Non-consumptive

Existence
Indirect use – carbon fixation, micro-climate regulation

Altruistic Bequest

Revealed preference methods Stated preference methods

 Environmental 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
y1 D At A, WTA in lieu of e improvement = DA
is Equivalent Surplus, ES
WTA

A B
e1 e0
y0
U1
WTP C

U0
At B, WTP to avoid deterioration =
e0 e1 Quantity or quality of the environmental good e BC is Equivalent Surplus, ES
At B, WTA compensation for
deterioration = DA, Compensating
Surplus, CS
 Environmental valuation theory 2

Monetary measures for environmental quality changes

Compensating Equivalent
Surplus Surplus

Improvement WTP for the WTA

change compensation
occurring for the change
not occurring
Deterioration WTA WTP for the
compensation change not to
for the change occur
occurring

WTP Willingness to pay

WTA Willingness to accept
CS Compensating surplus
ES Equivalent surplus
 Compensating Variation – the WTP/WTA disparity

Theory predicts that WTA should exceed WTP by a small amount.

Consider an individual who starts with private consumption of y1.

WTA for a decrease in the environmental good from e1 to e0 is DA

which is greater than WTP of BC for an increase in the
environmental good from e0 to e1
y1 D

For commodities where there are limited possibilities for

WTA substitution, WTA could be much larger than WTP. In the limiting
A B
case where there is perfect substitution between the composite
y0
U1 commodity and the environmental good, the indifference curves
WTP C become straight lines and the difference between WTP and WTA
U0
disappears.
e0 e1 Quantity or quality of the environmental good e
 CV – the WTP/WTA disparity – Prospect theory

Prospect theory
As outlined in Kahneman and Tversky (1979) - three elements
1. An individual views things in terms of changes from a reference
level, usually the status quo
2. Gains and losses are subject to diminishing returns
3. Loss aversion – the value function is steeper for losses than gains
Hence an endowment effect. People value a good or service more once their
property right to it has been established, place a higher value on a thing that
they own than on the same thing that they do not own.

If property rights are defined by the current level of environmental quality then improvements in environmental
quality should be valued using WTP and reductions in environmental quality should be valued using WTA.
Non-market valuation techniques
• Revealed Preferences
• Travel Cost Model
• Hedonic Pricing

• Stated Preferences
• Contingent Valuation
• Choice Modelling

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 The travel cost method

• The TC method is used for estimating use values, the recreational benefits
of environmental resources – national parks, forests, reserves, fishing and
hunting sites
• Travel costs incurred visiting a site vary across visitors
• It is assumed that visitors react to variations in travel costs as they would
to admission fee variation

• An individual may have non-use values regarding a site not visited. TC

cannot elicit such.
• TC can be used to estimate value of changes in quality of a site
 Travel Cost – Measurement
Maximise
u ( x, r , q) Utility function
u – utility
subject to
x – consumption of composite
commodity
m + wtw = x + cr Income budget constraint
and
r – visits to a recreational site t = t w + tr r Time budget constraint
q – site quality
Substituting in gives
m – non-labour income
w – wage rate
m + wt = x + (c + wt r )r
t – total time available Define the price of a trip as

tw – time spent working p = c + wt r

c – round trip travel cost of visit

r = r (m, w, p, q)
= demand function for visits
Travel Cost Method

• Data Required
• Visitors to site surveyed:
• How far travelled?
• How often visited in last year?
• Visited similar sites?
• Income?
• Family size?

→ Identify relationship between no. of visits and cost

per visit

→ Estimate consumer surplus (CS)

• → estimate change in CS if admission fee

introduced
 Travel cost method: Potential Local examples

Murmuration of starlings: Somerset Levels

Chesil Beach, Dorset
Entrance fee to prevent congestion?
Entrance fee to pay for protection against sea level rise-
induced erosion?
 TC – zonal model
1. Define a set of i concentric zones surrounding the recreational site of interest.

