VALUATION METHODS

Total Economic Valuation (TEV)

Economists use taxonomy of values for natural resources and the environment. Total economic value
encompasses both use value and non-use value (Figure.1). Use values not surprisingly, are those derived
from the benefits people gain from using the resource and environment. These are classified into direct
and indirect use values. Direct use values arise from the consumption of the resource, for example
firewood or recreation. Indirect use values refer to the functional or ecological service benefits generated
by the environment. People benefit from these but do not directly consume them. Values include
recreation and flood control function provided by a forest.

Fig.1. Total Economic Value

Altruistic value

Non-use values are important to people even though the resource is not directly or indirectly used. One
component is the bequest value, which is preserving the resources and the environment for future
generations. People may value being able to pass on certain natural resources or environmental function
to their children. Another component is existence value where people value just knowing that a natural
resource or environmental function exists, even though they may never see or use it. A good example is
the campaigns in the west to raise money for Black Rhino protection programmes in southern Africa.
Existence value refers to the value of knowing that something merely exists even though there may be no
desire to ever go see it, just knowing that it is there is important. An example of existence value could be
the value that an individual places on kangaroos in Australia. Lion and Tiger in India. People donate
money to save the species even though they may only see it in books or on television.

The last component, option value, cuts across both use and non-use values. This is the value of keeping
options open to generate use and non-use values in the future. A development project could destroy
unique habitat that has high potential tourism and ecological service functions (use values) that can be
passed on to future generations (non-use values). A decision to not approve the project could be based on
the option values at risk. By not proceeding with the project, society maintains the option of generating
other use and non-use values in the future. It should be noted that the values represented by use value in
the left-hand side of Figure.1 are more easily derived and tangible. Policy makers can understand the
value of forest production, or water quality. Direct use values in particular are also fairly easy to estimate.
Moving towards the right-hand side of Figure.1, values become more difficult to grasp and measure. In
theory, valuation should strive for total economic value, however in practice, economists have to settle for
a partial measure. Altruistic value is the value that an individual places on an ecosystem good or
service solely because they know that others enjoy it. Yosemite National Park could be a place of
altruistic value for someone if they valued it just because they knew that it was a favourite rock climbing
spot of many other people, and they wanted to make sure that existed for other people to get pleasure
from it.

The valuation of a natural resource or environmental service is usually based on the monetary value
individuals place on it. The maximum amount of money an individual is willing to pay for obtaining a
benefit or avoiding a loss in most situations reflects the preferences for such a benefit or loss. Preferences
are based on the values he or she attaches to the goods or services in question. The maximum willingness
to pay (WTP) can be considered therefore an expression of the individual’s values. Analogously, the
minimum Willingness to Accept (WTA) an amount of money as compensation for giving up a benefit or
for receiving a loss reflects the value of such a benefit or loss. As an example, we might be interested in
estimating the aggregate WTP of people to maintain the environmental quality and amenity benefits of
Victoria Falls in Zimbabwe. Alternatively we could estimate the WTA compensation where a
development project might compromise these values, by changing the water flow upstream or damaging
the rain forest along the fall.

When an individual buys an asset at the market price, the price paid directly reveals a lower bound of his
maximum willingness to pay. Our willingness to pay for such an asset is "at least" equal to the price paid.
For example, if we observe an individual paying 10 dollars for a kilo of sugar, this means that he or she
was willing to pay at least that much, otherwise they would not have bought it at that price. When
someone sells an asset at the market price, the amount of money received directly reveals an upper bound
for his or her minimum willingness to accept for giving up such an asset (Figure.2).
Where an asset has no market, obviously there is not a market price that reveals the lower bound of
individual’s maximum WTP and the upper bound of the minimum WTA. When evaluating WTP or WTA
for obtaining a money measure of the value individuals attach to non-marketed assets, we have to get this
information in alternative ways. These "alternative ways" are the techniques presented in the following
sections in this module.

Classification of Valuation Techniques

All valuation techniques attempt to get at WTP/WTA but some are better than others in terms of results.
A number of techniques for placing a value on non-marketed environmental goods and services are
available. A simple taxonomy is provided in Figure.2 based on whether or not a market price is available.
The complexity of the method increases as one moves to the right. The CV method, for example, is placed
at the extreme right because it is the most complex method. But, it is the only method that allows
incorporates non-use values, thus providing the closest estimate of total economic value. Were a market
price exists, this must be the basis of valuation. If markets are distorted, shadow pricing might be required
to improve the measure of value. Where no market price exists, a proxy value may be available.
Alternatively, where no proxy is available, a measure of value will have to be derived using more
complex methods.

Direct proxies:
Direct proxies to estimate value on environmental resources do not reflect the full WTP/WTA. These
methods involve cost or price information, which approximate values of environmental assets. The
advantage of using costs or market prices as proxies for WTP/WTA is that they are easily observable.
Market equilibrium prices are an acceptable base for applying these techniques if markets of the goods
and services involved are competitive and for small changes in their demand and supply. The actual costs
incurred as a result of environmental degradation can represent the minimum benefits from avoiding
environmental impacts.

Examples of direct proxies include:

• The loss of agriculture productivity from soil erosion (productivity loss);
• Medical expenditure due to air pollution (cost of illness);
• An ill person or premature death from air pollution (human capital cost);
• Averting or mitigating environmental impacts (response/preventative cost);
• Replacing environmental goods or services (replacement costs);
• An environmental aid project such as grants and donations (aid costs) ;
• The reconstruction of an environmental good (shadow project);
• Cost per unit of output (cost-effectiveness); and
• A close substitute (substitute costs).

All these proxies can be considered opportunity costs of environmental assets Furthermore, different costs
of the same impact can also value different functions of an environmental good or service. For example,
the cost of illness, human capital and productivity loss, are often complementary in that each reflects a
specific aspects of a healthy life. If all three approaches are used to value the different facets of human
health impact, one has to be cautious not to double count.

Indirect proxies: Indirect proxies for environmental goods and services are based on the observed
behaviour of individuals with respect to related markets. The Travel Cost Method (TCM) derives the
value of a recreational site from revealed information on the time and costs people spent to get there.
Hedonic prices infer the value of an environmental attribute from the price of a related market good. For
example, the noise associated with a particular residential area will be reflected in lower land and real
estate value, everything else being constant. The wage in a safe and quiet factory is expected to be lower
than in a dangerous and noisy factory producing the same quantity and quality products. The residual
value method derives the net price of a natural resource by deducting all the costs from the finished
product price. An implicit value is obtained from a reverse analysis (bottom-up analysis) similar to the
residual approach but for a project instead of a specific good or service. For example, a project to
establish sustainable forestry management for charcoal production may have a negative net present value.
The value of environmental benefits associated with the project to make the NPV positive or equal to a
desired rate is the implicit value.

While the indirect proxy methods involve more calculation they will not necessarily provide better
estimate of WTP for environmental goods and services than the direct proxies. They have the advantages
however, of relying on observed behaviour and existing market prices directly related to the
environmental attribute being valued. These valuation methods are more costly, time consuming and
require skilled analysis. Yet, if information is available and the analysis done properly, these methods
should provide a better approximation of WTP than the direct proxy approaches.
No proxies: Where no proxies are available, the Contingent Valuation Method (CVM) is the best
valuation approach. It consists of asking people directly, via a questionnaire or experimental techniques,
what they would be willing to pay for a benefit or what they would be willing to receive as compensation
for a deterioration of their environment. The questionnaire simulates a hypothetical (contingent) market of
a particular environmental good in which individuals (demand side) are asked to state their WTP/WTA
for a change (improvement or deterioration) in the provision (supply side) of the good in question. The
questionnaire has to provide the institutional context in which the good would be provided and on the
payment vehicle. CVM may apply equally to changes in public goods such as air quality, landscape or the
existence values of wildlife, as to goods and services sold to individuals, like water supply and sanitation.

It may apply to both use and non-use values which was not the case for the “proxy” techniques. A
challenge in developing countries is to modify the technique for cases where people have little income to
base a WTP question on.

Environmental impacts, welfare issues, and relevant valuation methods

ENVIRONMENTAL VALUATION METHODS

From scenic beauty and recreational opportunities to direct inputs into the production process,
environmental resources provide a complex set of values to individuals and benefits to society. Coastal
areas, for example, offer scenic panoramas and radiant sunsets. Fish and other edible sea life caught in
coastal areas provide a rich and nutritious source of food to consumers. Beaches are also excellent
recreation areas, used for relaxation, exercise, or bird watching. These are only the direct benefits. There
are also values that are not directly tied to use, such as climate modulation, physical protection, and
stewardship for future generations. All of these benefits are relevant in environmental valuation.

Use values, such as fishing and hiking, are the more direct and quantifiable category of environmental
values, but they capture only a portion of the total economic value of an environmental asset. Indirect-use
values, non-use values, and intrinsic values are also associated with preserving environmental resources.
Total economic value is represented by the following equation:

Total economic value = direct-use value + indirect-use value + non-use value + intrinsic value

Indirect-use values associated with coastal areas include biological support, physical protection, climate
modulation, and global life support. Non-use values are less direct, less tangible benefits to society and
include option and existence values. The option value is the value an individual places on the potential
future use of the resource, for example, benefits a beach would offer during future trips to the coastal area.
Existence values include bequest, stewardship, and benevolence motives. Bequest value is the satisfaction
gained through the ability to endow a natural resource on future generations. The stewardship motive is
derived from an altruistic sense of responsibility toward the preservation of the environment and a desire
to reduce environmental degradation. The benevolence motive reflects the desire to conserve an
environmental resource for potential use by others. Finally, the intrinsic value of nature reflects the belief
that all living organisms are valuable regardless of the monetary value placed on them by society.

Methods for Valuing the Environment

Environmental valuation is largely based on the assumption that individuals are willing to pay for
environmental gains and, conversely, are willing to accept compensation for some environmental losses.
The individual demonstrates preferences, which, in turn, place values on environmental resources. That
society values environmental resources is certain; monetizing the value placed on changes in
environmental assets such as coastal areas and water quality is far more complex. Environmental
economists have developed a number of market and non-market-based techniques to value the
environment. Figure 1 presents some of these techniques and classifies them according to the basis of the
monetary valuation, either market-based, surrogate market, or non-market-based.
Figure 1. Environmental Valuation Methods

I. MARKET PRICE METHOD

Market-Based Methods Economists generally prefer to rely on direct, observable market interactions to
place monetary values on goods and services. Markets enable economists to measure an individual's
willingness to pay to acquire or preserve environmental services. In turn, consumers reveal their
preferences through the choices they make in allocating scarce resources among competing alternatives.
There are a number of market-based methods of environmental valuation. This section identifies and
discusses three market-based techniques: a) factor of production approach, b) change in
producer/consumer surplus, and c) examination of defensive expenditures.

[Link] of production

The value of a natural resource can be monetized based on its value as a factor of production. An
Economic View of the Environment notes that the output of any firm is a function of several important
inputs (e.g., land, labour, capital, natural resources), which are collectively known as "factors of
production." In their role as factors of production, raw materials and environmental inputs are used in the
production of other goods. When a natural resource has direct value as a factor of production and the
impact of environmental degradation on future output of that resource can be accurately measured, the
resultant monetary value of the decline in production or higher cost of production can be measured. For
example, a decline in water quality could have a direct and detrimental impact on the productivity and
health of shellfish beds. This technique is methodologically straightforward; however, it is limited to
those resources that are used in the production process of goods and services sold in markets. Because
many goods and services produced by the environment are not sold in markets, the factor of production
method generally fails to capture the total value of the resource to society.

