Valuing the Environment: Exploring Valuation Techniques and Methods

This report delves into the critical concept of environmental valuation, which involves assigning monetary values to environmental goods, services, and natural resources to inform decision-making regarding their wise use and conservation. It begins by explaining the rationale behind environmental valuation, emphasizing its role in cost-benefit analysis, particularly in scenarios like dam construction, where economic and environmental considerations intersect. The report then categorizes the types of value, differentiating between use values (consumptive and non-consumptive) and non-use values (existence, option, quasi-option, bequest, and vicarious values). Furthermore, it explores various environmental valuation techniques, including market-based methods (direct market prices, market prices of alternatives or substitutes) and non-market valuation methods (indirect methods like the travel cost method and hedonic pricing, and direct methods like contingent valuation). The report provides detailed explanations of each method, their applications, advantages, and limitations, with examples and case studies to illustrate the concepts. Finally, the report discusses the hedonic pricing method, explaining its application in valuing environmental attributes like clean air, and its use in statistical analysis to determine the implicit price of such attributes.

Valuing the Environment

Why Value the Environment
• Valuation can simply be defined “as an attempt to put monetary values or to
environmental goods and services or natural resources”.
• It is a key exercise in economic analysis and its results provide important
information about values of environmental goods and services.
• This information can be used to influence decisions about wise use and
conservation of forests and other ecosystems.
• The basic aim of valuation is to determine people’s preferences by gauging how
much they are willing to pay (WTP) for given benefits or certain environmental
attributes e.g. keep a forest ecosystem intact.
• In other words, valuation also tries to gauge how much worse off they would
consider themselves to be as a result of changes in the state of the environment
such as degradation of a forest.

Why Value the Environment (Cont……)
• The policy relevance of valuation information is extensive, but might include:
– • demonstrating the value of biodiversity: awareness raising;
– • land use decisions: for conservation or other uses;
– • setting priorities for biodiversity conservation (within a limited budget);
– • limiting biodiversity attacks;
– • assessing biodiversity impacts of non-biodiversity investments;
– • determining damages for loss of biodiversity: liability regimes;
– • limiting or banning trade in endangered species;
– • choosing economic instruments for saving biodiversity (e.g. taxes, subsidies).

Why Value the Environment (Cont……)
• Why Cost-Benefit Analysis?
In some cases, however, governments must make specific decisions that have both
economic and environmental implications.
In such cases, decision makers use Cost-Benefit Analysis (CBA) to balance the
positive and the negative consequences of a proposed action
(Ex. construction of large Dam).

Why Value the Environment (Cont……)
CostBenefit
Farmland and wildlife habitat will be
flooded
Hydro.electric Power
Communities will have to relocateA Stable water supply for irrigation
Certain fish species may become
extinct
Flood control
Reduce scenic whitewater rafting and
hiking
Create new recreational opportunities
for lake boating and fishing
Othersothers
CBA for An Dam Construction

Why Value the Environment (Cont……)
How can we evaluate whether or not to
build the dam?
How can we put a dollar value on the
social and ecological losses that will
result?

Estimating Value
For Dam Construction Case
Economists use various techniques to estimate
different kinds of values.

Types of value

Types of Value (Cont…..)
The term value is used in many ways in studies
on the economic valuation of goods and
services, including use values and non-use
values.
It is important to clarify the meanings of the
different types of values, as the term can have
distinct meanings. The working definitions and
discussions of non-market values.

Use values
Use value refers to the benefit a user obtains, either
directly or indirectly, from participating in an activity.
Consumptive use can be described as participation in
activities that utilize and possibly deplete the forest
resources (e.g. hunting, fishing and tree cutting); while
non-consumptive uses are those uses or activities that
do not affect the resource (e.g. bird-watching in a
national park, appreciating a view at a look-out).

Non-use values
Non-use values do not involve any actual
physical consumption of the forest goods and
services.
Examples of non-use values include increases in
productivity, wellbeing, health, longevity (long
life), and feelings of peace and a decrease in
stress levels.
They are further classified as existence, option,
quasi-option, bequest and vicarious values

Existence values are those benefits that are
derived from the knowledge that non-timber
amenities and resources will continue to
exist regardless of the fact that the amenity
or the resource may never be used, seen or
visited.

