Chapter 05: Measuring the Benefits of Environmental Protection

Question 1

What is market and nonmarket benefits?

Answer 1

Benefits pollution control divided two categories:

(1) Market benefits

• Comes from added value to the marke
• Ex. Being healtier = go to work more = pay more

(2) Nonmarket benefits
* Infer how much people willing pay/accept for these benefits if market did exist
* Ex. Being healthier = be happier

Question 2

Determine the nonmarket benefit of environmental protection?

Answer 2

• Use: value in use
  
  • Ex. Clean river = able to use the river to swim
• Option: resource value if future benefits are uncertain and resource depletion is irreversible
  
  • Ex. Can (potentially) use the resource in the future
• Existence: value from the existence of a species
  
  • Ex. Don’t want it = brings a (nonmonetary) smile

TOTAL VALUE = Use + Option + Existence

Question 3

What is consumer surplus?

Answer 3

|Difference between the max youre willing to pay and what you actually pay|
- Cannot be a negative value: Zero or Strictly Positive

• Benefit measure pollution reduction = increase in consumer surplus due to reduction

Two ways determine consumer surplus:

1. Willingness-to-pay (WTP) for improved quality
2. Willingness-to-accept (WTA) compensation in exchange for degraded quality

Question 4

Reservation Price:

Answer 4

Max price (Reservation Price)= highest amount willing to pay

> Reservation Price: Any price above it and the market is gone

Question 5

Market Price:

Answer 5

Rest (Market Price) = consumer surplus

• First unit max: $15 - pay $5 = CS of $10
• Second unit max: $14 - pay $5 = CS of $9

Question 6

Formula for Consumer Surplus:

Answer 6

CS = 1/2(Q*)(P_R-P_M)

Question 7

WTP and WTA:

Answer 7

Two ways determine consumer surplus:

1. Willingness-to-pay (WTP) for improved quality
2. Willingness-to-accept (WTA) compensation in exchange for degraded quality

Question 8

How is the values for WTA and WTP calculated. How do they compare in theory and reality?

Answer 8

For consumer surplus:

• WTA and WTP are on either side of CS

WTA >= CS>=WTP

In theory, because income differences are small, WTA should only be a bit higher than WTP

However:

• WTA value typically 2-7 higher
  Difference presists even in tests controlled for inflation

(1) WTA bit higher than CS - individuals made ritcher when compensated for damage

(2) WTP bit lower than CS- individuals made poorer when paying for environmental improvement

Question 9

What accounts for the difference in WTA and WTP?

Answer 9

1. Endowment Effect: Adding something you dont have not a big deal; taking something away already have is worse
2. No Close Substitutes: Nothing substitutes for something
   Mom’s dead - nothing offered able to compare

Question 10

When is WTP/WTA used?

Answer 10

• Standard Practice: WTP (WTA estimates may be less reliable)
• If we think common property as belonging to “the people” = WTA may be best measurement

Question 11

Ethical question(s) regarding WTA and WTP?

Answer 11

Wither WPA/WTA, use of consumer surplus as benefit measure automatically leads higher benefits for clean-up in wealthier communities

• Rich = willing pay more clean-up, also requires higher levels of compensation for degradation

Ex. Putting a vlaue on the reduced risk of death:
One of the most important benefits of environmental clean-up

Question 12

What are two ways to access risk information?

Answer 12

1. Epidemiological:
   study past cases of human exposure
   
   • Expensive, uncommon, hard
2. Animal studies:
   
   • requies translating information for high-dose animal studies to low dose human exposure. Uncertainties

Question 13

What is preceived risk?