[Link] in producer/consumer surplus

The standard method used to measure the net economic benefit of a good or service in a market involves
an examination of consumer and producer surplus. As noted in An Economic View of the Environment,
consumer surplus is the difference between what each customer is willing to pay and the price of the good
or service and is represented by the area falling above the price line and below the demand curve.
Consumer surplus. Producer surplus is the difference between what a producer is paid with for a good or
service and what it costs to supply. The total economic benefit of a sale is the sum of the consumer and
producer surplus.

c. Defensive expenditure

A final market-based valuation method is that of defensive expenditures, which are made on the part of
industry and the public either to prevent or counteract the adverse effects of pollution (Feather 1995) or
other environmental stressors. The defensive expenditures method, also known as the averting behavior
approach, monetizes an environmental externality by measuring the resources expended to avoid its
negative impacts on a surrounding community. Types of defensive expenditures include water
purification devices, beach nourishment, and replanting sea grasses.

Productivity Method The productivity method measures the contribution that a non-market ecosystem
service has on a marketed commodity. This method is most useful in cases where a resource is a perfect
substitute for another input for production and in cases where the producers are the only ones to benefit
from changes in quantity or quality of the resource, and consumers are not affected
([Link], 2003). To measure this contribution, the production function for the
commodity needs to be established, then the changes to the function must be observed after a change in
the ecosystem service, and the economics changes must be measured. Changes in the quality or the
quantity of the ecosystem services will change the cost of the inputs and alter the production function of
the commodity. The changes can be seen through shifts in the consumer or producer surplus.

Market prices can often be used to value the output from a productive process and environmental
conditions often affect such processes. In these circumstances, values for a change in the environment can
be derived from the associated change in productivity. An increase in output due to the change is a
measure of an increase in benefit, and a decrease in output is a measure of an increase in cost.

When to use it

• Does the minimum benefit of noise control cover the cost?

• What are the economic effects of reducing emissions of greenhouse gases?

To resolve the latter question, the monetary values would need to be estimated for the benefits of land
conservation, shelter belts on farms and the preservation of forests. The monetary values for the costs of
land degradation would also be required.

One cost to society of preserving native forests is the loss in timber output following preservation. This
loss can be measured as the decrease in income from logging, which Rogers (1992) assessed in the
following two ways:

• loss in income due to failure to harvest the existing forest

• loss in income due to failure to harvest the existing forest and then regenerate and harvest the
subsequent forest.

Strengths and weaknesses

The strengths of the technique include:

• it is direct and straightforward

• it relies an observed market prices

• it relies on observed output levels.

The difficulties include:

• defining the physical flows of output over time

• ensuring the change in flow is related to the change in the environment.

The technique is widely used, especially in land conservation, forest management, watershed
management, tourism and grazing.

Avoidance Cost Method (ACM). The avoidance cost method offers a means for generating lower-bound
estimates of an important component of benefits like the use of groundwater as a source of drinking
water. From a public decision-making standpoint, the benefits of groundwater protection can be viewed as
damage avoided from groundwater contamination. Major categories of damage include: human health,
increased fear and anxiety, avoidance cost and property value loss, ecological damage and loss of
recreational use, and reduction/loss of nonuse values. The ACM is operationalized by estimating the costs
of behavior to prevent or mitigate adverse impacts of pollution. It infers benefits of measuring
consumption of goods and services that substitute for the environmental quality change. Analyses using
the avoidance cost method have shown that observed averting costs only provide a lower bound to
willingness-to-pay measures (Abdalla, 1994) and when these estimated costs are used as proxies for
willingness to pay estimates, are subject to potential errors in interpretation (Segerson, 1994). Another
issue is that the average expenditure on avoidance for those who chose to avoid the contamination is not a
measure of (or even a lower bound for) the average willingness to pay for the entire population since it
does not incorporate the lack of any expenditures by some portion of the population (since avoidance
costs reflect actual expenditures, conditional on the individual’s expectations regarding what others will
do to reduce exposure to the contaminant). For changes in environmental quality that specifically affect
human health, the monetary costs associated with the health effects are estimated. The monetary damages
associated health effects consist of three major things: foregone earnings through premature death,
sickness, or absenteeism; increased medical expenses; and psychic costs. There are studies that evaluated
the economic impacts of acute human health effects associated with pesticide use in developing countries
(Rola and Pingali, 1993; Antle and Pingali, 1994; Crissman et al., 1994; Antle and Capalbo, 1994;
Pingali, et al.1994).

Property value approach: The property value method is based on the general land value approach. The
objective is to determine the implicit prices of certain characteristics of properties. In the environmental
area, the aim of the method is to place a value on the benefits of environmental quality improvements, or
to estimate the costs of deterioration. The approach is based on a competitive real estate market, and its
demands on information and statistical analysis are significant.

Wage Differential:The wage differential approach is very similar to the property value approach. This
method is based on the theory that in a competitive market the demand for labor equals the value of its
marginal product and that the supply of labor varies with working and living conditions in an area. A
higher wage is therefore necessary to attract workers to locate in polluted areas or to undertake more risky
occupations. This method can only be used if the labor market is perfectly competitive. Another
consideration is that this method relies on private valuation of health risks, not necessarily social ones.
The level of information concerning occupational hazards of pesticide use must be high in order for
workers to make meaningful tradeoffs between health risks and remuneration. The effects of factors other
than the environment (like, skill level, job responsibility, alternative jobs available in the area, etc.) that
might influence wages must be eliminated to isolate the impacts of the environment, making it difficult to
implement this approach. Previous studies observed that Filipino farmers barely understand the health and
environmental risks of pesticide use and that precautionary and safety measures in applying pesticides are
often neglected. This lack of understanding implies that they may not be consciously aware of their
occupational hazards and therefore do not demand remuneration accordingly. Further investigation is
needed to determine if there are indeed differences in wages among work groups (harvesters, pesticide
applicators, and so forth) and if farmers really discriminate among work groups at all.

Replacement costs method:

The replacement cost method is, as the defensive expenditure method, based on the assumption about
perfect substitutes, but the replacement cost method is based on non-market behaviour. The cost of a
potential or actual replacement technique is used to derive a value of a change in environmental quality.

The cost of replacing an ecosystem service with a man-made substitute is used in the replacement cost
method as a measure of the economic value of the ecosystem service. Consequently, it must be possible to
identify a substitute for the ecosystem service. The cost of investment and the maintenance cost should
both be included in the replacement cost. The method could for example be applied to value the flood
protection capacity of wetlands by estimating the cost of replacing this capacity with the use of a human
made protection, i.e. some kind of artificial coastal defence such as breakwaters or sea walls. The method
could also be used to estimate a value of soil fertility by looking at the cost of fertilizers needed to
maintain a certain level of productivity.

The method is based on the possibility of finding perfect substitutes to ecosystem services. However, the
validity of the method does not only depend on the possibility of finding perfect substitutes. Replacement
costs can be a valid measure of economic value only if three conditions are met. Shabman and Batie
(1978) define the conditions and these conditions are also discussed in Leschine et al. (1997), in
Bocksteal et al. (2000) and in Freeman (2003). The conditions are the following:

1. The human engineered system provides functions that are equivalent in quality and magnitude to the
ecosystem service.

2. The human engineered system is the least cost alternative way of replacing the ecosystem service.

3. Individuals in aggregate would in fact be willing to incur these costs if the ecosystem service was no
longer available.

When to use it

• What is the cost of maintaining a sustainable flow of benefits?

• What is the cost of land degradation to shire councils?

To resolve the latter question, the monetary values would need to be estimated for the benefits of
environmental preservation and flood protection and the costs of land degradation, such as the cost of
damaged roads.

Strengths and weaknesses

Replacement costs can often be estimated relatively simply, so this technique has been widely applied.
Further, replacement costs are a useful measure of benefit when they are required to meet some socially
sanctioned constraint on use of the environment. The shadow-project technique applies the notion of
replacement costs in this way. The cost of a project to restore an environment to meet socially determined
standards is a minimum value of the benefits maintained (James 1991).

The weaknesses concern certain requirements that must be met for the replacement.

• The replacement goods and services must be identical to, or at least good substitutes for, the
original goods and services.

• The replacement must restore benefits lost due to the environmental effects, and not benefits lost
due to normal wear and tear.

• The method assumes, perhaps reasonably, that the benefit of the replacement exceeds the cost
otherwise the cost would not be incurred. The replacement cost therefore provides only a minimum
estimate of the benefit.
The relocation-cost technique

The relocation-cost method is similar to the preventative-expenditure technique in that activities to

maintain a level of enjoyment or output are costed. The activities now concern relocation of individual
activities or entire firms or households, rather than adjustments to defend an existing activity at an
existing location.

When to use it

• What are the true costs of developments, policies and programs?

• What do anglers do when their favourite trout stream closes?

To resolve the latter question, the monetary values would need to be estimated for the costs of loss of a
trout stream.

The benefits of maintaining a trout habitat have been estimated from the costs to anglers to relocate.
Anglers on the Ovens River in Victoria spent an average of $43 per trip in 1990 and caught between one
and five trout per visit. If the trout habitat were lost through river breakouts, engineering works or
vegetation growth, the anglers would need to spend $151 per trip to go to a good substitute trout river to
replace the environmental service of fishing (Sinden 1990). The net cost of replacement of $108 (151 -
43) is a measure of the individual benefit of retaining the trout habitat.

Sometimes a physical facility can no longer operate effectively at its existing location due to changed
environmental conditions. The cost of relocation is an estimate of the benefit from avoiding the damage.
For example, downstream inlet pipes may have to be relocated due to the activity of an upstream polluter.
If activities were relocated, the cost is an estimate of the damage expected in the present locality and of
the minimum benefit in avoiding the damage.

Strengths and weaknesses

This method provides a direct way to incorporate damage costs into the valuation of proposals. If the
development of an environmental resource would cause some other activity or facility to relocate, the
relocation costs are a legitimate charge against the project. If there are a number of possible sites for
relocation, the cost of the cheapest one is taken as the benchmark. In any case, the new arrangement
should leave the facility operating as closely as possible to the previous one.

Depreciation or net price method

Depreciation involves spreading the original cost of an asset over its entire useful life. The original cost is
a prepaid expense; therefore, it is logical that this cost be allocated to the accounting periods during which
the asset is used. Thus, it is also important that amount of depreciation which corresponds to the exact
loss in the value of the asset over time due to usage, wear and tear and obsolescence. The loss in value of
an asset over time is determined by remaining life, extent and nature of use and obsolescence. Three
common methods of calculating depreciation are discussed below.

Straight line Method

This method is easy, simple and usefully very satisfactory for most purposes. It assumes that assets are
used more or less to the same extent every year and therefore equal amounts of costs on account of their
use can be charged every year. By this method, depreciation will be

Original cost – Salvage value

Annual Depreciation =

Expected life

This method does not suit where assets get used up at varying rates eg., A tractor depreciates much more
during first few years than in later years.

Example: What would be the annual depreciation for an asset be whose cost is Rs.2000, salvage value
Rs.200 and expected useful life is 10 years?