Option value relates to the willingness to
pay for an option to have the resources
or services available in future when there
is uncertainty attached to its supply.

Quasi option value quasi-option value (QOV)
relates to willingness to pay to avoid an
irreversible commitment to development now,
given the expectation of future growth in
knowledge relevant to the implications of
development.

Bequest value is the value assigned
to preserving a resource for use by
future generations.
In a forestry context, a bequest value
could occur if an individual is willing
and able to pay for the preservation
of a forest resource so that his
children and grandchildren find the
resource in an intact state

Vicarious value deals with the value placed on a
resource that may have never been used or
planned to be used, but
benefit may be derived from mere pictures,
descriptions and other representations of the
resource.
Vicarious values may include the information
that certain rare species of animals like spotted
owls etc.

Figure: presents an example of the total economic value of a tropical forest.
Non-use values
Non-use values
Use values
Use values
Use values

Environmental valuation techniques
• Market-based methods
a) Direct market prices
b) Market prices of alternatives or substitutes
• Non-market valuation methods
– (A) INDIRECT METHODS
• The travel cost method
• Hedonic pricing
– (B) DIRECT METHODS
• Contingent valuation
• There are others; we will not consider them.

Market-price based approaches
• Market prices are the result of interaction between consumers and producers
with regards to the demand and supply of goods and services.
• If this transaction is carried out using currency, the value established within the
market is the market price.
• The market price method estimates the economic value of ecosystem products or
services that are bought and sold in commercial markets.
• When services are directly tradable in normal markets, the price represents the
exchange value.
• The market price method can be used to value changes in either the quantity or
quality of a good or service.

Market-price based approaches (Cont…….)
• It uses standard economic techniques for measuring the economic benefits from
marketed goods, based on the quantity people purchase at different prices, and
the quantity supplied at different prices.
• Application of the market price method requires data to estimate consumer
surplus and producer surplus.
• To estimate consumer surplus, the demand function must be estimated.
• This requires time series data on the quantity demanded at different prices, plus
data on other factors that might affect demand, such as income or other
demographic data.
• To estimate producer surplus, data on variable costs of production and revenues
received from the good are required.

a) Direct market prices
• The most simple and straightforward way of finding out the value of
environmental resources is to look at their market prices – what they cost to buy
or are worth to sell.
• Market prices reflect what people are willing to pay for them – the value that they
place on them.
• All the costs and benefits associated with a proposed or alternative use option
can be determined by the prices that are paid, assuming there are no market
distortions.
• However, it is often difficult to apply to environmental resources since many
environmental goods have no market at all (e.g. those used for subsistence
purposes).

a) Direct market prices (Cont…..)
• Further, it is not always true that market prices reflect economic scarcity and,
therefore, are economic efficient prices.
• Market prices can be distorted because of taxes, subsidies, monopolies, exchange
rates or other interventions so they do not reflect the true value of product.
• Table 3 below shows an example of calculating the gross value of crop production
in Nakivubo Wetland, Uganda, using Market prices.

a) Direct market prices (Cont…..)

b) Prices of alternative goods or substitutes
• Where environmental resources have no direct market themselves, they often
have close substitutes, which can be bought and sold.
• The prices of these substitute goods represent what it would cost to buy the next
best alternative if environmental resources were not available.
• They can be used as proxy/ shadow prices for the value of environmental
resources because they reflect the amount of money that they are worth in terms
of expenditures saved.
• Thus, substitute prices estimate implicit values for environmental goods and
services by means of the price paid for another good or service which is
marketed.
• This technique uses an actual market price to value a non-marketed quality of
the environment, e.g. medicinal plants extracted by local communities from a
forest.

b) Prices of alternative goods or substitutes (Cont…...)