2. Collect information on the annual number of visitors from each zone by means of a survey.

3. Calculate the visitation rate by dividing the number of visits arising from each zone by the population of
that zone.

4. Using a standard value per unit distance travelled and a standard value per unit of time calculate the return
trip travel cost from each zone.

5. Estimate a regression equation linking the visitation rate (v) to travel costs (c) i.e.

𝑣ො𝑖 = 𝛼 + 𝛽(𝑐𝑖 )

6. Use the equation to predict visitation rates with different hypothetical entrance fees e.g. starting with £10
vˆi =  +  (ci + 10)
7. Calculate total visitor numbers by multiplying the predicted visitation rate by the zonal population and
then sum across all i zones yielding a point on a demand curve.

8. Employ the same procedure to evaluate the effect of imposing various other hypothetical admission
charges e.g. £20, £30, £40 and £50 etc to identify additional points on the demand curve.

9. Estimate the total economic benefit of the site by calculating the area under the demand curve.
 TC – An illustrative ZTC model example: 1
Zone Visits Population Round-trip
(thousands) distance (miles)

1 15000 2000 10 Travel cost per mile = £1

2 48000 8000 15

3 11250 2500 20

4 45000 15000 25

5 34000 22660 30

Estimate the parameters of the trip generating function

Vi =  + Ci
where Vi is i-th zone trips per thousand population and Ci is the cost of
a trip from zone i. OLS gives
Vi = 10.5 − 0.3Ci
Assuming the same reaction to an admission price P, this can be written as

Vi = 10.5 − 0.3(Ci + P)

and used to simulate the effects of changes in P.

TC – An illustrative ZTC model example: 2
For P = £5, estimated trip generating function gives
Zone Ci + P Vi Vi x Population
(thousands)
1 15 6 12000
2 20 4.5 36000

3 25 3 7500
4 30 1.5 22500

5 35 0 0
Total 78000

Working through P = £10 and so on

P (£) Total Visits

0 153250

5 78000

10 36750

15 18000

20 3000

25 0
 TC – An illustrative ZTC model example: 3

The third step is to obtain from this data an estimate of consumers’ surplus for the year.
Given that in fact P = 0, consumers’ surplus is the total area under this surrogate demand
function, which is:

[(153 250 − 78000)  5  0.5] + [78000  5]

+
[(78 000 − 36 750)  5  0.5] + [36 750  5]
+
[(36 750 −18 000)  5  0.5] + [18 000  5]
+
[(18 000 − 3000)  5  0.5] + [3000  5]
+
[3000  5  0.5]

= £1 061 875
TC Example – Great Barrier Reef (Carr & Mendelsohn, (2003))
• 2 million annual visitors
• Sample of domestic and international visitors:
multi-modal travel
• 607 individuals; 39 zones of origin

• Annual consumer surplus: £800m - £1.8bn

• Range determined by functional form assumed

• Suggests benefits of conserving healthy reef

• More sensitive tourist management
• Policies to reduce marine acidification
 Travel Cost Method – limitations

• In most TC applications travel costs are ‘researcher assigned travel cost estimates’ (Randall 1994 – who
argues for the use of costs as perceived by visitors)

• Determination of the opportunity cost of time spent travelling

– TC model assumes that work and travel time confer negative utility and that individuals can
choose how much they work. This would value travel time at the wage rate. But need to value leisure time

• How to assign costs to the components of multi-purpose trips?

- Use random utility model:
→ Predicts probability that an individual will visit a given site from a list of substitute sites
→ Combine with count model that estimates no. of trips an individual will make to all sites of this type e.g.
beaches
 • HP often applied to the property market within which many
environmental goods are implicitly traded. Also, labour
Hedonic pricing market
• noise nuisance, air quality, physical separation from
locally-undesirable land uses, value of a statistical life.

• Households reveal their preferences for these goods through

their decision about where to locate.

First formal characterisation: Rosen (1974), building on

Lancaster’s characteristics theory of value (Lancaster,
1966).

