Chapter 8

1. Measuring the Benefits of Environmental Protection Chapter 8

2. 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

3. Use, Option, and Existence Value • The nonmarket benefits of environmental protection: • Use: value in use • Option: 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

4. 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

5. Consumer Surplus from Preservation

6. Measuring Benefits: WTP and WTA • There are two ways to determine surplus: • Willingness-to-pay (WTP) for improved quality • Willingness-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

7. Problems with WTA and WTP • WTA values are typically 2 to 7 times as high as WTP values • This difference persists even in tests specifically designed to control for inflated WTA figures

8. Problems with WTA and WTP

9. 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

10. Prospect Theory and Marginal Benefits of Cleanup

11. 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?

12. 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.

13. 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

14. Risk Comparisons: peanut butter?!

15. 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”

16. 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

17. Perceived Risk • Individuals may perceive risk differently than the actual risk for a few reasons: • Voluntary vs involuntary risk • Lack of knowledge • Distrust of Experts • People are risk averse

18. 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.

19. Why is nuclear waste at the bottom?

20. 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

21. The CV Method of Measuring Consumer Surplus

22. Sources of Error in CVs • Hypothetical Bias • Hypothetical questions  hypothetical responses • Free-riding • May lead understatement of true WTP • Strategic Bias • People might inflate their WTP to achieve greater clean-up if they believe they will not have to pay their WTP • Embedding Bias • Answers are strongly affected by the context provided about the issue at stake: MAIN PROBLEM!

23. 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 rare • CVs provide the only available means for estimating the existence value component of nonmarket benefits, so they are widely used

24. 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

25. Demand Curve Derived from Travel-Cost Data

26. 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)

27. 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

28. 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.

29. 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

30. 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

31. 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.

32. 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.

33. Problems: 1. Accurate information • Individuals might underestimate or overestimate risk of death 2. Sample selection bias • People accepting risky jobs are not likely representative of the “average” person with preference toward risk-aversion 3. Involuntary nature of risk • People may require more to accept risk imposed upon them without their consent

34. The Value of a Life • The value obtained from a hedonic regression is not the value of a specific life • We 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

35. 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 million • Pakistan: $300,000

36. 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?

37. WTA and WTP Redux Appendix 8A

38. WTA/WTP: Perfect Substitutes

39. WTA/WTP: Poor Substitutes

40. 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

41. 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