Class 6

1. Class 6 Environmental Benefit Cost Analysis Reference source (for the slides 1-18): http://www.agecon.purdue.edu/staff/shively/courses/AGEC406/index.htm

2. Correcting market failures Static efficiency is obtained when net benefits for a single period’s are maximized. If private efficiency does not equal social efficiency, then we have market failure. Intervention may be justified, and many approaches are available. What is the “best” way to correct the market failure?

3. Damages MD D Total Damage E Q of Emission Marginal damage function Dollar measure of incremental damage from pollution

4. Important cases 1. private benefits = social benefits private costs = social costs (no market failure) 2. private benefits = social benefits private costs NE social costs (positive or negative externality) 3. private benefits NE social benefits private costs = social costs (positive or negative externality)

5. PMC=SMC P* PMB=SMB Q* Q Case 1 private benefits = social benefitsprivate costs = social costs

6. PMC P* P PMB=SMB Q* Q Q Case 2 private benefits = social benefits private costs NE social costs SMC = PMC + MD MD

7. PMC=SMC P P* PMB Loss inBenefit SMB Q* Q Q Case 3 private benefits NE social benefits private costs = social costs

8. Possible interventions 1. Moral suasion 2. Government provision of goods 3. Damage prevention 4. Command and control 5. Economic Incentives

9. Deriving values for non-market goods Two conceptual approaches to valuation 1. Revealed preference 2. Stated preference

10. Revealed preference approaches Hedonic pricingprice attributed to characteristics of a good Hedonic wagesaccepted wages reflect tradeoffs such as risk and living conditions Travel costthe value of a recreation site reflects the cost people willingly pay to get to it

11. Stated preference approach Contingent valuationuse a survey to measure willingness to pay regarding actual or hypothetical changes in the environment

12. Example 1: Hedonic wage Construction work is risky, and the riskiest jobs have wage premia. What if workers are willing to accept a 1/1000 annual risk of death to take a job that pays $1200 more per year? What is the value of one “statistical life”?

13. Calculating the hedonic wage Workers are willing to accept a 1/1000 annual risk of death to take a job that pays $1200 more per year. $1,200 * 1000 = $1,200,0001000 people have a collective willingness to accept $1.2 million to be exposed to the death of one individual.

14. Example 2: Travel cost model 5 people 1 recreation site{A,B,C,D,E} B A D C E

15. Visitation data Individual Cost # visits A 0 50 B 25 45 C 50 40 D 125 25 E 250 0

16. Construct a demand curve Individual Cost # visits • E 250 E 250 0 D 125 25 C 50 40 B 25 45 A 0 50 TravelCost • D P = 250 -5Q • C B • A • 0 0 50 Number of visits

17. 250 • E P = 250 -5Q • TravelCost D • C 0 • B • A 0 25 50 Number of visits Demand curve can be used to find: 1. consumer surplus (TB) 2. impact of increased fees

19. Putting a Monetary Value on Environmental Goods • Is one value better than no value? • Is some number better than no number?

20. Example: Brasil Water Sanitation Example • A study in Brasil used a valuation approach that focused on asking people either directly what they are willing to pay, or less directly what their choices would be if they were faced with certain prices for the service in question. • The question: “if you are required to pay X, would yu connect to the new suppy or use an alternative supply?”

21. Example: Korup National Park in Cameroon • Africa’s oldest rainforest. Over 1000 species of plant, 1300 animal species (60 occur in nowhere else and 170 are currently listed as endangered). • WWF initiated a programme for conservation

22. Korup Project: Benefits and Costs • Cost of conservation Project: • Resource costs : -4475 • Foregone forest costs • Timber : -353 • Forest products : -223 Total costs: : -5051 • Benefits of Conservation Project • Direct use benefits • Use of forest products : 354 • Tourism : 680 • Indirect use benefits • Protection of fisheries : 1770 • Flood control : 265 • Soil productivity : 130 Total benefits : 3199 Net benefits: -1852 Net benefits when the discount rate is 6% : $ 319

23. Valuing Benefits for Risk Management • The difficulties in estimating physical damages • If they can be estimated, the next step is to try to place a monetary value on them. • The complexities of assigning monetary value

24. Types of Values • 1. Use value • 2. Option value • 3. Non use value Total WTP

25. Use Value: Use value reflects the willingness to pay for direct use of the environmental resource. • to use something simply requires one of the senses to be active (sight, sound, touch, taste or smell). • Hearing noise pollution, seeing a grizzly bear, eating freshly caught fish, consuming water for drinking or swimming, taking in a vista while hiking and touching your feet to the trail, smelling flowers or smelling foul air. • All of these constitute some kind of use of natural resources and the environment. Distinguishing between active use (consumptive) and passive use (nonconsumptive)

26. Option Value: Option value is the willingness to pay for the future ability to use the environment. • This is the value people place on having the option to use or ensuring something exists for potential future use. • Do you plan to go to Yellowstone National Park next summer? NO?? • Would you ever like to go? Yes?? • Place a value on the park to ensure it will still exist when one does want to go.