The hedonic price function describes price of a quality-

differentiated commodity in terms of its quality
attributes
 HP – Theoretical model
Let h be the price of housing, q1, q2,...,qn its characteristics and ε a random error term to
represent the non-quantifiable aspects. The hedonic price function is

h = h(q1, q2 ,..., qn ) + 

Taking derivative of the hedonic price function with respect to the jth characteristic yields
implicit price function for that characteristic

h(q1 , q2 ,..., qn )
pj =
q j
 HP – Theoretical model 1

• The hedonic price function = double envelope of buyers’

bid functions and sellers’ offer curves.
Prices
• Shape determined by aggregate supply and demand for
differing levels of the quality attributes within the market.
Hedonic price function

Offer curves • Bid curves: combinations of prices and levels of the quality
attribute that leave buyer at same level of utility.
• Slope represents maximum amount of money that the
individual is WTP for an extra unit of the quality attribute.
Increasing profit

Bid curves
• Offer curves: combinations of prices and levels of the
quality attribute that leave sellers with the same profit.

Increasing utility

Environmental Quality
 HP – Empirical implementation
Collecting information on the sale price of individual properties
• Dependent variable = sale price
• MWTP for housing attributes = present value of future benefits.
• implicit price of environmental quality reflects any anticipated change in environmental
quality.

• Control for characteristics of property.

• record all relevant characteristics of the property itself
• Site: e.g. the age of the property, type of property, length of the lease, presence of
central heating, availability of off-street parking etc.
• Location: e.g. distance to the nearest bus stop or train station, town centre, school,
shopping centre, crime rate, etc..
• Environmental: e.g. night time noise levels, ambient air quality, distance to the
nearest park, etc.

Risk of omitted variables: difficult to quantify e.g. physical attractiveness of building, the odour
arising from nearby industrial activities, quality of the view, etc.
Valuing improvements in air quality
Brookshire et al estimated property price differentials associated with air quality
improvements in Los Angeles. Used sample of 634 sales of family homes.
Results from hedonic house price regression
The dependent variable is the log of sale price. The independent variables are
Housing structure Accessibility
Sale date +ve Distance to beach -ve
Age -ve Distance to employment -ve
Living area +ve

Bathrooms +ve Air pollution

Pool +ve Total suspended particulates -ve
Fireplaces +ve Nitrogen Oxide -ve

Neighbourhood in separate regressions – coefficient signs same in both

Crime, Log of -ve
School Quality +ve
Ethnic composition(% white) +ve
Housing density -ve
Public safety expenditures +ve
Except for crime, all estimated coefficients significant at 1%
R2 = 0.89 in both regressions
For an improvement from ‘poor’ to ‘fair’ air quality, rent
differential $15.44 to $45.93 per month, from ‘fair’ to ‘good’
$33.17 to $128.46 (1978 prices). Higher differential associated
with higher income community
Hedonic valuation example: National Accounting

• Value of green and blue space implicit in

property prices in urban areas in Great Britain
• Zoopla: data on > 1 m properties sold in GB 2009
- 2016.
• OS dataset: location and extent of green spaces
likely to be accessible to the public.
• Predicted average property prices g/b space:
£246,010. Price in absence of g/b spaces:
£241,197
→ £130.9 billion for the stock value of blue and
green spaces.
• Value of nature implicit in property prices – Hedonic Pricing Method (HPM)
methodology note - Office for National Statistics (ons.gov.uk)
Stated Preference Methods

Contingent Valuation Choice Modelling

 Contingent Valuation Method - Overview
• Values estimated in a hypothetical market based on
surveys in which respondents are asked how much they
are willing to pay for the use and conservation of an
environmental good.