2000 - 200

Annual depreciation = ----------------- = Rs.180.00 per year

10

Diminishing Balance Method

According to this method, a fixed rate of depreciation is used every year and applied to the remaining
value of the assets at the beginning of each year. It is important to note that salvage value is not subtracted
from the original cost. Instead, fixed rate of depreciation, which should be nearly twice that used under
the straight line method, is applied to the unrecovered balance until the salvage value is reached, after that
no depreciation is computed.

Example: Assume a Rs.10000 asset with an expected life of 10 years and a salvage value of Rs.500. The
rate of depreciation is 20 per cent. The calculations would proceed as follows:

Table. Diminishing balance method

Year Value at the Annual depreciation (Rs) Remaining balance (Rs.)

beginning of
the year (Rs.)

1 10000.00 10000 X 0.2 = 2000 10000 - 2000 = 8000

2 8000.00 8000 X 0.2 = 1600 8000 – 1600 = 6400

3 6400.00 6400 X 0.2 = 1280 6400 – 1280 = 5120

. . . .
 . . . .

After the third year, the same procedure is continued till the remaining balance reduces to an amount
equal to the salvage value i.e. Rs.500 in our case. After that no depreciation is calculated. This method is
suitable for a situation where an asset depreciates at a faster rate in the beginning of its life.
Sum- of- the-Year - Digits Method

In this method the annual depreciation is calculated by using the following formula.

Annual Depreciation (AD) = F X Amount to be depreciated

Where amount to be depreciated equals the cost less salvage value and F is a fraction.

Years of remaining life at the beginning of

accounting Period

Fraction for any year =

Sum of year digits

Example: Assume an asset with an original cost of Rs.1200, an expected life of 10 years and salvage
value of Rs.100. Annual depreciation for this asset over the useful life of the asset can be calculated as
follows:
Table. Sum of the year digits method

Year Value at the Annual depreciation (Rs.) Remaining

beginning of the balance (Rs.)
year
1 1200.00 10/55 (1200 – 100) = 200 1000.00
2 1000.00 9/55 (1200 – 100) = 180 820.00
3 820.00 8/55 (1200 – 100) = 160 660.00
. . . .
. . . .

This method suits to those assets for which relatively higher depreciation needs to be charged during the
earlier years of their life. This method differs from the declining balance method in that the rate of decline
in depreciation is uniform from year to year whereas in the declining balance method it keeps on
declining.

Surrogate Market Methods (or revealed preference method) In the absence of clearly defined markets, the
value of environmental resources can be derived from information acquired through surrogate markets.
The most common markets used as surrogates when monetizing environmental resources are those for
property and labor. The surrogate market methods discussed below are the hedonic price method and the
travel cost method, with a brief look at the use of random utility models for environmental valuation.

Hedonic price method

The hedonic price method of environmental valuation uses surrogate markets for placing a value on
environmental quality. The real estate market is the most commonly used surrogate in hedonic pricing of
environmental values. Air, water, and noise pollution have a direct impact on property values. By
comparing properties with otherwise similar characteristics or by examining the price of a property over
time as environmental conditions change and correcting for all nonenvironmental factors, information in
the housing market can be used to estimate people's willingness to pay for environmental quality.

The Hedonic Price method is based on consumer theory, which seeks to explain the value of a commodity
as a bundle of various characteristics. Market goods are often regarded as intermediate inputs into the
production of more basic attributes that the individuals really demand. It is based on the more general
land value approach which decomposes real estate prices into components attributable to different
characteristics like pollution, accessibility, proximity to schools, shops, parks, etc. The method seeks to
determine the increased WTP for improved local environmental quality, as reflected in housing prices in
cleaner surroundings. It assumes a competitive housing market, and its demands on information and tools
of statistical analysis are high.

Multiple regression analysis is used to identify how much of a property differential is due to a particular
environmental difference between properties. It has been found through several studies that multiple
regression analyses in such cases over estimate the benefits by 2 to 3 times. The problem here is that most
households are not aware of the costs or benefits of an environmental attribute and hence don’t know it
when they adjust their residential locations due to a particular attribute.

Issues that arise while employing regression analysis in Hedonic Pricing Method:

• The choice of variables.

• The presence of multicollinearity (a statistical phenomenon in which two or more independent

variables in a multiple regression model are highly correlated).

• Omitted variable bias (an independent variable that should be in the model is ignored).

Travel Cost method

Travel cost method

The travel cost method is used to estimate economic use values associated with ecosystems or
sites that are used for recreation.

This method can be used to estimate the economic benefits or costs resulting from:

1. Changes in access costs for a recreational site

2. Elimination of an existing recreational site
3. Addition of a new recreational site
4. Changes in environmental quality at a recreational site
 The basic premise of the travel cost method is that the time and travel cost expenses that people
incur to visit a site represent the “price” of access to the site. Thus, peoples’ willingness to pay to visit the
site can be estimated based on the number of trips that they make at different travel costs.

Hypothetical Situation

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.

Why to Use the Travel Cost Method?

The travel cost method was selected in this case for two main reasons:

1. The site is primarily valuable to people as a recreational site. There are no endangered species or other
highly unique qualities that would make non-use values for the site significant.

2. The expenditures for projects to protect the site are relatively low. Thus, using a relatively inexpensive
method like travel cost makes the most sense.

Main Steps to Travel Cost Method

1. Select site

2. Divide the area into zones

3. Sample visitors to the site

4. Obtain visitation rates for each zone

5. Estimate travel costs

6. Derive a statistical regression

7. Construct a demand curve

8. Estimate consumer surplus

9. Estimate benefits of environmental improvements at site

Options for Applying the Travel Cost Method:

 There are several ways to approach the problem, using variations of the travel cost method. These
include:

1. A simple zonal travel cost approach, using mostly secondary data with some simple data collected
from visitors.
2. An individual travel cost approach, using a more detailed survey of visitors.
3. A random utility approach using survey and other data and more complicated statistical
techniques.
Zonal Travel Cost Approach

The zonal travel cost method is the simplest and least expensive approach. It will estimate a value
for recreational services of the site as a whole. It cannot easily be used to value a change in quality of
recreation for a site and may not consider some of the factors that may be important determinants of
value.

The zonal travel cost method is applied by collecting information on the number of visits to the
site from different distances. Because the travel time and costs will increase with distance, this
information allows the researcher to calculate the number of visits at different “prices.”

Step 1:

The first step is to define a set of zones surrounding the site. These may be defined by
concentric circles around the site or by geographic divisions that make sense, such as metropolitan areas
or counties surrounding the site at different distances.

Step 2:

The second step is to collect information on the number of visitors from each zone, and the
number of visits made in the last year. For this hypothetical example, assume that staff at the site keeps
records of the number of visitors and their zip code, which can be used to calculate total visits per zone
over the last year.

Step 3:

The third step is to calculate the visitation rates per 1000 population in each zone. This is simply
the total visits per year from the zone, divided by the zone’s population in thousands.

Table 1: Visitation Rates

Zone Total Visits/Year Zone Population Visits/1000

0 400 1000 400

1 400 2000 200

2 400 4000 100

3 400 8000 50

Beyond 3 0

Total Visit 1600

Step 4:

The fourth step is to calculate the average round trip travel distance and travel time to the site
for each zone. Assume that people in Zone 0 have zero travel distance and time. Each other zone will
have an increasing travel time and distance. Next, using average cost per mile and per hour of travel time,
the researcher can calculate the travel cost per trip.

Assume that this cost per mile is $.30. The cost of time is more complicated. The simplest
approach is to use the average hourly wage. Assume that it is $9/hour, or $.15/minute, for all zones,
although in practice it is likely to differ by zone.

Table 2: Travel Distance and Travel Time to the Site for Each Zone

Zone Round Trip Round Trip Distance times Travel Time times Total Travel

Travel Distance Travel Time Cost/Mile ($.30) Cost/Minute ($.15) Cost/Trip

( in mile) (in minute)

0 0 0 0 0 0

1 20 30 $6 $4.50 $10.50

2 40 60 $12 $9.00 $21.00

3 80 120 $24 $18.00 $42.00

Step 5:
 The fifth step is to estimate using regression analysis, the equation that relates visits per capita to
travel costs and other important variables. In this simple model, the analysis might include demographic
variables such as age, income, gender, and education levels, using the average values for each zone.

To maintain the simplest possible model, calculating the equation with only the travel cost and
visits/1000, Visits/1000 = 330 – 7.755*(Travel Cost).

Step 6:

The sixth step is to construct the demand function for visits to the site, using the results of the
regression analysis. The first point on the demand curve is the total visitors to the site at current access
costs (assuming there is no entry fee for the site), which in this example is 1600 visits per year. The other
points are found by estimating the number of visitors with different hypothetical entrance fees (assuming
that an entrance fee is viewed in the same way as travel costs).

For the purposes of our example, start by assuming a $10 entrance fee. Plugging this into the
estimated regression equation, V = 330 – 7.755C

Table:3 Total Visits

Zone Travel Cost plus $10 Visits/1000 Population Total Visits

0 10 252 1000 252

1 20.50 171 2000 342

2 31.00 90 4000 360

3 52.00 0 8000 0

Total Visits 954

This gives the second point on the demand curve - 954 visits at an entry fee of $10. In the same
way, the number of visits for increasing entry fees can be calculated, to

Table: 4 Visit and Entry Fee

Entry Fee Total Visits

$20 409
$30 129

$40 20

$50 0

Step 7:

The final step is to estimate the total economic benefit of the site to visitors by calculating the
consumer surplus, or the area under the demand curve. This results in a total estimate of economic
benefits from recreational uses of the site of around $23,000 per year, or around $14.38 per visit
($23,000/1,600).

How Do We Use the Results?

Remember that the agency staff’s objective was to decide whether it is worthwhile to spend
money on programs and actions to protect this site. If the actions cost less than $23,000 per year, the cost
will be less than the benefits provided by the site.

If the costs are greater than this, the staff will have to decide whether other factors make them
worthwhile.

Statistical regression

Individual Travel Cost Approach

The individual travel cost approach is similar to the zonal approach, but uses survey data from
individual visitors in the statistical analysis, rather than data from each zone. This method thus requires
more data collection and slightly more complicated analysis, but will give more precise results.
The survey might ask for the following information:

1. Location of the visitor’s home – how far they travelled to the site
2. How many times they visited the site in the past year or season
3. The length of the trip
4. The amount of time spent at the site
5. Travel expenses
6. The person’s income or other information on the value of their time
7. Other socioeconomic characteristics of the visitor
8. Other locations visited during the same trip, and amount of time spent at each
9. Other reasons for the trip (is the trip only to visit the site, or for several
reason)
10. Perceptions of environmental quality or quality of fishing at the site
11. Substitute sites that the person might visit instead of this site

Using the survey data, the researcher can proceed in a similar way to the zonal model by estimating
using regression analysis, the relationship between number of visits and travel costs and other relevant
variables.

The regression equation gives us the demand function for the “average” visitor to the site, and the
area below this demand curve gives the average consumer surplus. This is multiplied by the total relevant
population (the population in the region where visitors come from) to estimate the total consumer surplus
for the site.

