Assessing Benefits for Environmental Decision Making

1. Assessing Benefits for Environmental Decision Making Chapter 7 Benefit-cost analysis is a risk management strategy; it guides environmental decisions.

2. 1. Environmental Benefits: Conceptual Issues • Environmental benefits measure damage reductions • Policy brings about changes in these damage reductions, and these changes are referred to as __________________–the reduction in health, ecological, and property damages associated with an environmental policy initiative

3. Types of Incremental Benefits • Primary environmental benefits • Damage-reducing effects, a direct consequence of implementing environmental policy • Secondary environmental benefits • Indirect gains to society, may arise from a stimulative effect of primary benefits

4. Assign Value to Incremental Benefits • Environmental quality is a public, ____________ good: its D cannot be identified • But if we could infer society’s D (or MSB) for environmental quality, we could measure incremental benefits as follows: • Area under MSB is TSB • Changes in TSB: incremental benefits

5. Most environmental goods/services, such as clean air and water, and healthy fish and wildlife populations, are not traded in markets. Their economic value—how much people would be willing to pay for them—is not revealed in market. To assign monetary values to them, we use non-market valuation methods.

6. Incremental Benefits = $91.25 million Modeling Incremental Benefits (MSB) • Find baseline TSB before policy • Find new TSB after policy is implemented • Subtract baseline TSB from new TSB 25 19.0 17.5 MSB ($millions) MSB = 25 - 0.3A D = MSB 0 20 25 A (abatement %)

7. Incremental Benefits = $91.25 million Modeling Incremental Benefits (TSB) TSB 531.25 440.0 TSB = 25A - 0.15A2 TSB ($millions) 0 20 25 A (abatement %)

8. Valuing Environmental QualityTwo Sources of Value • ____________________________________ • (1) User valueis the benefit derived from physical use or access to an environmental good • Direct user value— the benefit derived from directly consuming services provided by an environmental good • Indirect user value—the benefit derived from indirect consumption of an environmental good • (2) Existence valueis the benefit received from the continuance of an environmental good

9. Existence value: a New Jersey resident who has never seen the Grand Canyon and who never intends to visit it can derive satisfaction simply from knowing it exists. Society derives utility from environmental quality through two sources of value.

10. 2. Approaches to Measuring Benefits • Physical linkage approach • Estimates benefits based upon a ________ relationship between environmental resource and user of resource • Behavioral linkage approach • Estimates benefits using observations of___________ in actualmarkets or survey responses about hypothetical markets

11. Overview (see Table 7.2 on page 154) • Physical Linkage • Damage Function Method • Behavioral Linkage • Direct Methods • Political Referendum Method • Contingent Valuation Method • Indirect Methods • Averting Expenditure Method • Travel Cost Method • Hedonic Price Method

12. 3. Damage Function Method • Specifies a relationship between a contaminant (C) and some observed total damage (TD) • Estimates benefits as TD declines from the policy-induced change in C • Note: ______________ function is one type of damage function

13. Damage reduction in nonmonetary terms Damage Function Model Page 156 TD0 Damage function TD1 Suppose policy causes a decline in the contaminant from C0 to C1 Total damages (TD) 0 C1 C0 Contaminant (C)

14. Assessing the Damage Function Method • Estimates only one type of incremental benefit at a time • Represents only a first step, since it is not capable of simultaneously monetizing the damage reduction that it identifies

15. FYI Example • Suppose a U.S. policy reduces pollution damage to crops, resulting in a higher crop yield as an incremental benefit • Model as an increase in supply (S) • Measure the incremental benefit as: D(consumer surplus + producer surplus)

16. Incremental benefit = ebc FYI Page 157 Incremental Benefits $ S0 a S1 b P0 c P1 e D Q of corn 0 Q0 Q1

17. 4. Contingent Valuation Method (CVM) • Estimates benefits from survey responses about WTP for environmental quality ____________ upon hypothetical market • Steps: • Construct model of hypothetical market • Design survey • Assess honesty of respondents

18. Assessing the CVM • Broad applicability: it can be applied to a variety of environmental goods • Can capture existence as well as user value • Inherent biases due to survey approach --How to improve survey? Use photographs/maps to more accurately depict the environmental good; and avoid technical jargon

19. 5. Averting Expenditure Method (AEM) • Estimates benefits as the ________________ __________on goods that are substitutes for a cleaner environment • As pollution damages the environment, people incur “averting” expenditures to improve their personal environment • This spending is reduced as policy improves the overall environment • This spending reduction is an estimate of the WTP for associated incremental benefits Application: AEM is used to estimate environmental benefits in the areas of urban smog and drinking water.

20. Modeling AEM FYI • Define overall environmental quality (E) • The relevant market for study is personal environmental quality (X) • D is MB; S is MC or averting expenditures • MC0 of X0 is linked to a given level of E0 • As the overall environment improves, or as E increases from say, E0 to E1, the individual incurs lower costs, so MC shifts right from MC0 to MC1 andX0 improves to X1 • Change in spending for the same level of X isan estimate of incremental benefits

21. Modeling AEM E rises to E1 FYI abc is WTP for improvement in E based on achieving X1 $ MC0 (based on E0) b MC1 (based on E1) c d a D = MB 0 X0 X1 Personal environmental quality (X)

22. Modeling AEM FYI abd is WTP for improvement in E based on achieving X0 (acts as a lower bound) $ MC0 (based on E0) b c MC1 (based on E1) d a D = MB 0 X0 X1 Personal environmental quality (X)

23. Assessing the AEM • Problem of ______________________ • Some AE yield benefits other than those from improving environmental quality • e.g., air conditioning provides comfort as well as filters the air • Hence, the benefit estimate can be biased

24. 6. Travel Cost Method • Estimates benefits as an increase in __________ ___________ in the market for the recreational use of the environment, as policy improves the environmental quality • As policy improves the environment, the D for recreational use of the environment increases, causing an increase in CS • This CS increase is the benefit estimate

25. We use travel costs to a recreational site to estimate recreational demand. People make expenditures in the form of travel cost and time in order to consume recreational services. We don’t know how much people pay for environmental quality, but we know how much they pay for traveling to a lake.

26. CS = abcd Page 164 Modeling TCMMarket is recreational services of lake Original CS = abP0 c New CS = cdP0 a Price (P) of admission Policy improves lake’s quality so D increases d Price line P0 b D1 D0 0 V0 V1 Number of Visits (V)

27. Assessing the TCM • Estimates only user value • Addresses only recreational use (not useful for estimating commercial benefits) Application: TCM is used to value improvements to water bodies used mainly for recreation.

28. 7. Hedonic Price Method (HPM) Relating to pleasure/environmental amenity • Uses estimated _______,orimplicit,price of an environmental attribute to value a policy-driven improvement • e.g., PHOUSE = f(X1, X2, ….Xn, E), where: • each Xi is an attribute of the house, and E is the environmental quality in the area • Hedonics uses regression analysis, which provides estimates of the prices of the individual attributes, including E

29. This price could be used to estimate the D for environmental quality, which in turn could be used to measure the incremental benefit of improving that quality • Recall that incremental benefit can be measured as an area under the D curve The most common example of the HPM is in the housing market: the price of a property is determined by the characteristics of the house (size, features, condition) as well as the characteristics of the surrounding neighborhood (accessibility to schools, level of water and air pollution and noise…) The hedonic pricing model is used to estimate the extent to which each factor affects the price.

30. Assessing the HPM • Logical, intuitive • Difficult to employ • Requires complex empirical modeling • Requires extensive data