Advantages and limitations of the market price methods
• The market price method uses observed data of actual consumer
preferences.
•
• The method uses standard, accepted economic techniques.
• However, market data may only be available for a limited number
of goods and services provided by an ecological resource and may
not reflect the value of all productive uses of a resource- does not
measure TEV.
• Further, the true economic value of goods or services may not be
fully reflected in market transactions, due to market imperfections
and/or policy failures.

Hedonic Pricing Method
• The technique of hedonic pricing was developed by Griliches (1971) and Rosen
(1974).
• It consists of a method of estimating implicit prices of characteristics which
differentiate closely related products.
• HP of unmarketed environmental services are based on the following principle.
• Suppose that an environmental resource that you wish to value is not itself traded
in any market, possibly because the resource is a public good.
• As a result, no market price exist which can reveal preferences or willingness to
pay for the resource.
• Suppose also that the resource can be defined in terms of service it yields or an
attribute it embodies.

Hedonic Pricing Method (Cont…...)
• This attribute may however be embodied in other goods or assets which are
marketed , and which do have observable prices.
• In such circumstances, statistical techniques may be enable the investigator to
identify the contribution which the attribute in question makes to the price to the
traded goods.
• We could then identify the implicit or shadow price for the attribute of interest
and regard this as an estimate of the value of environmental resource.
• In what circumstances might such a valuation route be possible and appropriate?
• One example might be the value of clean air (or conversely the cost of
atmospheric pollution).
• Whilst clean air is not a traded good, it is an attribute which seems to influence
residential property prices.

Hedonic Pricing Method (Cont…...)
• Evidence from reveal preference suggests that, other things being equal, a
positive relationship exists between the prices that people are willing to pay for
housing and the quality of ambient air standard.
• Examination of property prices might therefore enable one to impute the value of
clean air.
• Let us look at this technique in the case of estimating the willingness to pay for
the clean air.

Hedonic Pricing Method (Cont…...)
• Suppose,
• X = An index of the level of air pollution and
• R = The rent that an individual is willing to pay for housing services.
• R is a decreasing function of the leve of air pollution. That is
• R = R(X), R/(X) < 0
• One possible form of this rent-pollution function is illustrated in figure 10.9.
• How could one obtained an estimate of such a rent function?
• Assume that data can be collected from housing rents, air quality and a set of
attributes which influence housing rents, such as house size, amenities, proximity
to employment and neighbourhood characteristics.
• A representative sample of properties should be drawn in such a way that
properties in the sample are chosen from a variety of locations with differing level
of ambient air quality.

Hedonic Pricing Method (Cont…...)

Hedonic Pricing Method (Cont…...)
• Multiple regression analysis can be used to estimate the relationship between
rents and air pollution, holding all other determinants of house rents are constant
values.
• The outcome of such an empirical exercise will be a rent pollution function.
• The hedonic price technique uses information derived from this function to
estimate the value of environmental improvements.
• Explanation of figure 10.9.

Hedonic Pricing Method (Cont…...)
• The implicit or shadow price of a unit of pollution is then the rate of change of
R(X) with respect to X, which we shall denote as r(X).
• Note that if the rent-pollution function is non-linear(as in figure 10.9) then the
shadow price of pollution r(X) will vary with the level of pollution.
• Information derived from the estimated rent function will not provide the
researcher with an exact measure of the true welfare changes arising from air
quality improvements.
• The HPT will often require that a second step be carried out.
• We will usually be interested in obtaining an aggregate WTP for some population
of individuals.
• This population is likely to comprise distinct subsets of individuals, living in
different localities, and varying in terms of factors such as income and age.

Hedonic Pricing Method (Cont…...)
• The WTP for an environmental improvement will vary with these characteristics.
• Ideally, the researcher should estimate separate demand curves for the
environmental improvement for each of these population subsets.
• This can be done by a second stage regression technique.
• An inverse demand curve is estimated in which the implicit price, r, that people in
a particular area are willing to pay for environmental improvements (obtained
from the first stage) is related to average characteristics such as age and income
for that area.
• So suppose that we have N different area, each one of which is indexed by the
subscript i.