Random Utility Approach

The random utility approach is the most complicated and expensive of the travel cost approaches.
It is also the “state of the art” approach, because it allows for much more flexibility in calculating
benefits. It is the best approach to use to estimate benefits for specific characteristics, or quality changes,
of sites, rather than for the site as a whole

Case Study Examples of the Travel Cost Method

Case # 1 - Environmental Conservation

The Situation
 Hell Canyon on the Snake River separating Oregon and Idaho offers spectacular vistas and
outdoor amenities to visitors from around the country and supports important fish and wildlife habitat.

It also has economic potential as a site to develop hydropower. Generating hydropower there
would require building a dam behind which would form a large lake. The dam and the resulting lake
would significantly and permanently alter the ecological and aesthetic characteristics of Hell Canyon.

The Challenge

During the 1970’s, there were major controversies regarding the future of Hell Canyon. Environmental
economists from Resources for the Future in Washington, D.C. were asked to develop an economic
analysis to justify preserving Hell Canyon in its natural state in the face of its obvious economic potential
as a source of hydropower.

The Analysis

Researchers estimated that the net economic value (cost savings) of producing hydropower at
Hell Canyon was $80,000 higher than at the "next best" site which was not environmentally sensitive.
They then conducted a low cost/low precision travel cost survey to estimate the recreational value of Hell
Canyon and concluded that it was about $900,000.

The researchers did not attempt to strongly defend the "scientific" credibility of the valuation
method they used or the results. However, at public hearings, they emphasized that, even if the "true
value" of recreation at Hell Canyon was ten times less than their estimate, it would still be greater than the
$80,000 economic payoff from generating power .

The Results

Based largely on the results of this non market valuation study, Congress voted to prohibit further
development of Hell Canyon.

Case # 2 - Improvements in Water Quality

The Situation

The costs to farmers and taxpayers of implementing on farm best management practices to reduce
sediment and nutrient runoff to the Chesapeake Bay are well known. Controversies arose during the
1980’s, which continue today, over the benefits of resulting improvements in water quality.

The Challenge
 Economists were asked to assess the economic benefits of water quality improvements to beach
users in the Chesapeake Bay area. They needed to establish linkages between differences in water quality
and differences in willingness to pay for beach use. The hypothesis that to be tested was that average
willingness to pay, as reflected in the travel costs to visitors to particular beaches, was positively
correlated with water quality. If the hypothesis was correct the empirical results would allow researchers
to estimate the increase in willingness to pay of improving water quality at all beaches.

The Analysis

Researchers selected the concentration of nitrogen and phosphorous in the water at the monitoring
station nearest to the beach as an index of water quality at the beach. This was assumed to reflect the level
of objectionable visual and other characteristics that affect the value of beach use. A cross sectional
analysis of travel cost data collected from 484 people at 11 public beaches was used to impute the
aggregate willingness to pay for a 20 % increase in water quality, which was assumed to be associated
with a 20 % reduction in total nitrogen and phosphorus.

The Results

1. The average annual benefits to all Maryland beach users of the improvements in water quality
were estimated to be $35 million in 1984 dollars. These were thought to be conservative for
several reasons, including:
2. The value of improvements in water quality was only shown to increase the value of current
beach use. However, improved water quality can also be expected to increase overall beach use.
3. Estimates ignore visitors from outside the Baltimore Washington statistical metropolitan
sampling area.
4. The population and incomes in origin zones near the Chesapeake Bay beach areas are increasing,
which is likely to increase visitor days and thus total willingness to pay.
Applying the Travel Cost Method:

To apply the travel cost method, information must be collected about

1. Number of visits from each origin zone (usually defined by zip code)
2. Demographic information about people from each zone
3. Round trip mileage from each zone
4. Travel costs per mile
5. The value of time spent travelling, or the opportunity cost of travel time
Advantages of the Travel Cost Method:
 1. The travel cost method closely mimics the more conventional empirical techniques used by
economists to estimate economic values based on market prices.
2. The method is based on actual behaviour what people actually do rather than stated willingness to
pay what people say they would do in a hypothetical situation.
3. The method is relatively inexpensive to apply.
4. On site surveys provide opportunities for large sample sizes, as visitors tend to be interested in
participating.
5. The results are relatively easy to interpret and explain.
Issues and Limitations of the Travel Cost Method:

1. The travel cost method assumes that people perceive and respond to changes in travel costs the
same way that they would respond to changes in admission price.
2. The simplest models assume that individuals take a trip for a single purpose to visit a specific
recreational site.
3. Defining and measuring the opportunity cost of time, or the value of time spent travelling, can be
problematic. Because the time spent traveling could have been used in other ways, it has an
"opportunity cost“.
4. The availability of substitute sites will affect values. For e.g. if two people travel the same
distance, they are assumed to have the same value.
5. Interviewing visitors on site can introduce sampling biases to the analysis.
6. Measuring recreational quality, and relating recreational quality to environmental quality can be
difficult.
7. Standard travel cost approaches provides information about current conditions, but not about
gains or losses from anticipated changes in resource conditions.
8. The travel cost method is limited in its scope of application because it requires user participation.
9. As in all statistical methods, certain statistical problems can affect the results.
Hedonic Pricing Method

The hedonic pricing method is used to estimate economic values for ecosystem or environmental
services that directly affect market prices. It is most commonly applied to variations in property values for
example housing prices that reflect the value of local environmental attributes. It can be used to estimate
economic benefits or costs associated with:

1. Environmental quality including air pollution, water pollution, or noise pollution

2. Environmental amenities, such as aesthetic views or proximity to recreational sites
Steps to Perform Hedonic Pricing Method

1. Define market commodity (e.g., land) and its attributes (including environmental attributes).
2. Specify hedonic price function (i.e., relationship between market price and all relevant attributes
of the commodity).
3. Estimate hedonic price function using multiple regression techniques.

Steps to Perform Hedonic Pricing Method

The basic premise of the hedonic pricing method is that the price of a marketed good is related to
its characteristics or the services it provides. For example, the price of a car reflects the characteristics of
that car transportation, comfort, style, luxury, fuel economy, etc. Therefore, we can value the individual
characteristics of a car or other good by looking at how the price people are willing to pay for it changes
when the characteristics change.

The hedonic pricing method is most often used to value environmental amenities that affect the
price of residential properties.

Why Use the Hedonic Pricing Method?

The hedonic pricing method was selected in this case because:

1. Housing prices in the area appear to be related to proximity to open space.

2. Data on real estate transactions and open space parcels are readily available, thus making this the least
expensive and least complicated approach.

Application of the Hedonic Pricing Method

Step 1:

The first step is to collect data on residential property sales in the region for a specific time period
(usually one year). The required data include:

a) Selling prices and locations of residential properties

b) Property characteristics that affect selling prices, such as plot size, number and size of
rooms, and number of bathrooms
c) Neighbourhood characteristics that affect selling prices, such as property taxes, crime
rates, and quality of schools
 d) Accessibility characteristics that affect prices, such as distances to work and shopping
centres, and availability of public transportation
e) Environmental characteristics that affect prices
Step 2:

Once the data are collected and compiled, the next step is to statistically estimate a function that
relates property values to the property characteristics, including the distance to open space. The resulting
function measures the portion of the property price that is attributable to each characteristic.

Thus, the researcher can estimate the value of preserving open space by looking at how the value
of the average home changes when the amount of open space nearby changes.

Case Study Example of the Hedonic Pricing Method

Values of Environmental Amenities in Southold, Long Island

The Situation

The town of Southold, Long Island, New York has coastlines on both the Peconic Bay and Long
Island Sound. Compared to the rest of Long Island, it is a relatively rural area, with a large amount of
farmland. However, population and housing density are rapidly increasing in the town, resulting in
development pressures on farmland and other types of open space.

The Challenge

The Peconic Estuary Program is considering various management actions for the Estuary and
surrounding land areas. In order to assess some of the values that may result from these management
actions, a hedonic valuation study was conducted, using 1996 housing transactions.

The Analysis
 The study found that the following variables that are relevant for local environmental
management were had significant effects on property values in Southold:

Open Space: Properties adjacent to open space had, on average 12.8 % higher per-acre value than similar
properties located elsewhere.

Farmland: Properties located adjacent to farmland had, on average 13.3 % lower per acre value.

Major Roads: Properties located within 20 meters of a major road had on average16.2 % lower per-acre
value.

Zoning: Properties located within an area with two- or three-acre zoning had, on average 16.7 % higher
per acre value.

Wetlands: For every percentage point increase in the percent of a parcel classified as a wetland, the
average per-acre value increased by 3 %.

The Results

Based on the results of this study, managers could for example calculate the value of preserving a
parcel of open space by calculating the effects on property values adjacent to the parcel. For a
hypothetical simple case, the value of preserving a 10 acre parcel of open space, surrounded by 15
“average” properties, was calculated as $410,907.

Applying the Hedonic Pricing Method Using Housing Prices

In general, the price of a house is related to the characteristics of the house and property itself, the
characteristics of the neighbourhood and community, and environmental characteristics

To apply the hedonic pricing method the following information was collected:

A measure or index of the environmental amenity of interest. Cross section and/or time series
data on property values and property and household characteristics for a well-defined market area that
includes homes with different levels of environmental quality or different distances to an environmental
amenity, such as open space or the coastline.

Advantages of the Hedonic Pricing Method:

1. The method’s main strength is that it can be used to estimate values based on actual choices.
 2. Property markets are relatively efficient in responding to information, so can be good indications
of value.
3. Property records are typically very reliable.
4. Data on property sales and characteristics are readily available through many sources and can be
related to other secondary data sources to obtain descriptive variables for the analysis.
5. The method is versatile and can be adapted to consider several possible interactions between
market goods and environmental quality.
Issues and Limitations:

1. The scope of environmental benefits that can be measured is limited to things that are related to
housing prices.
2. The method will only capture people’s willingness to pay for perceived differences in
environmental attributes, and their direct consequences.
3. The method is relatively complex to implement and interpret, requiring a high degree of statistical
expertise.
4. The results depend heavily on model specification.
5. Large amount of data must be gathered and manipulated.
6. The time and expense to carry out an application depends on the availability and accessibility of
data.

II. Stated Preference or Non-market methods

1. Contingent valuation method (cvm)

The CVM method is the best approach to get at the WTP/WTA for the total economic value (including
non-use values) of an environmental improvement. This is an important consideration since some CVM
studies have shown that non-use value in some cases can be 40 percent of total economic value for
wilderness preservation and even above 60 percent for water quality project. Basically, people are asked
how much they would be willing to pay for a specified environmental quality improvement. If people
understand fully the environmental impact and answer truthfully the WTP/WTA question, this approach
is ideal because the analysts would get an individual’s strength of preference for the proposed
environmental change. The values expressed by people in CVM interviews are contingent upon such
factors as the description of the environmental good, whether it is provided, and the way it would be paid
for. The central problem in the application of this valuation method is whether the intentions people
indicate before the change will accurately describe their behaviour after the change when people face no
penalty or cost associated with a discrepancy between the two.

The possible environmental changes about which one individual can be asked to express his
value judgement about an environmental change are:
Environmental improvement. The value of the environmental improvement in such a situation
can be measured either by:

• The individual’s Maximum Willingness to Pay (max. WTP) to obtain the environmental
improvement;

• The individual’s Minimum Willingness to Accept (min. WTA) a compensation to forgo the
environmental improvement.

