Lecture 12 - Non-Market Valuation

ENCI707: Engineering Demand and Policy Analysis

Based on lecture by Mikołaj Czajkowski

Outline

  1. Motivation for valuation
  2. Individuals’ motivation for willingness to pay (WTP)
  3. Economic theory
  4. Nonmarket valuation methods
  5. Short history of contingent valuation

Foundations of Economic Valuation

Topics

Why Economic Valuation?

Environmental Decision Making

Environmental changes affect:

  • Human welfare
  • Economic activity
  • Public goods
  • External effects

Applications:

  • Cost-benefit analysis
  • Environmental policy evaluation
  • Priority setting
  • Legal damage assessment
  • Green national accounting

Cost-Benefit Analysis

Basic Framework

A complete CBA should:

  • Compare all costs and benefits
  • Include environmental and health impacts
  • Quantify environmental changes
  • Value those changes monetarily
  • Calculate net benefits
  • Account for discounting
  • Compare alternatives

Example: Electricity Generation

The Problem

Electricity production generates:

  • Air pollution
  • Greenhouse gases
  • Health impacts
  • Ecosystem damage

These external effects are often not reflected in market prices.

Economic theory suggests:

  • Taxing emissions according to marginal external damage
  • Comparing technologies based on social costs

External Costs of Electricity

The ExternE Approach

Major European research efforts:

  • ExternE
  • ExternEPol
  • NEEDS
  • CASES
  • EXIOPOL

Goal:

Estimate the external costs of electricity generation.

Impact Pathway Approach

Valuation Process

  1. Emissions released
  2. Atmospheric transport
  3. Chemical transformations
  4. Concentration changes
  5. Physical impacts
  6. Welfare impacts
  7. Monetary valuation

Types of Welfare Effects

Examples

Health:

  • Mortality
  • Morbidity

Environment:

  • Biodiversity loss
  • Acidification
  • Eutrophication

Economic:

  • Agriculture
  • Materials damage

Why Valuation Matters

Importance in Practice

Economic valuation:

  • Supports major policy decisions
  • Appears in thousands of studies
  • Is central to welfare economics
  • Is used in environment, health, transportation, and culture

Examples include large regulatory analyses such as clean water policies.

Sources of Economic Value

Total Economic Value (TEV)

[ TEV = UV + EV + SV + BV + OV + ]

Where:

  • UV = Use Value
  • EV = Existence Value
  • SV = Stewardship Value
  • BV = Bequest Value
  • OV = Option Value

Use and Non-Use Values

Use Value

Benefits obtained from direct or indirect use.

Examples:

  • Recreation
  • Fishing
  • Water consumption

Non-Use Value

Benefits independent of actual use.

Examples:

  • Knowing a species exists
  • Preserving resources for future generations

Existence Value

Definition

Utility gained simply from knowing that an environmental resource exists.

Examples:

  • Endangered species protection
  • Wilderness preservation

Individuals may value protection even if they never visit the resource.

Stewardship Value

Definition

Value derived from acting as a responsible caretaker.

Examples:

  • Maintaining water quality
  • Preserving habitats
  • Preventing human-caused species losses

Bequest and Option Values

Bequest Value

Protecting resources for future generations.

Option Value

Maintaining future opportunities for use.

Important when:

  • Future preferences are uncertain
  • Environmental damage may be irreversible

Other Motivations

Altruism

Concern for others’ welfare.

Examples:

  • Concern for future generations
  • Concern for wildlife

Warm Glow

Utility from contributing to a socially desirable cause.

Examples:

  • Charitable giving
  • Environmental donations

What Is Economic Value?

Price vs Value

Price is not necessarily value.

Economic value is linked to:

  • Preferences
  • Welfare
  • Willingness to pay

The relevant concept is welfare change.

Willingness to Pay

Concept

WTP measures:

The maximum amount an individual would sacrifice to obtain a benefit or avoid a loss.

WTP is the foundation of modern economic valuation.

Consumer Surplus

Basic Idea

Consumer surplus equals:

  • What consumers are willing to pay
  • Minus what they actually pay

Graphically:

  • Area under the demand curve
  • Above market price

Welfare Measures

Beyond Consumer Surplus

When income effects matter:

Compensating Variation (CV)

Income adjustment needed after a change to restore original utility.

Equivalent Variation (EV)

Income adjustment before a change to achieve final utility.

WTP and WTA

Property Rights Matter

Two key measures:

  • WTP (Willingness to Pay)
  • WTA (Willingness to Accept)

Choice depends on:

  • Initial entitlement
  • Property rights

Nonmarket Goods

Why Special Methods?

Examples:

  • Biodiversity
  • Water quality
  • Recreation sites
  • Ecosystem services

These goods often lack market prices.

Valuation Approaches

Two Major Families

Revealed Preference (RP)

Observed behavior in actual markets.

Stated Preference (SP)

Choices observed in hypothetical settings.

Revealed Preference Methods

Examples

Productivity Method

Environmental inputs used in production.

Avoided Damage Method

Value inferred from prevented losses.

Hedonic Pricing

Property or wage markets.

Travel Cost Method

Recreation demand and site valuation.

Hedonic Pricing

Applications

Examples:

  • House prices near lakes
  • Air quality impacts on housing
  • Labor market risk premiums
  • Value of statistical life

Approach:

  • Collect market data
  • Statistically isolate environmental effects

Travel Cost Method

Applications

Examples:

  • National parks
  • Urban parks
  • Recreation areas

Uses:

  • Travel expenses
  • Travel time
  • Visit frequency

to estimate demand.

Limitations of RP Methods

Challenges

  • Suitable markets may not exist
  • Only observed conditions can be valued
  • Limited ability to estimate passive-use values

Often produces lower-bound estimates.

Stated Preference Methods

Main Idea

Respondents evaluate hypothetical scenarios.

Allows valuation of:

  • Future policies
  • Unobserved outcomes
  • Non-use values

Includes:

  • Contingent valuation
  • Discrete choice experiments

Contingent Valuation

Basic Question

Typical format:

What is the maximum amount you would be willing to pay?

Advantages:

  • Simple
  • Direct

Challenges:

  • Strategic responses
  • Hypothetical bias

Early Elicitation Formats

Historical Approaches

Bidding Game

Iterative price adjustments.

Open-Ended Questions

Direct WTP response.

Payment Cards

Respondents select from offered values.

Problems with Early Methods

Common Issues

  • Starting point bias
  • Nonresponse
  • WTP/WTA disparity
  • Incentive compatibility concerns
  • Hypothetical bias

The Exxon Valdez Turning Point

Why It Matters

The oil spill generated:

  • Large environmental damages
  • Legal disputes over valuation
  • Major scrutiny of contingent valuation methods

NOAA Panel Recommendations

Arrow-Solow Panel

Recommendations:

  • Use realistic scenarios
  • Use referendum-style questions
  • Use single binary choice formats
  • Emphasize incentive compatibility

These recommendations became highly influential.

Emergence of Choice Experiments

Adamowicz, Louviere & Williams (1994)

Respondents choose among alternatives characterized by:

  • Multiple attributes
  • Different levels

Benefits:

  • Richer preference information
  • Explicit valuation of attributes

Advantages

  • More information per respondent
  • Attribute-level valuation
  • Flexible policy analysis
  • Closer connection to random utility theory

Terminology

Key Takeaways

Summary

  • Economic valuation supports environmental decision making.
  • Value is based on welfare and preferences.
  • Total economic value includes use and non-use components.
  • Many environmental goods lack market prices.
  • RP and SP methods provide complementary approaches.
  • DCEs emerged as a powerful stated-preference method.