• Purpose of contingent valuation is to estimate individual

willingness to pay for changes in the quantity or quality of
environmental goods or services

• Wide range of applications – e.g. health, biodiversity,

cultural monuments, landscape

• Uses: CBA, Internalising externality in environmental tax;

national accounting; participative exercise; compensation
 Contingent valuation - Theory
CV = survey-based technique. Measures stated preference
CV can measure both Use and Non-use values
CV provides theoretically correct WTP and WTA measures of utility change
CV is the most widely used valuation technique
 • The steps involved in conducting a CV study:

Contingent 1. Creating a survey instrument (i.e. questionnaire).

valuation – 2. Choosing an appropriate survey technique. e.g. mail, online

Overview of 3. Identifying the population of interest and developing a sampling strategy.

method 4. Analysing the responses to the survey.

5. Aggregating the WTP or WTA responses over the population of interest

6. Evaluating ex-post the success (or otherwise) of the CV exercise.

CV - Creating the survey instrument
• 1.Explanation of the purpose of the exercise

• 2. Questions about respondent’s knowledge and attitudes

• 3. Description of problem

• 4. Description of project to address problem

• 5. Statement of payment vehicle

• 6.Reminders about substitutes and income constraints

• 7. Ask about WTP via one of elicitation methods

• 8. Follow-up questions ( to identify protest bids etc)

• 9. Questions about respondent characteristics

 Payment vehicle
• Whose welfare are we interested in?
=> Important for sampling plan
• TAX? => One time Tax is incentive compatible. But emotional reactions?
• How do we choose the tax level? Focus groups, previous research, pre-test, optimal bidding design
literature, cost of the public program

Percentage of YES responses to the bid

100
Percentage of YES

80

60

40

20

0
5 15 20 40 60 80 100 150
TAX
 WTP question – Elicitation method

• Open Ended:
• “How much are you willing to pay for public good A?”

• Bidding Game:
1) “Are you willing to pay X for public good A?”
2a) If Yes to (1), “Are you willing to pay Y for public good A?” (Y>X)
3a) If Yes (2a), “Are you willing to pay Z for public good A?” (Z>Y).
4a) if Yes to (3a) …
If No to (Na), WTP questions stop.
2b) If No to (1), “Are you willing to pay T for public good A?” (T<X)
…
Anchoring?

• Payment Cards:
• choose a WTP point estimate from a list of values
Anchoring?
 WTP question – Elicitation method

• Dichotomous or Discrete Choice CV (Referendum format):

• “Are you willing to pay X for public good A?” => STOP

tell respondent if referendum supports project it goes ahead and costs each $x, which is varied
across respondents. Incentive compatible. Easy to understand

• Dichotomous or Discrete Choice CV with follow-up:

1) “Are you willing to pay X for public good A?”
2a) If Yes to 1, “Are you willing to pay Y for public good A?” (Y>X)
=> STOP
2b) If No to 1, “Are you willing to pay Z for public good A?” (Z<X)
=> STOP

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 • Identify the population from which the sample is to be drawn - the
group liable to be affected by a change in the level of provision of the
environmental good.

• For use values: base on current patterns of use.

• E.g. if we wished to assess the use value of improved water quality
in a lake include the population of anglers using the lake.
CVM -
• For some non-use values e.g. those relating to tropical forests, the
Sampling candidate population is potentially the whole global population.

• The required sample size determined by e.g. statistical precision

required and the financial cost of the surveys.

• Key: sample is representative of the target population. All members of

the relevant population should have equal probability of being included
in sample.
 • Although economic theory suggests that mean
WTP is more appropriate there are two practical
arguments in favour of using the median.

• First - political acceptance. In order to gain

democratic support it may be necessary to base any
decision on a value for the environmental good
which at least 50 percent of households would be
WTP.
CV - Mean or •
• Second - the median may be more robust to
median? outlying observations.
• In many CV exercises there are a handful of
individuals who submit very high bids – not
accounting for their budget constraint?
• Although few in number, such individuals can
exert considerable influence on estimates of
mean WTP.
• Exclude from the analysis?
 Contingent Valuation - Aggregation
Aggregate mean or median WTP values over the target population.
- national population
- number of people using a particular environmental resource
- number of households living within a particular radius of the site
- living in a particular political region.