Environmental damage. The value of the environmental damage in such a situation can be
measured either by:

• The individual’s Maximum Willingness to Pay (max. WTP) to avoid the environmental
damage;

• The individual’s Minimum Willingness to Accept (min. WTA) a compensation to consent

the environmental damage. In order to obtain answers that reflect the true maximum WTP, or minimum
WTA of the respondent, different formats for eliciting the value judgement have been experienced. The
main formats are:
• Open ended questions;

• Bidding Games; and

• Dichotomous choice (referendum) questions.

Open-ended format

Simple CVM exercises can be based on the so called “open ended” elicitation format, where the
individual is asked to state a maximum WTP or minimum WTA for a described environmental change. In
this case, descriptive statistics (such as means and medians) can be used to obtain rough indications about
the respondents’ value judgements. The main drawback of this approach is that it is easy for the
respondent to introduce a “strategic bias”, by stating a WTP/WTA lower or higher than the true one to
influence the decision making process. Strategic Bias : Causes survey results to differ from actual
willingness to pay because individual have an incentive to not reveal the truth because they can secure a
benefit in excess of the costs they have to pay. This arises from the free rider problem. For example, if
individuals are told that a service will be provided if the total sum they are willing to pay exceeds the cost
of provision and that each will be charged a price according to their maximum willingness to pay then
individuals will have an incentive to understate his or her demand.

A second is that the individual may be unprepared to express a value judgement without any reference
point to express his or her value judgement. This reference point is often termed the “bound”.

Bidding game format

To avoid a high rate of “loose” and/or missing answers caused by the lack of bounds in the open ended
format, an iterative technique called “bidding game” can be used. In this case the respondent is asked
whether he or she accepts to pay (or to be compensated with) a given amount of money. If they refuse the
proposed amount, the question is repeated with a reduced (or increased) amount, by a given percentage
(say, 10 percent). The procedure is repeated until the respondent answers “yes”. This amount is the
maximum WTP (or minimum WTA) for obtaining (or to give up) the environmental improvement. If the
individual accepts the initially proposed amount, the procedure continues until the individual answer
“no”. This amount is also the maximum WTP (or minimum WTA) for obtaining (or to give up) the
environmental improvement. This elicitation technique has a main drawback called “starting point bias”.
It has been observed that the final value judgement is affected by the initial proposed amount.

Dichotomous choice

To contain the starting point bias and the strategic bias, the “dichotomous choice” (referendum) format
can be used. In this case, a possible range of values for the maximum WTP (or minimum WTA) of
individuals is pre-set by the analyst. The sample of interviewed individuals is divided in sub-samples. A
value within the pre-set range is assigned to each sub-sample. Each individual within a sub-sample is then
asked whether he or she is willing to pay (or to accept) the assigned value to obtain (or to consent to) the
environmental improvement (or damage). He or she is not allowed to state an amount as in the case of the
open-ended format, or to play with subsequent acceptance/refusal answers as in the bidding game format.
Besides, he or she does not know the range of values within which the proposed amount is bounded. In
this case however, the outcome of the individual answer it is not the maximum WTP (or minimum WTA)
but only the consensus or refusal to pay (or to accept as compensation) a given amount of money. Specific
statistical techniques are therefore required to work out the individual’s value judgement about the
environmental change.

Combined approaches

In order to take account of the possible differences in the results due to the use of one, rather than another
elicitation format, the three main elicitation formats can be used. The sample is split as in the
dichotomous choice approach. A bidding game is proposed for a fixed maximum number of bids and an
open ended question is lastly posed to obtain the maximum WTP (or minimum WTA) when the
respondent switches from “yes” to “no” either if also the last bid is accepted.

Organisation of a CVM Study

The major elements of a CVM survey are:

• A scenario is described where the impacts of the change in the provision of an environmental
good/service are outlined;

• The respondents are invited to consider and to understand the proposed scenario within which the
choice concerning the environmental good/service will occur; and

• The respondents are invited to supply their statements concerning their WTP/WTA, from which
the value attached to a change in the provision of the good/service in question is inferred.
Fig. Organisation of CVM study

The first step concerns a definition of the objectives of the survey.

[Link] to value: the purposes of the survey and the object of the valuation exercise must be identified
and stated clearly. What is the environmental good or service we want to place a value on? Are we
valuing the whole environmental good, one of its attributes, a specific change in the quality/quantity of
the good/service?

[Link] of the value and measure unit: Is the analyst eliciting the marginal value or the average value
to the individual of the good/service? What is the measure unit?

[Link] span of the valuation. The analyst must decide whether to collect monthly, annual, multi-period
WTP/WTA or lump sum WTP/WTA.

[Link] should be interviewed: the relevant economic agents have to be defined, i.e., who is affected by
the change in the provision of the environmental good or service (individuals, households, production
units).

The second step concerns the design of the questionnaire. This activity is of fundamental importance.
Indeed, a well-conceived questionnaire is the basis for the success.

[Link]. The interviewer explains some likely reasons (not necessarily all of them) of the survey
to the interviewee, to make him involved.
[Link]-economic information. To analyse the answers and to interpret them in the socioeconomic
context of the respondent, data about the interviewee, his household and his social environment are
normally collected (e.g. age, education, marital status, number of members of the household, annual
income of the household etc.).

[Link] design. The scenario description is of course different for each specific study. The scenario
usually provides a clear and careful description of the environmental good/service object of the valuation,
its changes under given conditions, the impacts of the change on the users/consumers, possibly the type of
policies envisaged to secure (prevent) the change and who will pay for them. The WTP/WTA question
must be phrased to present a clear, readily understood and plausible scenario. One important dimension of
the scenario design is describing the availability of substitutes for the commodity valued. The value of a
malaria vaccine, for instance, should depend on the existence of other methods for preventing the disease.
Such methods should be clearly spelled out to respondents in the course of the survey; otherwise people
may make different assumptions about the commodity being valued.

It is necessary also to include some final questions to check if the scenario has been communicated
successfully (debriefing questions). Failure to communicate a realistic scenario to the respondent is likely
to result in the respondent not taking the scenario seriously or replacing it with something of his own
invention, either of which may bias WTP.

[Link] format. The elicitation procedure establishes the way the question for obtaining the value
judgement is posed. Whatever the elicitation format however, it is important that before asking the
individual what he would pay for the commodity valued, he should be reminded that his expenditures on
other goods must be reduced by this amount; i.e., he should be reminded of his budget constraint. It is also
desirable to follow questions that elicit WTP with questions to determine whether a respondent who says
he will pay nothing for the good is stating his true valuation or a protest bid. A respondent may say that he
will pay nothing for a good that he in fact values if he believes that he should not have to pay for it or
otherwise disagrees with the scenario presented in the survey.

[Link] vehicle: the choice of the payment vehicle is of utmost importance in the design of a CVM
questionnaire. One procedure for determining the most appropriate PV is to carry out a pilot study in
which several alternatives are tested. The analysis of the results will allow to identify the payment method
the respondents are most familiar with and the most preferred by them. Possible payment vehicles are
entrance fees (e.g., National Parks), taxes (e.g., pollution), contribution to funds (e.g., existence values
such as protection of endangered species), charges (e.g., water use for agricultural, industrial, or domestic
purposes). In rural areas in Africa, the choice of payment vehicle is a major challenge since many people
have low incomes in a subsistence society.

The third step concerns the management of the survey. Sample selection and choices about how, where,
and when to interview are presented.

[Link] selection. After determining the population whose WTP is to be measured, which, depends on
the nature and location of the commodity to be valued, the researcher ideally uses probability sampling
procedures to select a sample who will receive the contingent valuation questionnaire. This involves
constructing a sampling frame and selecting from the sampling frame in such a way that the probability of
each person being selected is known. Cost considerations have sometimes led to the use of convenience
samples, i.e. interviewees selected at shopping malls or through newspaper advertisements. Such samples
are usually adequate when the goal is testing how certain treatments (e.g., changes in scenario) affect
responses, but do not allow WTP values to be generalised for the population.

[Link], when and where to run the survey. The researcher must also determine the method of
administering the questionnaire. WTP may be elicited through in-person interviews, or in mail or
telephone surveys. The choice of administration method depends in part on the nature of survey. Visual
aids can be used only with in-person and mail surveys. Some elicitation techniques (e.g., questions whose
wording depends on the response to previous questions) are difficult to administer in mail surveys. Which
method is chosen will affect both the cost of conducting the survey and the response rate. Response rates
are generally lower for mail surveys and may lead to non-response or sample selection bias. This occurs
when people who refuse to answer the survey (e.g., due to lack of interest in the topic) have WTP values
that are systematically different from (e.g., lower than) those of respondents.

The fourth step (data base creation and analysis) is similar to most socio-economic surveys.

2. Choice Experiments (CE)

In a choice experiment, individuals are given a hypothetical setting and asked to choose their preferred
alternative among several alternatives in a choice set, and they are usually asked to perform a sequence of
such choices. Each alternative is described by a number of attributes or characteristics. A monetary value
is included as one of the attributes, along with other attributes of importance, when describing the profile
of the alternative presented. Thus, when individuals make their choice, they implicitly make trade-offs
between the levels of the attributes in the different alternatives presented in a choice set. This enables the
researcher to derive the value of each of the different attributes of a particular alternative (Alpizar,
Carlsson and Martinsson, 2001). CE involves considerable effort in the design of relevant scenarios with
appropriate attributes and in the use of statistical methods.

Using CE, the WTP for specific “attributes” of the proposed environmental change or alternative can be
derived. This disaggregation allows for the possibility of compensating the some attributes of the
situational change in kind and others monetarily (Adamowicz et al., 2005). CE also enables much greater
accuracy in framing the final alternative.

There are three important advantages that CE has over CVM (Alpizar, Carlsson and Martinsson, 2001):
(i) reduction in some of the potential biases of CVM (ii) more information is elicited from the respondent
compared to CVM and (iii) the potential of testing for internal consistency. The only major disadvantage
of CE is that is it far more complex and expensive to administer compared to CVM.

III. OTHER METHODS

Dose Response based Valuation

This is an indirect procedure of valuating environmental costs and benefits. Dose Response method
analysis the relationship between say, pollution and an effect it has, for instance, health effects. It is the
process of characterizing the relationship between the dose of an agent administered, and the occurrence
of an adverse health effect amongst the exposed. The incidence of the effect is then estimated as a
function of human exposure to the agent. ‘Dose’ indicates the amount of the agent while ‘response’ refers
to the effect of the agent once administered. Dose-response relationships are determined graphically by
determining the effect of varying the administered dose on the response. Generally, increasing the dose of
a harmful agent will result in a proportional increase in both the incidence of an adverse effect as well as
the severity of the effect. Dose Response method is usually administered when the exposed population is
unaware of the effects of pollution because it is not direct; it is also employed in developing countries
where there is lack of data for such valuation methods.

Benefits Transfer

As valuation exercises are costly, researchers need some means of estimating non-market benefits without
always having to undertake an individual study. Benefits Transfer is looked at as a way to make
environmental valuation a standardized component of environmental Cost Benefit Analysis for policy
making and environmental management. Benefits Transfer mainly works by taking estimates from one or
more original studies, and transferring the results to a new context by adjusting for two factors: (a)
differing socio-economic characteristics of beneficiaries, and (b) differing environmental characteristics
of the two different contexts. There are two main approaches to benefit transfers:

1. Transfer of adjusted mean WTP values eg. Fishing – average mean WTP per fishing day.

2. Transfer of benefit functions, eg. Transfer bid curves estimated from other studies.

Usually, a meta-analysis (a statistical analysis of past valuation studies) is carried out. The transfer error is
usually between 20-40% for the first method (absolute transfer error) and can go up to 228% for the
second method (benefit function transfer error).

