Revealed-preference methods

Outline

• Hedonic pricing method

• Travel cost method

• Davao study

Readings

• Lesser et al., pp. 276-281, 296-304

• Choe, Whittington, Lauria

Hedonic pricing method

• Measures how the characteristics of a marketed asset, including environmental attributes, affect its price

• Typically applied to housing: “hedonic property method”– Earliest application: Ridker (1967)– Has also been applied to agricultural land

• Can also be applied to wages: “hedonic wage method”– Job selection might reflect regional amenities or

occupational health risks

Common observations

• Houses near airports tend to sell for lower prices• So do houses downwind from oil refineries and

slaughterhouses• Houses with panoramic views tend to sell for

higher prices

Hence, although there are no markets for noise, smell, or view, such environmental characteristics can affect house prices

Hedonic property method:basic idea

• Housing is made up of several characteristics, including environmental quality, that determine its value

• The price of a house is the sum of the products of the implicit prices of those characteristics times the amounts of the characteristics in the house

• Statistical methods can be used to decompose house price into these implicit prices, as long as the characteristics vary within the sample of houses

Revealed preference method

• Synonym: “indirect” method• Analyze “behavioral trail” left by

individuals’ actual decisions, not what individuals say they would do (“stated preferences”) under hypothetical conditions

• Implications: cannot use revealed preference methods to value new goods, or changes outside range of current conditions

Surrogate markets

• Housing market is not really a market for houses, but rather a surrogate market for the characteristics of houses

• Similarly, demand for parks is not really demand for parks per se, but rather demand for different environmental services provided by parks (travel cost method)

Types of values that hedonic property method can estimate

• Use values

• Among non-use values, perhaps option values, but not others (e.g., existence)

Typical applications

• Ambient environmental quality: air, water, noise, odor pollution

• Proximity to noxious sites: dumps, incinerators, airports

• Natural hazards: floods, earthquakes, landslides, radon

• Proximity to desirable amenities: beaches, parks, vistas, cultural sites

Hedonic price function• Relationship between price and attributes:

PH = 0 + 1A1 + 2A2 +

PH = price of house

A1 = airport noise

A2 = size of house = error term

0, 1, 2 = coefficients

• Econometric methods (multivariate regression) can be used to estimate the coefficients

• For the linear function

PH = 0 + 1A1 + 2A2 + ,

the implicit price for amenity A1 is just the coefficient 1:

PH/A1 = 1

Example: Housing and air pollution in U.S.

Travel cost method: basic idea

• The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it

Travel cost method: basic idea

• The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it

• Visitors who live at different distances from the site thus face different implicit prices

Travel cost method: basic idea

• The “price” of using a recreation site is not only the entry fee, but also the monetary and time costs of traveling to it

• Visitors who live at different distances from the site thus face different implicit prices

• We can estimate a demand curve for the site by relating the number of visits to the total travel cost

Entry fee vs. Implicit price

• Parks often have no entry fee, or fee hasn’t varied over time or across users

• Cannot estimate a demand curve if there’s no price variation

• Analyze demand as a function of implicit price: total cost of visiting park, not just entry fee

History of TCM

• One of oldest and most frequently used valuation methods

• Concept is due to Harold Hotelling, in response to request from National Park Service in the late 1940s

• Operationalized by Marion Clawson in the 1950s

• Refined by Jack Knetsch in the 1960s

Recreational applications

• National parks and other protected areas

• Sporting sites (hunting, fishing)

• Archaeological sites

• Cultural sites (museums)

Other applications

• Collection of fuelwood

• Collection of water

In principle, can be applied to any good whose consumption involves travel-related costs

Related terminology

• Revealed preference method: TCM is a prime example of this category of valuation methods, which infer WTP or WTA from observed (not hypothetical) behavior

Related terminology

• Revealed preference method: TCM is a prime example of this category of valuation methods, which infer WTP or WTA from observed (not hypothetical) behavior

• Surrogate market method: demand for transportation services is surrogate for demand for environmental amenities at destination

Types of travel cost models

• Zonal: average data on visitors; a given site

• Individual: data on individual visitors; a given site

• Multi-site (ditto): data on individual visitors; a set of sites

• Hedonic: average or individual data on visitors; characteristics of a given site