27. Nonuse Value: Nonuse value represents an individuals’ willingness to pay to preserve a resource that he or she will never use. • These values are often called existence values. This is a very different category of value and, of course, represents the most problematic as well as controversial to monetize. • These are less tangible values, but can be quite large.

28. Total Willingness to Pay (TWP): Total Willingness to Pay = Use Value + Option Value + Nonuse Value.

29. The Concept of Consumer Surplus • Consumer surplus: Difference between what is one willing to pay and what one actually pays. • Willingness to pay for one extra unit of pollution reduction • Divergence between willingness to pay and willingness to accept.

30. People are more willing to sacrifice to maintaion the existing quality of the environment than they are to improve environmental quality. • Prospect theory • Risk assessment and perception

31. Contingent Valuation • Asking people their WTP or WTA • Survey responses are contingent upon the questions aske • Sources of possible errors: • Potential for free riding • Strategic bias • Hypothetical nature • Embedding bias

32. “This research is designed to more closely examine some of the trade-offs between industrial development, recreation, and the environment in the Lake Powell area. In connection with these objectives, I would like to ask you a few questions to see how you feel about environmental quality and its future in this area. There are plans to construct a large electric generating plant north of Lake Powell. This plant is expected to be at least as large as the Navajo Plant on the south side of the lake. Have you noticed the Navajo Plant or its smokestacks? _____ Yes ____No CV: A Sample Survey

33. Depending on exactly where and how a new plant is constructed, it could have a significant effect on the quality of the environment. • If the plant is built near the lake, it could be visible for many miles up and down the lake. If air pollution is not strictly controlled, visibility in the area may be significantly affected. • These photographs (interviewer shows photographs) are designed to show how a new powerplant on the north side of the lake might appear.

34. Situation A shows a possible plant site but assumes that the powerplant would be built at some distant location, not visible from the lake area. • In situation B the powerplant is easily seen from the lake, but emits very little smoke; visibility is virtually unaffected. • Situation C is intended to show the situation with the greatest impact on the environment of recreationists in the area. It is easily seen from the lake, and the smoke substantially reduces visibility.

35. Vacationers, of course, spend considerable amounts of money and time and effort to equip themselves with vehicles, boats, camping, and fishing gear, and for traveling to the destination of their choice. It is reasonable to assume that the amount of money you are willing to spend for a recreational experience depends, among other things, on the quality of the experience you expect.

36. An improved experience would be expected to be of greater value to you than a degraded one. Since it does cost money to improve the environment, we would like to get an estimate of how much a better environment is worth to you.

37. First, let’s assume that visitors to the Glen Canyon National Recreation Area are to finance environmental improvements by paying an entrance fee to be admitted into the recreation area. This will be the only way to finance such improvements in the area. Let’s also assume that all visitors to the area will pay the same daily fee as you, and all the money collected will be used to finance the environmental improvements shown in the photos.

38. Would you be willing to pay a $1.00 per day fee to prevent Situation C from occurring, thus preserving Situation A? $2.00 per day? (increment by $1.00 per day until a negative response is obtained, then decrease the bid by 25 cents per day until a positive response is obtained, and record the amount.) _________$/day

39. Would you be willing to pay a $1.00 per day fee to prevent Situation B from occurring, thus preserving Situation A? (repeat bidding procedure) • (Answer only if a zero bid was recorded for either question above.) Did you bid zero because you believe that:________ the damage is not significant________ it is unfair or immoral to expect the victim of the damage to have to pay the costs of preventing the damage________ other http://web.mit.edu/urbanupgrading/urbanenvironment/tools/contingent-valuation.html

40. Travel Cost • Measure the benefits associated with recreational resources

41. Example • A site used mainly for recreational fishing is threatened by development in the surrounding area.  Pollution and other impacts from this development could destroy the fish habitat at the site, resulting in a serious decline in, or total loss of, the site’s ability to provide recreational fishing services.  • Resource agency staff want to determine the value of programs or actions to protect fish habitat at the site.

42. The first step involved with the TCM is the creation of a trip generating function. In an actual travel cost study, this stage could not take place before a certain amount of thought and research concerning the goals and form of the study, and a significant amount of data collection work.

44. Hedonic Regression • Changes in prices of related goods to infer the WTP for healthier environment.

45. Take, for example, the housing market in two cities with different levels of air quality. Demand 1 represents the dirty air city and demand 2 represents the clean air city. The price differential, dP, is the marginal willingness to pay (in higher housing prices) for the difference in air quality.

46. These price differentials can be estimated using regression methods. Imagine that you collect data on housing prices in a local market (these are recorded in the courthouse after the sale) and the characteristics of the house (square footage, lot size, etc.). You are also able to merge in other variables such as school district, local tax rates, and other “neighborhood” characteristics.