Hedonic Pricing Method (Cont…...)
• We might estimate a model of the form
• ri = ri (Xi, Yi, AGEi, Zi) + ui i = 1, ……………, N
• In which Z denotes a vector of other variables that are thought to be relevant in
explaining differences in WTP from one area to another.
• If estimates of such an equation can be obtained, then it will possible to obtain
estimates of the total WTP for an environmental improvement by a
representative citizen of each area, and then to aggregate overall areas and
persons to infer the required total WTP.

Problems with and limitations of the HPT
• 1. It is only capable of measuring that subset of use values for which people are
willing to pay and actually do so through the related market.
• It has to be recognised from the outset, therefore, that hedonic pricing can only
provide us with estimate of some subset of the values in which we might be
interested.
• Furthermore, if we have reason to believe that consumers are not fully informed
about the qualities of the attributes being valued, hedonic price estimates are of
little relevance.
• 2. The hedonic price equation (and the second step demand equation, if this is
estimated) will, in most cases, impose rather strong assumptions about
separability of consumers utility function.

Problems with and limitations of the HPT
• In particular, the functional forms of regression model that are usually chosen
impose weak separability, permitting rent-pollution and demand equations for
other goods consumer purchase.
• Standard consumer demand theory and research evidence from applied studies
of consumer demand cast doubt upon the validity of weak separability,
particularly when large changes occur, as is often the case when we are dealing
with environmental projects.
• 3. Econometric pitfalls – small sample size, uncertainty with choice of relevant
variables, sample selection bias and the choices of functional form.
• If the selected regression model is not statistically well-specified , the estimator
obtained should not be regarded as valid one.

The Travel Cost Method (TCM)
• A common method of imputing the values associated with non-marketed
recreational or cultural facilities has been through the use of observed travel
costs.
• These techniques have been widely used in Europe, North America and Australia
and are finding application in developing countries in the estimation of the values
of game reserves and tourism development.
• The technique seems to have been first proposed by Hotelling (1931) and
subsequently developed by Clawson (1959) and Clawson and Knetsch (1966).
• Visitors to outdoor recreational facilities, nature reserves and so on usually incur
costs, in terms of time and money, in travelling to such sites.

The Travel Cost Method (Cont….)
• Knowledge on these expenditures can be used to infer the values placed by
visitors on environmental resources.
• Suppose we consider a particular geographical area, which contains just one
wildlife reserve.
• Our objective is to estimate the (use) value of this reserve. The location of the site
in the area we study is represented in Figure 10.10.
• Let ZA and ZB denote the number of visits per period to the site from zones A and
B respectively, each expressed as a proportion of the population of the zone in
question.
• Let the average travel costs per trip for each visitor from zone zone A be PA and
from zone B be PB.
• These travel cost should include all relevant costs, including the costs of time
spent and marginal disutility of travel itself (if any).

The Travel Cost Method (Cont….)

The Travel Cost Method (Cont….)
• This information is portrayed in figure 10.11.
• Here the objective is to show that this relationship between travel cost and
frequency of visit can be interpreted as a demand curve for the wildlife reserve
and that it can be used to estimate the WTP for this reserve.
• Here WTP denote the total or gross value of a consumer drives from a resource
to which he/she travels.
• The term consumer surplus will be used to refer to the excess of this WTP over
the total travel costs of reaching the site.
• So consumer surplus is the net value of the resource, and will be lower than WTP
by the amount of travel costs

Figure 10.11: Travel Costs and Visit Frequency

The Travel Cost Method (Cont….)
• Explanation of the Figure 10.11

The Travel Cost Method (Cont….)
• How do we find the total WTP for all visitors to the site?
• This involves two steps:
• Firstly, multiplying the WTP for each visitors from zone A gives the total WTP for
visitors from zone A.
• Then repeating this process for each zone, and then summing over all zones, we
obtain an aggregate WTP for the site. More formally, the aggregate consumer’s
surplus is given by
• Where Z = Z(P) is the function relating visitor frequency (Z) – total number of
visitors divided by population – to average total cost (P)
• N is the total number of distinct zones of origin of visitors, ni is the population of
zone I, P0 is the average travel cost for the average visitor from the zone at which
the visit rate falls to zero.