Features that are common across TCM models

• Typically implemented using cross-sectional data

• Econometric-based

• Two-stage procedure to obtain estimates of consumer surplus

Davao study: individual TCM

1. Asked each household (i) annual number of visits it made to Times Beach before and after health advisory (Vi

0, Vi*)

2. Calculated prices of visits to Times Beach (pi) and substitute sites (sij) as sum of:

a. Roundtrip travel costs• E.g., bus fare

b. Costs of roundtrip travel time• Assumed cost per hour equaled half of hourly

wage rate

– There’s no entry fee– If there were, it should be included, too

3. Pooled data across households and estimated demand functions (“trip generating functions”) that relate annual number of visits to pi, sij, household income (yi), and other socioeconomic characteristics (hi):

Vi0 = b0

0 + b10pi + b2

0sij + b30yi + b4

0hi + i

Vi* = b0

* + b1*pi + b2

*sij + b3*yi + b4

*hi + i

– What do we expect the signs of the coefficients to be?

4. For each household, calculated difference in consumer surplus between the two demand functions

• This can be interpreted as the household’s WTP for restoring Times Beach

• Do we interpret it as compensating variation, equivalent variation, or something else?

Calculating consumer surplus

1. For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as

Vi = ci + b1pi

where ci = b0 + b2sij + b3yi + b4hi

Calculating consumer surplus

1. For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as

Vi = ci + b1pi

where ci = b0 + b2sij + b3yi + b4hi

2. Solve for pi: pi = –ci/b1 – Vi/b1 • Can interpret intercept, –ci/b1 , as choke price: price

that causes number of visits to drop to zero: Vi = 0

Calculating consumer surplus

1. For each household, plug in actual values for sij, yi, and hi and rewrite demand functions as

Vi = ci + b1pi

where ci = b0 + b2sij + b3yi + b4hi

2. Solve for pi: pi = –ci/b1 – Vi/b1 • Can interpret intercept, –ci/b1 , as choke price: price that

causes number of visits to drop to zero: Vi = 0

3. Calculate consumer surplus by applying the formula,

MCS = ½(–ci/b1 – pi)Vi

WTP: TCM vs. CVM

• TCM: 36 pesos/month

WTP: TCM vs. CVM

• TCM: 36 pesos/month• CVM (Scenario 1, mean for households that used

beach before advisory): 37 pesos/month

WTP: TCM vs. CVM

• TCM: 36 pesos/month• CVM (Scenario 1, mean for households that used

beach before advisory): 37 pesos/month• Looks good, but:

– CVM yields WTP for well-defined reference utility level ; TCM yields Marshallian WTP

– CVM measures use and non-use values; TCM measures only use values

– CVM measures WTP for cleaning up river and sea; TCM measures WTP just for Times Beach

Time costs

• Time has an opportunity cost (OC), both while traveling and while on site

• Time-related costs are often the largest portion of total travel costs

OC of time and the wage rate

• Does OC of time equal the pre-tax wage rate?

OC of time and the wage rate

• Does OC of time equal the pre-tax wage rate?– No: taxes drive a wedge between OC of time and gross

compensation

• How about post-tax wage?

OC of time and the wage rate

• Does OC of time equal the pre-tax wage rate?– No: taxes drive a wedge between OC of time and gross

compensation

• How about post-tax wage?– Overstates OC of time if work involves nonpecuniary

costs (stress)

• Is time fungible between work and travel?

OC of time and the wage rate

• Does OC of time equal the pre-tax wage rate?– No: taxes drive a wedge between OC of time and gross

compensation

• How about post-tax wage?– Overstates OC of time if work involves nonpecuniary

costs (stress)

• Is time fungible between work and travel?– Can work while traveling (laptops), or might not be

able to work if not traveling (institutional constraints)

OC of time and the wage rate

• Does OC of time equal the pre-tax wage rate?– No: taxes drive a wedge between OC of time and gross

compensation

• How about post-tax wage?– Overstates OC of time if work involves nonpecuniary costs (stress)

• Is time fungible between work and travel?– Can work while traveling (laptops), or might not be able to work if

not traveling (institutional constraints)

• People might enjoy travel itself

Usual assumption: OC of time equals 25-50% of pre-tax wage