If the sample is representative of the target population

AggregateWTP = N WTP
N, the number of observational units (typically the number of households) in the target population

If the sample is not representative of the target population then stratify the sample and calculate a mean
WTP appropriate for each household type

Mean WTP for each household type multiplied by Ni the number of observational units of each type present
in the target population
AggregateWTP =  N i  WTPi
i

Important if the sample is geographically unrepresentative and WTP for the project depends on distance to the site.
 • Establishing the success or failure of a CV study
• CV surveys ought to be reliable in the sense that administering the same survey to a
different sample of respondents or the same sample of respondents at a later date
should yield similar results.

• Surveys designed and undertaken by different researchers but purporting to measure

the same thing should also produce similar results.
CV – reliability • Face validity – does the survey ask the right questions about the right scenario?
and validity
• Criterion validity – compare with actual referendum outcome

• Convergent validity – compare with results from another valuation method

• Theoretical validity – estimate a bid function ( a regression equation) with arguments

that explain the bid. Do the coefficient signs agree with theory/expectations? Is, eg, WTP
positively related to income?
 CVM Example Application: Exxon Valdez
• Wrecking of oil tanker – Alaskan coast, 1989
• Legally, people could sue for lost non-use values – habitat,
wildlife, etc.
• Survey of 8000 households in US
• Mean WTP to avoid repeat event = £55/annum; Median
WTP = £40
• Total value = £4bn - £8bn

Sample text: “As you can see from this card, 22,600 dead birds were found. (POINT)

The actual number of birds killed by the oil was larger because not all the bodies were recovered.

Scientists estimate that the total number of birds killed by the spill was between 75,000 and 150,000.

One hundred of the area’s approximately 5,000 bald eagles were also found dead from the oil.
The spill did not threaten any of the Alaskan bird species, including the eagles, with extinction.”
 Part – whole bias. The value
for a specific good the same
Potential biases have been Hypothetical bias. No
as for a more inclusive
identified in the CV money is actually being
good. A particular species
literature spent!
and all endangered species.
Embedding

Insensitivity to scope. A
manifestation of part –
Interviewer bias - Yea Temporal embedding –
CV – types of whole bias, or reflecting
that the bid responses are
largely symbolic in nature –
saying - to please the
interviewer
WTP insensitive to
frequency of payment

bias and ‘warm glow’ effects

problems Strategic bias – e.g.

Starting point bias – Sequence effects – the
respondents believe
anchoring to values not order of questions affects
answers will affect their tax
reflecting their true WTP. the WTP/A values given
liability.

Information bias –
individual’s WTP reflects
inadequacy of their
knowledge
 Stated Preference: Choice Experiments
1) Economics often includes tradeoffs:
• Is exposure to a valuable chemical worth reduced fertility? (Scasny and Zverinova, 2014)
• Is a shorter wait time worth higher likelihood of side-effects? (Regier et al., 2014)
• Is more expensive water worth reduced environmental risks? (Logar et al., 2014)

2) Choice Experiments (CE) ask individuals what choice they would make:
• Which mode of transport will you take? Bus, car, train, cycle? (Hess and Palma, 2019)
• Which conservation policy do you prefer? (Faccioli, Kuhfuss and Czajkowski, 2019)

Two main difference between CE and Contingent Valuation:

• CE WTP is marginal whereas CV WTP is total.
• CE present attributes and levels, CV presents text.
Choice Experiments: Overview

1) CE are valuable for eliciting preferences for marginal changes in hypothetical scenarios.
But leads to hypothetical bias.

2) Popularly used in transport, health, marketing and environmental economics to understand how individuals
trade-off attributes. How do results compare to observed behaviour?

3) Obtain more information per respondent than other valuation techniques.