Conclusion

Environmental valuation techniques are primarily driven by the principle that individuals are self-
interested and demonstrate preferences that form the basis of market interactions. These market
interactions demonstrate how individuals value environmental goods and services. The market-based
nature of economic theory emphasizes the maximization of human welfare. The market, in turn,
determines resource allocation based on the forces of supply and demand.

The environment, thus, is used as an instrument to achieve human satisfaction. In turn, the environment
can be treated like any other commodity and its associated value can be broken down into many elements.
For example, the value of coastal areas could be theoretically quantified based on the value of the
products it offers (e.g., fish, crabs, clams, recreation, and bird watching). In this manner, environmental
valuation can be viewed as a mechanistic approach in which the total value of an environmental system is
assessed in terms of the value of its individual parts.

Existence values are not demonstrated in the marketplace and are at least somewhat based on unselfish
motives making them problematic to environmental analysts. To quantify existence values accurately
within the framework of environmental valuation is difficult. Revealed preference methods (e.g., travel
cost method and hedonic pricing methods) measure the demand for the environmental resource by
measuring the demand for associated market goods. Existence values are not adequately captured using
these methods. Existence values are only revealed through surveys of individual willingness to pay for the
environmental resource or willingness to accept compensation for environmental losses.
Strength and Weakness of different valuation methods
DIRECT METHOD

 Contingent Valuation Method –CVM

 Choice Modeling

CONTINGENT VALUATION METHOD –CVM

Environmental resources like

A. Scenic view of mountains and beaches,

B. Wilderness experience in national parks,
C. Basic life support functions associated with ecosystem health and biodiversity etc.
1. Give utility to human-beings - do not have market values - not directly bought and sold in
the markets, May not be using the environmental resource now, but would like to have
the option to use it in the future.
2. Valuation is based on the description of a hypothetical scenario (e.g. a protection of a
forest that is commercially used today)
3. People are asked in a survey what they would be willing to pay out of their personal or
household budget for an enhancement of an ecosystem service (e.g. increased
biodiversity as a consequence of conserving a previously commercially exploited forest).
 4. Commonly used technique for valuing the non-use values/passive values of the
environment
5. Survey based method, where people are asked directly how much money they would be
willing to pay
6. People are asked for the amount of compensation they would be WTA to give up specific
environmental goods or services
7. ‘Contingent’ valuation method because people are asked to state their willingness to pay,
contingent on a specific hypothetical scenario and description of the environmental
service
8. The contingent valuation method is also referred to as a ‘stated preference’ method,
because it asks people to directly state their values, rather than inferring values from
actual choices.
9. The theoretical method was first proposed by Ciriacy-Wantrup (1947) a method for
eliciting market valuation of a non-market good.
10. Practically applied in 1963 by (Davis, 1963) to estimate the value hunters and tourists
placed on a particular wilderness area.
11. Gained popularity after the use of method in quantifying the damages following the
Exxon Valdez oil spill in Prince William Sound in USA in 1989.

Survey

Define relevant population- potential buyers and user of public good

Survey mode -

a. Personal interview, person to person

b. Personal interview session using an interactive medium (computer)
c. Mail questionnaire (with follow-ups)
d. Telephone interview
Step 1

Define the objectives of the study

• Description of the site

• What services are being valued (site, wildlife habitat, national park, water body etc.,)
• Who is the relevant population (entire country ,local or global community)
 • Time span of valuation
• Establishment of value to be estimated and unit of measurement
Step 2

• Preliminary decision about the survey (questionnaire, visual aids etc.)

• Size of the sample
• Who will be surveyed
• Who will pay for the good and who will use the good?
Step 3- Questionnaire design

• Design the survey based on initial interviews and focus groups for designing the survey
• Introduction – general information about the site
• Socioeconomic information
• Scenario formulation
• WTP/WTA elicitation format
• Payment vehicles
• Pre-test the questionnaire
PAYMENT MECHANISMS- Contingent Valuation Method

SI:N FORMAT MAIN FEATURES

O

1. Bidding games Respondents are offered progressively higher bids until they reach their
maximum WTP

2. Payment card A range of values is provided on a card and the respondent is requested to
choose one

3. Open-ended Respondents are asked to report their maximum WTP

questions

4. Dichotomous A single amount is offered and respondents are asked to provide a ‘yes’ or
choice ‘no’ answer, also referred to as the ‘take it or leave it’ approach
(referendum)

5. Double-bounded Respondents who answer ‘no’ to the first amount are offered a lower
referendum amount, and those who answer ‘yes’ are offered a higher amount
6. Trichotomous Respondents are offered three choices to the payment:‘yes’, ‘no’ and
choice’ ‘indifferent

7. Close–ended Respondents are asked whether they would pay money

questions

Step 4- Actual survey implementation

• Decide the sampling technique

• Decide how, when and where to run the interviews
• Training of enumerators
• Running the interviews
Step 5: Compile, analyses and report the results

• Enter the data

• Analyze WTP/WTA using appropriate statistical techniques
• Identify any responses that may not express the respondents’ value for the site
• Deal with non-response bias
• Get an estimate of willingness to pay
• Extrapolate the benefit or the loss for the entire population
• Compute annual net benefits
• Compute total value of environmental services
Possible bias in CVM

• Starting point bias

• Vehicle bias
• Information bias
• Hypothetical market bias
• Strategic bias or Free riding bias
• Mental account bias
• Interviewer and Respondent Bias
Suggestions by NOAA for a good CVM study

• For a single dichotomous question (yes-no type) format, a total sample size of at least 1000
respondents is required
• High non-response rates would render the survey unreliable
• Face-to-face interviewing is likely to yield the most reliable results
 • Full reporting of data and questionnaires is required for good practice
• Pilot surveying and pre-testing are essential elements in any CVM Study
• Accurate description of program of policy
• WTP format is preferred to WTA format.
• Accurate information of the valuation situation must be presented to the respondents, particular
care is required over the use of photographs
• A no-answer should be explicitly allowed in addition to the ‘yes’ and ‘no’ vote options on the
main valuation question
• Cross-tabulations of other questions such as attitudes toward site, environment etc.
• Checks for understanding
• Alternative expenditure possibilities provided
• Present-value calculations made as clear as possible
Contingent Valuation Method has been used to estimate the benefits from

•Increasing air and water quality

•Reducing risk from drinking water and
•Groundwater contaminants
•Outdoor recreation
•Protecting wetlands,
•Wilderness areas,
•Endangered species,
•Cultural heritage sites;
•Improvements in public education
•Public utility reliability;
•Reduction of food and transportation risks
•Health care queues
•Provision of basic environmental services such as drinking water and
•Garbage pickup in developing countries (Carson, 2000)
Advantages of CV

Very flexible.

1. Can be used to estimate economic value of about anything but best to use it to estimate value of
goods and services easily identified and understood by users
 2. CV is the most widely accepted method for estimating TEV including non use, option and
bequest values (only method to estimate option or existence values)
3. CV has been widely used and a great deal of research is being conducted to improve the
methodology, make results more valid and reliable and understand strengths and limitations
Limitation

1. Whether CV really measures WTP still controversial (most people unfamiliar making choices
about ecosystem services)
2. Results highly sensitive to design of choice scenarios and how survey conducted (psychological
aspects)
3. Estimates of nonuse values are difficult to validate externally.
4. Stated intentions of willingness to pay may exceed true feelings.
5. Results may appear inconsistent with tenets of rational choice
6. Respondents may be unfamiliar with the good or service being valued and not have an adequate
basis for articulating their true value
7. Respondents may express a value for the satisfaction ("warm glow") of giving rather than the
value of the goods or service in question
8. Respondents may fail to take questions seriously because the financial implications of their
responses are not binding.
INDIRECT VALUATION TECHNIQUE

Indirect valuation techniques seek to determine preferences for the environment from actual,
observed market-based information. Peoples' preferences for the environment can be revealed indirectly
by examining their behaviour in markets that are linked to the environment. Some goods and services are
complements to environmental quality, others are proxies, surrogates or substitutes for it. By examining
the prices paid in environment related markets, peoples' environmental preferences can be uncovered.

These techniques are termed indirect because they do not rely on people's direct answers to
questions about how much they would be willing to pay (or accept) for an environmental quality change
(Pearce and Moran, 1994)

Indirect valuation techniques are commonly employed to value non-marketed environmental

goods and services and can be divided into two categories:

1. Surrogate market approaches and

2. Market valuation of physical effects (MVPE).
Surrogate Market Techniques

Involve looking at markets for goods and services which are related to the environmental good or
service. The goods or services bought and sold in these surrogate markets will often complement, or
substitute for the environmental commodities in question. An advantage of these techniques is that they
rely on actual choices rather than on hypothetical choices as direct market approaches do. Surrogate
market approaches include the household production function approaches such as the travel cost method
and hedonic pricing and wage techniques (Pearce and Moran ,1994).

Market Valuation of Physical Effect

MVPE is sometimes thought of as a short cut valuation method because it proceeds straight to
estimating the impact of environmental change on the receptor concerned (OECD 1995). Where
environmental damage or improvement shows up in changes in the quantity or price of marketed inputs or
outputs, the value of the change can be measured using market prices. Theoretically, changes in the total
consumers plus producers' surplus should be measured. However, if changes are small, the monetary
measure can be approximated by market values. A valuation technique in this category is the production
function approach. These techniques are not concerned with what people say they prefer, or with inferring
environmental values indirectly by observing what people do.

Methods of Indirect Valuation

1. Travel cost method

2. Hedonic pricing
3. Contingent valuation method
4. Production function/ productivity method
5. Human capital method
6. Cost based methods
I. Damage avoided
II. Replacement costs
III. Preventive/ averting expenditure

Travel cost method

The travel cost method is used to estimate economic use values associated with ecosystems or
sites that are used for recreation.
 This method can be used to estimate the economic benefits or costs resulting from:

5. Changes in access costs for a recreational site

6. Elimination of an existing recreational site
7. Addition of a new recreational site
8. Changes in environmental quality at a recreational site
The basic premise of the travel cost method is that the time and travel cost expenses that people
incur to visit a site represent the “price” of access to the site. Thus, peoples’ willingness to pay to visit the
site can be estimated based on the number of trips that they make at different travel costs.

Hypothetical Situation

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.

Why to Use the Travel Cost Method?

The travel cost method was selected in this case for two main reasons:

1. The site is primarily valuable to people as a recreational site. There are no endangered species or other
highly unique qualities that would make non-use values for the site significant.

2. The expenditures for projects to protect the site are relatively low. Thus, using a relatively inexpensive
method like travel cost makes the most sense.

