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ECON 4910, L5. Slide 1/ 13
Environmental Economics – Lecture 5
Valuation
Florian K. Diekert February 26, 2015
Perman et al (2011) ch. 11-13
ECON 4910, L5. Slide 2/ 13
Preview lecture 5
1. Theory
I Categories of environmental benefitsI WTP and WTA
2. PracticeI Stated preference methods
I The method of “contingent valuation” (CV)I Discussion: (http:
//www.aeaweb.org/articles.php?doi=10.1257/jep.26.4)
I Revealed preferences
I Travel cost methodI Hedonic pricingI Production function based techniques
ECON 4910, L5. Slide 3/ 13
Valuation: Theory
ECON 4910, L5. Slide 4/ 13
Categories of environmental benefits
In the old edition of the Perman book (2003), there were a lot ofacronyms, summarized in two equations:
EC = UV + EV + OV + QOV
TV = CUV + NCUV + NUV
ECON 4910, L5. Slide 5/ 13
Willingness-to-pay & willingness-to-acceptEnvironmental valuation theory 1
Assume that quantity/quality of environmental good e can be treated as an argument in a well-behaved utility function. The individual cannot choose level of e. y is income.
u = u(y, e)
e0 e1
At A, WTP for e improvement = BC is Compensating Surplus, CS
At A, WTA in lieu of e improvement = DA is Equivalent Surplus, ES
e1 e0
At B, WTP to avoid deterioration = BC is Equivalent Surplus, ES
At B, WTA compensation for deterioration = DA, Compensating Surplus, CS
Figure: Slide taken from Perman’s webpage http://personal.strath.ac.uk/r.perman/ppts.htm
ECON 4910, L5. Slide 6/ 13
Willingness-to-pay & willingness-to-accept
ECON 4910, L5. Slide 7/ 13
Compensating and Equivalent variaton
I Compensating variation is the change in income that wouldcompensate for the price change
I Equivalent variation is the change in income that would beequivalent to the price change
Two necessary conditions for environmental quality changes to beapproximately identified by price changes in demand functions:
I Non-essentialness
I Weak complementarity
ECON 4910, L5. Slide 7/ 13
Compensating and Equivalent variaton
I Compensating variation is the change in income that wouldcompensate for the price change
I Equivalent variation is the change in income that would beequivalent to the price change
Two necessary conditions for environmental quality changes to beapproximately identified by price changes in demand functions:
I Non-essentialness
I Weak complementarity
ECON 4910, L5. Slide 8/ 13
Valuation: Practice
ECON 4910, L5. Slide 9/ 13
Stated preference methods: Contingent Valuation
Excerpt of NOAA-panel recommendation:
I Sample from entire affected population
I Personal interview
I Pre-testing
I Referendum format
I WTP instead of WTA
I Reminder of undamaged substitutes
I ‘No-answer’ option available
ECON 4910, L5. Slide 10/ 13
Contingent Valuation: Discussion
ECON 4910, L5. Slide 11/ 13
Revealed preference methods
1. Travel cost method
2. Hedonic pricing
3. Production function based techniques
ECON 4910, L5. Slide 11/ 13
Revealed preference methods
1. Travel cost method
2. Hedonic pricing
3. Production function based techniques
ECON 4910, L5. Slide 11/ 13
Revealed preference methods
1. Travel cost method
2. Hedonic pricing
3. Production function based techniques
ECON 4910, L5. Slide 12/ 13
Review lecture 5
1. TheoryI Categories of environmental benefitsI WTP and WTA
2. Practice
I Stated preference methods (in part. “contingent valuation”)I Revealed preferences: Travel cost method, Hedonic pricing,
Production function based techniques
ECON 4910, L5. Slide 13/ 13
Preview next lecture
1. A heuristic definition of cost-benefit analysis
2. Detour: The moral of choosing A over B
3. Cost-benefit analysis in a static and certain world
I Tests for marginal and non-marginal projects
I CBA and social welfare functions
4. Dynamic aspects
5. Accounting for uncertainty, risk, and irreversibility