But at risk of increased task-complexity, fatigue and learning effects, and expertise required by the analyst.
 Choice Experiments: Overview
1) The theoretical foundation starts with Lancaster (1966) characteristics theory of
value:
• Utility of a good is composed of the utility of different attributes of the good

2) Attributes are characteristics or features of the good or scenario

• Of a good: cost, weight, aesthetics, longevity etc.
• Of a scenario: spatial coverage, species involved, change in GHG emissions.

3) Consider a chocolate bar that reduces sugar:

• Increase in utility as individual perceives themselves to be reducing health risks.
• Decrease in utility if individual perceives a reduction in taste
Choice Experiment: Analysis
Choice Experiment: Analysis
Choice Experiment: Analysis
Choice Experiments: Overview
CEs present respondents (individuals responding to the survey) with alternatives that vary along the levels of
attributes:

Alternatives: Options to choose from.

• A status quo option is required - respondents may already be utility maximising.
• Weng et al. (2020) suggested that status quo plus one alternative optimally balances complexity and
information, although the status quo plus two alternatives is common; see a review in Clark et al. (2014).

Attributes: Attributes, features or characteristics of the scenario.

• For example: cost, time, aesthetics, health effects.
• Deciding which attributes are relevant and realistic and how to describe these is typically the first step in
design.

Levels: Value of the attributes with and without the policy.

• Levels: 0,1,2 or 10%, 50%, 100%, or £1,£2, £5
• Challenge is to describe realistically and usefully.
 Choice Experiment: Example of Micro-plastics
1) Funded by the Environment Agency to estimate the value of restrictions on intentionally-added
microplastics.
• Is the reduction in potential risk worth less effective cosmetic products?

2) The European Chemicals Agency proposed a restriction on the use of microplastics.

• We were interested in how consumers react to cosmetic products that no longer contain
microplastics.

3) Manufacturers may add microplastics to cosmetic personal care products including sun cream,
toothpaste, moisturiser etc. to increase product value.

4) Microplastics released to the marine environment (via rinsing down-the-drain) are highly persistent
and may accumulate and concentrate within organisms.
• However, currently no evidence of toxicity or human health effects.
 Choice Experiment: Example choice
Option A Option B

Reduction in the effectiveness of the personal care product. 0% 5%

Percentage reduction in the release of microplastics from cosmetics. 0% 10%

Increase in product price. £0 £1

I prefer:

The two alternatives correspond to an opt-out status quo (Option A) without changes, and a scenario similar
to the ECHA restriction (Option B).
The status quo option is required for consistency with theory while we choose only one alternative scenario
for simplicity (Bateman et al., 2002).
The two alternatives differ only in the levels of the three attributes:
Two (percentage reduction in performance and percentage reduction in release) with three levels and one
attribute (product price) with four levels.
 Choice Experiment Example: Method
1) Given three attributes and four levels there could be a maximum of LA = 64 tasks
This is an example of a Full-Factorial design: number of tasks is a function of the number of attributes and levels.
• Benefit: Allows estimation of all effects.
• Cost: The number of choice tasks is too demanding.

2) Instead, we used a Fractional-Factorial design which reduces the number of tasks by using only a subset of the
possible tasks: our design had 16 total choices.
• Benefit: Requires fewer tasks to be completed.
• Cost: Cannot identify all effects.

3) We then divided the 16 possible tasks into four blocks of four tasks
• Respondents were then randomly assigned to one of four blocks.
• Overall, each respondent completed one example task plus the four in their block - 5 tasks total to minimise
complexity while eliciting sufficient information.
Choice Experiment Example: Results
Choice Experiment Example: Results
Choice Experiments: Conclusions
 • Recognition of human welfare derived from environment
• Advantages of quantification; specifically, allows trade-offs to be made
using common metric in, e.g. Cost-Benefit Analysis
Non-Market
Valuation: • Components of Total Economic Value include use and non-use values

Conclusions • Range of methods to estimate (components of) TEV include revealed

and stated preferences
• Strengths and weaknesses
• Limits to transferability?