Main Steps to Travel Cost Method

1. Select site

2. Divide the area into zones

3. Sample visitors to the site

4. Obtain visitation rates for each zone

5. Estimate travel costs

6. Derive a statistical regression

7. Construct a demand curve

8. Estimate consumer surplus

9. Estimate benefits of environmental improvements at site

Options for Applying the Travel Cost Method:

There are several ways to approach the problem, using variations of the travel cost method. These
include:

4. A simple zonal travel cost approach, using mostly secondary data with some simple data collected
from visitors.
5. An individual travel cost approach, using a more detailed survey of visitors.
6. A random utility approach using survey and other data and more complicated statistical
techniques.
Zonal Travel Cost Approach

The zonal travel cost method is the simplest and least expensive approach. It will estimate a value
for recreational services of the site as a whole. It cannot easily be used to value a change in quality of
recreation for a site and may not consider some of the factors that may be important determinants of
value.

The zonal travel cost method is applied by collecting information on the number of visits to the
site from different distances. Because the travel time and costs will increase with distance, this
information allows the researcher to calculate the number of visits at different “prices.”

Step 1:

The first step is to define a set of zones surrounding the site. These may be defined by
concentric circles around the site or by geographic divisions that make sense, such as metropolitan areas
or counties surrounding the site at different distances.

Step 2:
 The second step is to collect information on the number of visitors from each zone, and the
number of visits made in the last year. For this hypothetical example, assume that staff at the site keeps
records of the number of visitors and their zip code, which can be used to calculate total visits per zone
over the last year.

Step 3:

The third step is to calculate the visitation rates per 1000 population in each zone. This is simply
the total visits per year from the zone, divided by the zone’s population in thousands.

Table 15. 1: Visitation Rates

Zone Total Visits/Year Zone Population Visits/1000

0 400 1000 400

1 400 2000 200

2 400 4000 100

3 400 8000 50

Beyond 3 0

Total Visit 1600

Step 4:

The fourth step is to calculate the average round trip travel distance and travel time to the site
for each zone. Assume that people in Zone 0 have zero travel distance and time. Each other zone will
have an increasing travel time and distance. Next, using average cost per mile and per hour of travel time,
the researcher can calculate the travel cost per trip.

Assume that this cost per mile is $.30. The cost of time is more complicated. The simplest
approach is to use the average hourly wage. Assume that it is $9/hour, or $.15/minute, for all zones,
although in practice it is likely to differ by zone.
 Table 15.2: Travel Distance and Travel Time to the Site for Each Zone

Zone Round Trip Round Trip Distance times Travel Time times Total Travel

Travel Distance Travel Time Cost/Mile ($.30) Cost/Minute ($.15) Cost/Trip

( in mile) (in minute)

0 0 0 0 0 0

1 20 30 $6 $4.50 $10.50

2 40 60 $12 $9.00 $21.00

3 80 120 $24 $18.00 $42.00

Step 5:

The fifth step is to estimate using regression analysis, the equation that relates visits per capita to
travel costs and other important variables. In this simple model, the analysis might include demographic
variables such as age, income, gender, and education levels, using the average values for each zone.

To maintain the simplest possible model, calculating the equation with only the travel cost and
visits/1000, Visits/1000 = 330 – 7.755*(Travel Cost).

Step 6:

The sixth step is to construct the demand function for visits to the site, using the results of the
regression analysis. The first point on the demand curve is the total visitors to the site at current access
costs (assuming there is no entry fee for the site), which in this example is 1600 visits per year. The other
points are found by estimating the number of visitors with different hypothetical entrance fees (assuming
that an entrance fee is viewed in the same way as travel costs).

For the purposes of our example, start by assuming a $10 entrance fee. Plugging this into the
estimated regression equation, V = 330 – 7.755C

Table:15.3 Total Visits

Zone Travel Cost plus $10 Visits/1000 Population Total Visits

0 10 252 1000 252

1 20.50 171 2000 342

2 31.00 90 4000 360

3 52.00 0 8000 0

Total Visits 954

This gives the second point on the demand curve - 954 visits at an entry fee of $10. In the same
way, the number of visits for increasing entry fees can be calculated, to

Table: 15.4 Visit and Entry Fee

Entry Fee Total Visits

$20 409

$30 129

$40 20

$50 0

Step 7:

The final step is to estimate the total economic benefit of the site to visitors by calculating the
consumer surplus, or the area under the demand curve. This results in a total estimate of economic
benefits from recreational uses of the site of around $23,000 per year, or around $14.38 per visit
($23,000/1,600).

How Do We Use the Results?

Remember that the agency staff’s objective was to decide whether it is worthwhile to spend
money on programs and actions to protect this site. If the actions cost less than $23,000 per year, the cost
will be less than the benefits provided by the site.

If the costs are greater than this, the staff will have to decide whether other factors make them
worthwhile.

Statistical regression
Individual Travel Cost Approach

The individual travel cost approach is similar to the zonal approach, but uses survey data from
individual visitors in the statistical analysis, rather than data from each zone. This method thus requires
more data collection and slightly more complicated analysis, but will give more precise results.

The survey might ask for the following information:

12. Location of the visitor’s home – how far they travelled to the site
13. How many times they visited the site in the past year or season
14. The length of the trip
15. The amount of time spent at the site
16. Travel expenses
17. The person’s income or other information on the value of their time
18. Other socioeconomic characteristics of the visitor
19. Other locations visited during the same trip, and amount of time spent at each
20. Other reasons for the trip (is the trip only to visit the site, or for several
reason)
21. Perceptions of environmental quality or quality of fishing at the site
22. Substitute sites that the person might visit instead of this site

Using the survey data, the researcher can proceed in a similar way to the zonal model by estimating
using regression analysis, the relationship between number of visits and travel costs and other relevant
variables.
 The regression equation gives us the demand function for the “average” visitor to the site, and the
area below this demand curve gives the average consumer surplus. This is multiplied by the total relevant
population (the population in the region where visitors come from) to estimate the total consumer surplus
for the site.

Random Utility Approach

The random utility approach is the most complicated and expensive of the travel cost approaches.
It is also the “state of the art” approach, because it allows for much more flexibility in calculating
benefits. It is the best approach to use to estimate benefits for specific characteristics, or quality changes,
of sites, rather than for the site as a whole

Case Study Examples of the Travel Cost Method

Case # 1 - Environmental Conservation

The Situation

Hell Canyon on the Snake River separating Oregon and Idaho offers spectacular vistas and
outdoor amenities to visitors from around the country and supports important fish and wildlife habitat.

It also has economic potential as a site to develop hydropower. Generating hydropower there
would require building a dam behind which would form a large lake. The dam and the resulting lake
would significantly and permanently alter the ecological and aesthetic characteristics of Hell Canyon.

The Challenge

During the 1970’s, there were major controversies regarding the future of Hell Canyon. Environmental
economists from Resources for the Future in Washington, D.C. were asked to develop an economic
analysis to justify preserving Hell Canyon in its natural state in the face of its obvious economic potential
as a source of hydropower.

The Analysis

Researchers estimated that the net economic value (cost savings) of producing hydropower at
Hell Canyon was $80,000 higher than at the "next best" site which was not environmentally sensitive.
They then conducted a low cost/low precision travel cost survey to estimate the recreational value of Hell
Canyon and concluded that it was about $900,000.

The researchers did not attempt to strongly defend the "scientific" credibility of the valuation
method they used or the results. However, at public hearings, they emphasized that, even if the "true
value" of recreation at Hell Canyon was ten times less than their estimate, it would still be greater than the
$80,000 economic payoff from generating power .

The Results

Based largely on the results of this non market valuation study, Congress voted to prohibit further
development of Hell Canyon.

Case # 2 - Improvements in Water Quality

The Situation

The costs to farmers and taxpayers of implementing on farm best management practices to reduce
sediment and nutrient runoff to the Chesapeake Bay are well known. Controversies arose during the
1980’s, which continue today, over the benefits of resulting improvements in water quality.

The Challenge

Economists were asked to assess the economic benefits of water quality improvements to beach
users in the Chesapeake Bay area. They needed to establish linkages between differences in water quality
and differences in willingness to pay for beach use. The hypothesis that to be tested was that average
willingness to pay, as reflected in the travel costs to visitors to particular beaches, was positively
correlated with water quality. If the hypothesis was correct the empirical results would allow researchers
to estimate the increase in willingness to pay of improving water quality at all beaches.

The Analysis

Researchers selected the concentration of nitrogen and phosphorous in the water at the monitoring
station nearest to the beach as an index of water quality at the beach. This was assumed to reflect the level
of objectionable visual and other characteristics that affect the value of beach use. A cross sectional
analysis of travel cost data collected from 484 people at 11 public beaches was used to impute the
aggregate willingness to pay for a 20 % increase in water quality, which was assumed to be associated
with a 20 % reduction in total nitrogen and phosphorus.
The Results

5. The average annual benefits to all Maryland beach users of the improvements in water quality
were estimated to be $35 million in 1984 dollars. These were thought to be conservative for
several reasons, including:
6. The value of improvements in water quality was only shown to increase the value of current
beach use. However, improved water quality can also be expected to increase overall beach use.
7. Estimates ignore visitors from outside the Baltimore Washington statistical metropolitan
sampling area.
8. The population and incomes in origin zones near the Chesapeake Bay beach areas are increasing,
which is likely to increase visitor days and thus total willingness to pay.
Applying the Travel Cost Method:

To apply the travel cost method, information must be collected about

6. Number of visits from each origin zone (usually defined by zip code)
7. Demographic information about people from each zone
8. Round trip mileage from each zone
9. Travel costs per mile
10. The value of time spent travelling, or the opportunity cost of travel time
Advantages of the Travel Cost Method:

6. The travel cost method closely mimics the more conventional empirical techniques used by
economists to estimate economic values based on market prices.
7. The method is based on actual behaviour what people actually do rather than stated willingness to
pay what people say they would do in a hypothetical situation.
8. The method is relatively inexpensive to apply.
9. On site surveys provide opportunities for large sample sizes, as visitors tend to be interested in
participating.
10. The results are relatively easy to interpret and explain.
Issues and Limitations of the Travel Cost Method:

10. The travel cost method assumes that people perceive and respond to changes in travel costs the
same way that they would respond to changes in admission price.
11. The simplest models assume that individuals take a trip for a single purpose to visit a specific
recreational site.
 12. Defining and measuring the opportunity cost of time, or the value of time spent travelling, can be
problematic. Because the time spent traveling could have been used in other ways, it has an
"opportunity cost“.
13. The availability of substitute sites will affect values. For e.g. if two people travel the same
distance, they are assumed to have the same value.
14. Interviewing visitors on site can introduce sampling biases to the analysis.
15. Measuring recreational quality, and relating recreational quality to environmental quality can be
difficult.
16. Standard travel cost approaches provides information about current conditions, but not about
gains or losses from anticipated changes in resource conditions.
17. The travel cost method is limited in its scope of application because it requires user participation.
18. As in all statistical methods, certain statistical problems can affect the results.
Hedonic Pricing Method

The hedonic pricing method is used to estimate economic values for ecosystem or environmental
services that directly affect market prices. It is most commonly applied to variations in property values for
example housing prices that reflect the value of local environmental attributes. It can be used to estimate
economic benefits or costs associated with:

3. Environmental quality including air pollution, water pollution, or noise pollution

4. Environmental amenities, such as aesthetic views or proximity to recreational sites
Steps to Perform Hedonic Pricing Method

4. Define market commodity (e.g., land) and its attributes (including environmental attributes).
5. Specify hedonic price function (i.e., relationship between market price and all relevant attributes
of the commodity).
6. Estimate hedonic price function using multiple regression techniques.