The Travel Cost Method (Cont….)
• This technique can also be used to estimate the increment in the value that would
result from improvements in the environmental quality of the site.
• Freeman (1979), for example, analysis the effects on the demand for recreation of
a change in water quality.
• The technique involves augmenting the travel cost visit function with a variable
that represents water quality.
• This allows the researcher to identify the on the demand for some given resource
site of an improvement in water quality.
• This is illustrated in Figure 10.12

Figure 10.12 An improvement in site quality

The Travel Cost Method (Cont….)
• Explanation of the Figure 10.12

Limitation of the Travel Cost Techniques
• Travel cost techniques can only provide as with estimates of some of the values in
which we might be interested.
• The approach is very useful for valuating resource based recreational amenities,
where it has been very widely applied but it has found very few applications
outside this particular area.
• A number of methodological issues warrant attention.
• Our presentation of the travel cost technique has modelled the visit frequency to
a single site as a function only of the travel costs to that site alone.
• We would expect that many factors influence the frequency of visits to any given
site.

Limitation of the Travel Cost Method (Cont….)
• So more generally, if there are n distinct sites available to visit, the frequency of
visit to site j might be modelled as
• Zj = Zj (Pi,….., Pn,  ), j = 1, …….., n
• Where P1 to Pn are a set of travel costs to the jth and all other sites, and  denote
a vector of other explanatory variables, such as income levels, social class, taste
and so on.
• The total procedure is very data demanding and statistically difficult and is rarely
undertaken.
• An empirical question concern the value which should be assigned to the time
costs of travel.
• It is common in empirical work to use some proportion of average wage rates as
a proxy for travel time costs

Limitation of the Travel Cost Method (Cont….)
• This procedure is open to much criticism.
• It is usual practice of assuming that travel time incurs negative utility is
questionable, particularly when travel is time itself pleasurable.
• Double counting occur in travel cost studies.
• When a new site is developed, the net addition to welfare will only be equal to
the welfare gained from the new site if existing site has zero substitutability for
the new one.
• There are also problems associated with sample-selection bias.

Contingent Valuation
• Contingent Valuation:
a. It relies on surveys to estimate individual (and aggregate) WTP to
preserve the environment, etc.
i. Willingness to Pay to preserve the environment, or for a program.
ii. Willingness to Accept for environmental damage.
• Methods of survey administration:
i. in person (preferred)
ii. telephone
iii. mail
iv. combination of above
• Types of CV
i. open ended: how much would you be willing to pay to do …
ii. closed ended: are you willing to pay $X to do …

Elements of a CV questionnaire
• Elements of a CV questionnaire
•
i. Careful description of goods to be valued:
· What would you pay for environmental safety?
· What would you pay for increased visibility?
•
ii. description of the payment method
· nature of payment (utility bill, tax increase, etc.)
· frequency of payment (lump sum, monthly, etc.)
· where payment goes
•
iii. Method of converting individual payments to overall WTP·
· relevant population
· socioeconomic characteristics of respondents

potential problems of CV
• Some potential problems of CV
1. Strategic Bias: Strategic bias arises when the respondents provide a biased answer
in order to influence a particular outcome.
2. Hypothetical Bias: Hypothetical bias may arise because the respondent is being
confronted by a contrived, rather than actual, set of choices.
· Example: “How much would you be willing to pay to eliminate all air pollution in
the Dhaka?”
or
“How much would you be willing to pay to guarantee the preservation of all
species.”
3. Information Bias: Information bias may arise whenever respondents are forced to
value attributes with which they have little or no experience.
· Example: "How much would you be willing to pay to avoid electricity outages
once a week for 4 hours each time?“
4. Starting Point Bias: Starting point bias may arise in those survey instruments in
which the respondent is asked to check off his or her answer from a predefined
range of possibilities.

Other potential problems
Other potential problems:
• Situational Effects: Customer responses to surveys may depend upon
the customer's situation or recent experiences.
• Sampling Bias: What sample to choose when you conduct the
survey?
• Non-response Bias