Chapter 7 Assessing Benefits for Environmental Decision Making

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

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 2

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 3

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 4

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. 5

Modeling Incremental Benefits (MSB) • Find baseline TSB before policy • Find new TSB after policy is implemented • Subtract baseline TSB from new TSB MSB ($millions) 25 Incremental Benefits = $91. 25 million 19. 0 17. 5 MSB = 25 - 0. 3 A D = MSB 0 20 25 A (abatement %) 6

Modeling Incremental Benefits (TSB) TSB = 25 A - 0. 15 A 2 TSB ($millions) 531. 25 440. 0 Incremental Benefits = $91. 25 million TSB 0 20 25 A (abatement %) 7

Valuing Environmental Quality Two Sources of Value • __________________ – (1) User value is 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 value is the benefit received from the continuance of an environmental good 8

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. 9

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 actual markets or survey responses about hypothetical markets 10

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 11

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 12

Damage Function Model Page 156 Total damages (TD) Damage reduction in nonmonetary terms TD 0 Damage function TD 1 0 Suppose policy causes a decline in the contaminant from C 0 to C 1 C 0 Contaminant (C) 13

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 14

Example FYI • 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: (consumer surplus + producer surplus) 15

Page 157 Incremental Benefits $ S 0 a P 0 P 1 FYI Incremental benefit = ebc S 1 b c e D 0 Q 1 Q of corn 16

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 17

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 18

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. 19

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 – MC 0 of X 0 is linked to a given level of E 0 – As the overall environment improves, or as E increases from say, E 0 to E 1, the individual incurs lower costs, so MC shifts right from MC 0 to MC 1 and X 0 improves to X 1 • Change in spending for the same level of X is an estimate of incremental benefits 20

Modeling AEM FYI abc is WTP for improvement $ in E based on achieving X 1 MC 0 (based on E 0) E rises to E 1 b c MC 1 (based on E 1) d a D = MB 0 X 1 Personal environmental quality (X) 21

Modeling AEM FYI abd is WTP for improvement in E based on achieving X 0 (acts as a lower bound) $ MC 0 (based on E 0) b c MC 1 (based on E 1) d a D = MB 0 X 1 Personal environmental quality (X) 22

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 23

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 24

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. 25

Page 164 Modeling TCM Price (P) of admission Market is recreational services of lake Original CS = ab. P 0 New CS = cd. P 0 c a CS = abcd Policy improves lake’s quality so D increases P 0 b 0 d Price line D 0 V 1 D 1 Number of Visits (V) 26

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. 27

7. Hedonic Price Method (HPM) Relating to pleasure/environmental amenity • Uses estimated _______, or implicit, price of an environmental attribute to value a policy-driven improvement – e. g. , PHOUSE = f(X 1, X 2, …. 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 28

• 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. 29

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