Steps to Perform Hedonic Pricing Method

The basic premise of the hedonic pricing method is that the price of a marketed good is related to
its characteristics or the services it provides. For example, the price of a car reflects the characteristics of
that car transportation, comfort, style, luxury, fuel economy, etc. Therefore, we can value the individual
characteristics of a car or other good by looking at how the price people are willing to pay for it changes
when the characteristics change.
 The hedonic pricing method is most often used to value environmental amenities that affect the
price of residential properties.

Why Use the Hedonic Pricing Method?

The hedonic pricing method was selected in this case because:

1. Housing prices in the area appear to be related to proximity to open space.

2. Data on real estate transactions and open space parcels are readily available, thus making this the least
expensive and least complicated approach.

Application of the Hedonic Pricing Method

Step 1:

The first step is to collect data on residential property sales in the region for a specific time period
(usually one year). The required data include:

f) Selling prices and locations of residential properties

g) Property characteristics that affect selling prices, such as plot size, number and size of
rooms, and number of bathrooms
h) Neighbourhood characteristics that affect selling prices, such as property taxes, crime
rates, and quality of schools
i) Accessibility characteristics that affect prices, such as distances to work and shopping
centres, and availability of public transportation
j) Environmental characteristics that affect prices
Step 2:

Once the data are collected and compiled, the next step is to statistically estimate a function that
relates property values to the property characteristics, including the distance to open space. The resulting
function measures the portion of the property price that is attributable to each characteristic.

Thus, the researcher can estimate the value of preserving open space by looking at how the value
of the average home changes when the amount of open space nearby changes.
 Case Study Example of the Hedonic Pricing Method

Values of Environmental Amenities in Southold, Long Island

The Situation

The town of Southold, Long Island, New York has coastlines on both the Peconic Bay and Long
Island Sound. Compared to the rest of Long Island, it is a relatively rural area, with a large amount of
farmland. However, population and housing density are rapidly increasing in the town, resulting in
development pressures on farmland and other types of open space.

The Challenge

The Peconic Estuary Program is considering various management actions for the Estuary and
surrounding land areas. In order to assess some of the values that may result from these management
actions, a hedonic valuation study was conducted, using 1996 housing transactions.

The Analysis

The study found that the following variables that are relevant for local environmental
management were had significant effects on property values in Southold:

Open Space: Properties adjacent to open space had, on average 12.8 % higher per-acre value than similar
properties located elsewhere.

Farmland: Properties located adjacent to farmland had, on average 13.3 % lower per acre value.

Major Roads: Properties located within 20 meters of a major road had on average16.2 % lower per-acre
value.
Zoning: Properties located within an area with two- or three-acre zoning had, on average 16.7 % higher
per acre value.

Wetlands: For every percentage point increase in the percent of a parcel classified as a wetland, the
average per-acre value increased by 3 %.

The Results

Based on the results of this study, managers could for example calculate the value of preserving a
parcel of open space by calculating the effects on property values adjacent to the parcel. For a
hypothetical simple case, the value of preserving a 10 acre parcel of open space, surrounded by 15
“average” properties, was calculated as $410,907.

Applying the Hedonic Pricing Method Using Housing Prices

In general, the price of a house is related to the characteristics of the house and property itself, the
characteristics of the neighbourhood and community, and environmental characteristics

To apply the hedonic pricing method the following information was collected:

A measure or index of the environmental amenity of interest. Cross section and/or time series
data on property values and property and household characteristics for a well-defined market area that
includes homes with different levels of environmental quality or different distances to an environmental
amenity, such as open space or the coastline.

Advantages of the Hedonic Pricing Method:

6. The method’s main strength is that it can be used to estimate values based on actual choices.
7. Property markets are relatively efficient in responding to information, so can be good indications
of value.
8. Property records are typically very reliable.
9. Data on property sales and characteristics are readily available through many sources and can be
related to other secondary data sources to obtain descriptive variables for the analysis.
10. The method is versatile and can be adapted to consider several possible interactions between
market goods and environmental quality.
Issues and Limitations:

7. The scope of environmental benefits that can be measured is limited to things that are related to
housing prices.
 8. The method will only capture people’s willingness to pay for perceived differences in
environmental attributes, and their direct consequences.
9. The method is relatively complex to implement and interpret, requiring a high degree of statistical
expertise.
10. The results depend heavily on model specification.
11. Large amount of data must be gathered and manipulated.
12. The time and expense to carry out an application depends on the availability and accessibility of
data.
Contingent Choice Method

The contingent choice method is similar to contingent valuation, in that it can be used to estimate
economic values for virtually any ecosystem or environmental service, and can be used to estimate non-
use as well as use values. Like contingent valuation, it is a hypothetical method – it asks people to make
choices based on a hypothetical scenario.

However, it differs from contingent valuation because it does not directly ask people to state their
values in dollars. Instead, values are inferred from the hypothetical choices or trade-offs that people make.

The contingent choice method asks the respondent to state a preference between one group of
environmental services or characteristics, at a given price or cost to the individual, and another group of
environmental characteristics at a different price or cost.

Because it focuses on trade-offs among scenarios with different characteristics, contingent choice
is especially suited to policy decisions where a set of possible actions might result in different impacts on
natural resources or environmental services.

For example, improved water quality in a lake will improve the quality of several services
provided by the lake, such as drinking water supply, fishing, swimming, and biodiversity. In addition,
while contingent choice can be used to estimate dollar values, the results may also be used to simply rank
options, without focusing on dollar values.

Hypothetical Scenario:

In the contingent valuation section, we used the case of a remote site on public land that provides
important habitat for several species of wildlife. The management agency in charge of the area must
decide whether to issue a lease for mining at the site.
 Suppose that there are several possible options for preserving and/or using the site. These include
allowing no mining and preserving the site as a wilderness habitat area, and various levels and locations
for the mining operation, each of which would have different impacts on the site.

Thus, several options must be weighed in terms of costs and benefits to the public. Again,
because the area is remote, few people actually visit it, or view the animals that rely on it for habitat.
Therefore, non-use values are the largest component of the value for preserving the site.

Why Use the Contingent Choice Method?

The contingent choice method was selected in this case because we want to value the outcomes of
several policy options, and because non-use values are important.

Alternative Approaches:

Since non-use values are significant and few people actually visit the site, other methods, such as
the travel cost method, will underestimate the benefits of preserving the site. In this case, contingent
valuation methods might also be used. However, because we need to value several levels of services
based on different scenarios the survey questions might become quite complicated.

Application of the Contingent Choice Method

Because both contingent choice and contingent valuation are hypothetical survey based methods,
their application is very similar. The main differences are in the design of the valuation question(s) and
the data analysis.

Step 1:

The first step is to define the valuation problem. This would include determining exactly what
services are being valued and who the relevant population is. In this case, the resource to be valued is a
specific site and the services it provides _ primarily wildlife habitat.

Step 2:
 The second step is to make preliminary decisions about the survey itself, including whether it will
be conducted by mail, phone or in person, how large the sample size will be, who will be surveyed, and
other related questions.

Step 3:

The next step is the actual survey design. This is the most important and difficult part of the
process and may take six months or more to complete. It is accomplished in several steps. The survey
design process usually starts with initial interviews and/or focus groups with the types of people who will
be receiving the final survey, in this case the general public. At this stage, the researchers would test
different approaches to the choice question. Usually, a contingent choice survey will ask each respondent
a series of choice questions, each presenting different combinations and levels of the relevant services, as
well as the cost to the respondent of the action or policy.

Step 4:

The next step is the actual survey implementation. The first task is to select the survey sample.
Ideally, the sample should be a randomly selected sample of the relevant population using standard
statistical sampling methods.

Step 5:

The final step is to compile, analyse and report the results. The statistical analysis for contingent
choice is often more complicated than that for contingent valuation, requiring the use of discrete choice
analysis methods to infer willingness to pay from the trade-offs made by respondents.

Case Study of the Contingent Choice Method

Landfill Siting in Rhode Island

The Situation
 With its primary landfill nearing capacity, the State of Rhode Island was faced with the need to
choose locations for new landfills, a controversial process.

The Challenge

Besides technical considerations, the State wanted to address the social and economic trade-offs
and values related to the location of a landfill. In this way, State officials hoped to avoid some of the
controversy associated with landfill siting.

The Analysis

Researchers at the University of Rhode Island conducted a contingent choice, paired comparison
survey. The survey asked Rhode Island residents to choose between pairs of hypothetical sites and
locations for a new landfill, described in terms of their characteristics.

The site comparisons described the natural resources that would be lost on a hypothetical 500 acre
landfill site. The location comparisons described the area surrounding the landfill. Each comparison also
gave the cost per household for locating a landfill at each hypothetical site or location.

The Results

The results of the survey were used by the State to predict how residents would vote in a
referendum on different possible landfill locations. First, 59 possible sites were selected based on
geological and public health criteria.

These sites were ranked using the contingent choice survey results, in order to come up with a
short list of potential sites, which was further evaluated and narrowed down. The final decision, based on
geological, public health, public preferences and political considerations was to expand the existing
landfill site.

Applying the Contingent Choice Method

There are a variety of formats for applying contingent choice methods, including:

Contingent Ranking

Contingent ranking surveys ask individuals to compare and rank alternate program outcomes with
various characteristics, including costs.
 For instance, people might be asked to compare and rank several mutually exclusive
environmental improvement programs under consideration for a watershed, each of which has different
outcomes and different costs.

Respondents are asked to rank the alternatives in order of preference.

Discrete Choice

In the discrete choice approach, respondents are simultaneously shown two or more different
alternatives and their characteristics and asked to identify the most preferred alternative in the choice.

Paired Rating

This is a variation on the discrete choice format, where respondents are asked to compare two
alternate situations and are asked to rate them in terms of strength of preference.

For instance, people might be asked to compare two environmental improvement programs and
their outcomes, and state which is preferred, and whether it is strongly, moderately, or slightly preferred
to the other program.

Advantages of the Contingent Choice Method

1. The contingent choice method can be used to value the outcomes of an action as a whole, as well
as the various attributes or effects of the action.
2. The method allows respondents to think in terms of trade-off which may be easier than directly
expressing dollar values. The trade-off process may encourage respondent introspection and make
it easier to check for consistency of responses.
3. Respondents are generally more comfortable providing qualitative rankings or ratings of attribute
bundles that include prices, rather than dollar valuation of the same bundles without prices
4. Survey methods may be better at estimating relative values than absolute values.
5. The method minimizes many of the biases that can arise in open ended contingent valuation
studies where respondents are presented with the unfamiliar and often unrealistic task of putting
prices on non-market amenities.
6. The method has the potential to reduce problems such as expressions of symbolic values, protest
bids, and some of the other sources of potential bias associated with contingent valuation.
Issues and Limitations of the Contingent Choice Method

1. Respondents may find some trade-offs difficult to evaluate, because they are unfamiliar.
2. The respondents’ behaviour underlying the results of a contingent choice study is not well
understood. Respondents may resort to simplified decision rules if the choices are too
complicated, which can bias the results of the statistical analysis.
3. If the number of attributes or levels of attributes is increased, the sample size and/or number of
comparisons each respondent makes must be increased.
4. When presented with a large number of trade-off questions, respondents may lose interest or
become frustrated.
5. Contingent choice may extract preferences in the form of attitudes instead of behaviour
intentions.