Answer 13

Humans preceive risk differently than actual risks:

1. Voluntary vs. involuntary risk
2. Lack of knowledge
3. Distrust experts
4. People risk averse

Question 14

Risk Aversion:

Answer 14

> Risk Aversion: people dislike exposure to catastrophic events w/ low probability more than unpleasant events occuring w/high probability
Even if they have the same average cost

Risk = Risk/Person * # People

• Two things same risk assessment = not the same risk
  
  • Risk 1/200 people in class die OR the next person walks into the class = both risk 1 (same amount tho different)

Question 15

What are the two sections and three methods for measuring benefits data-collection?

Answer 15

(1) Stated Preferences: Value of benefits obtained from survey methods

Method #1: Contingent Valuation Analysis

(2) Revealed Preferences: Value of benefits inferred from observed market data

Method #2: Travel Cost Analysis

Method #3: Hedonic Regression Analysis

Question 16

Define contingent valuation?

Answer 16

Contingent Valuation: (CV Analysis) Survey methods used by economists to determine the benefit of environmental protection; survey response are “contingent” upon questions asked (ask people WTP/WTA)

Question 17

What are the sources of error for contingent valuation?

Answer 17

1. Hypothetical Bias: leads to hypothetical responses (”if”)
   
   1. The bias exists of a hypothetical question
   2. No consequence for action
2. Free-riding: May lead understatement of true WTP
   
   1. Let someone else pay for it and use it later
   2. Answer dishonestly (assume everyone else answers honestly)
3. Strategic Bias: People inflate their WTP to achieve greater clean-up if they believe they do not have to pay WTP
   
   1. Going to have to do it = think strategically
4. Embedding Bias: Answers strongly affected context provided (MAIN PROBLEM)
   
   1. Ask you a series of questions that lead to a certain conclusion - last question inferred from previous ones
   2. Only publish one
   3. Series of questions leading = intentionally misleading

Question 18

How useful is contingent valuation?

Answer 18

• Disagreement about reliability of CV
• Doing “state of the art job” expensive
• Only available means for estimating existence value component of nonmarket benefits (used widely)

Question 19

What is travel cost?

Answer 19

• Measure amount money people expend to use resource (parks, rivers, beaches)
• Relating differences in travel costs to difference in consumption - demand curve for resource derived and consumer surplus estimated
• Use travel costs to set up demand curve = use to determien CS/WTA/WTP

Question 20

How do you derive a demand curve for travel costs?

Answer 20

Demand Curve Derivated:

Total Consumer Surplus

= Area A surplus + Area B surplus + Area C surplus

= 1000 people * (d + e + f) + 1000 people * ((d + e) - 6*25) + 1000 people * (d-50)

Question 21

How do you determine travel costs for society?

Answer 21

Use subdivisions’s worth * num# people > Add together = value to society

Question 22

What are the problems with the travel costs method?

Answer 22

Problems:

1. People have different opportunity costs
2. Some have alternative recreational opportunities
   Travel cost method has been textended to address both issues

Question 23

What is hedonic regression?

Answer 23

• y = Predicted Value and control variables
• Uses changees in price from related (complementary) goods to infer WTP for healthier environment
• Estimates pleasure (utility) associated improved environment

Question 24

How can hedonic regression be used to assess the value of human life?

Answer 24

Ex. The Value of Human Life

• Most ethically charged aspect of benefit-cost analysis = requirement that we put n montary value on human life

(Old approach - still used court cases) Retired/disabled person = “worth” $0

Economic approach: “wage-risk studies”

• Isolate wage premium people paid to accept risk jobs (police, firefighter)
• Estimate WPA a reduction in the risk of death, and implicity, the value of life
• Holding all else equal
• Not the value of a specific life = amount of money the average individual in society requires to accept a higher risk of death

Question 25

Problems with hedonic regression?

Answer 25

Problems:

1. Accurate Information (Under/overestimation of risk of death)
2. Sample selection bias (People select risky jobs are not likely to represent the “average” person’s preference towards risk-aversion
3. Involuntary nature of risk (Require more to accept risk imposed upon them without their consent)

Moral Issue: puts larger value on life for folks from rich than poor countries