DEMAND FOR ENVIRONMENTAL GOODS :-

Individual demand curve :- depends on individual marginal valuation

of goods at different levels.
Determinants:- income, substitutes/complements.
Aggregate demand curve ➔ summation of individual demand curve.

Demand curve for environmental goods :- How much is the

willingness to pay for particular level of environmental goods.
Examples:- air quality, clean rivers etc.

Problem: characteristic of public good

Difficult to measure demand curve ➔ no market for environmental good
(Difference)
Similarity with conventional good
→consumption of environment goods also involves trade offs.
(consumer theory).
Difference between ordinary public goods and environmental goods.

Ordinary public goods:-

They are produced at a cost. So consumers have a reference point to
cost. E.g. roads, schools

Environmental goods:-
disconnected from supply side. E.g. forest

willingness to pay:
concept of price and consumer surplus is also applicable despite
absence of market.

Price ➔ Marginal willingness to pay

Surplus ➔ total willingness to pay

Note: Consumer surplus is equal to total surplus, since there is no

payment for pollution.
Prices and Marginal willingness to Pay

The negative value of MWTP implies :

• demand curve lies in the fourth quadrant.
• Individual needs to be compensated for additional unit of pollution.
• At a particular level of NOX, MWTP is higher for higher income level.
Value of marginal damage from one unit of pollution is always equal
to marginal benefit from one less unit of pollution.
Types of environmental goods:
Use Value vs Non Use Value

Use value is the value derived form consuming a good.

In the case of environmental goods it include the current use, expected
use and possible use.

Direct impact of environment.

• Damage to health
• Economic cost (Production cost)
Material damage causes less direct impact on humans. (soiling of
building)
Indirect impact of environment:
Damage to ecosystem (agriculture, forests, fishery, pharmaceuticals and
recreational use of ecosystem)
Non use value:
It is a gain in the person’s utility without the person actually
consuming the good.
e.g. Ecosystem in remote part of the world.

Altruistic Value: Value one derives from others utility/welfare.

Existence Value: A value attached to knowing something exist.

Bequest Value: Well being of descendants.

• Measuring Demand for Environmental goods

1. Revealed Preference: Observe real choice from some market and

infer information on the trade off between money and
environmental good.

Types:
I. Hedonics: how the price of conventional goods (e.g- house)
varies as amount of closely related environmental good changes
(air quality).

II. Household Production:- assumes that consumer will combine

private and environmental good to produce another good.
Observed expenditure on private good will be the lower bound
value of environmental good/bad.
2. Stated Preference: (hypothetical market) -- Asking people how
they would trade off money for environmental good. E.g.
Opinion polls & surveys
Limitation:
• Absence of real choice, Lack of realism
• Difficult to get accurate information

Types:

Contingent Valuation Method: direct revelation from potential

consumers; Value contingent upon there being a market.
3. Experimental market:
Subjects are given some money and asked to make choice using that
money.

Constructed market: hypothetical or real

1. Laboratory experiments to find how people trade money for

environmental goods.
Limitations :
• These are Expensive.
• Based on non random samples: so generalization become difficult

2. Official referendum : Environmental goods offered to community

through referenda.
E.g. government announce tax/ subsidy proposal and people state
their preference through voting.

Other:- Benefit transfer: poor man’s approach

Revealed Preference and Restricted Demand

Estimate demand curve for environmental good.

• By observing actual behaviour of individuals.
• By looking at how they make trade off between market good and
environmental good.

Demand of conventional good depends on:-

• Own price
• Price of complementary goods
• Price of substitutes
• Income/wealth

We cant derive demand of environmental good in the same manner. (no

market ➔ no price)

Solution:- Restricted demand

Restricted Demand
x = h(px, q)
x is the quantity of market good
px is the price for market good
q is environment good

ΔWTP/ Δq = MWTP = f(px , q)

It is restricted demand for q.

Only variable is q in this case
which is linked with the market
of good x.
Willingness to Pay (WTP):
What a person would pay for more of an environmental good.
Willingness to Accept (WTA):
What a person would accept as a compensation for a little less of an
environmental good.

Generally, MWTA >> MWTP

WTP is determined by income

or wealth but WTA is not. E.g:
flood
Change in the environmental
good is large (non marginal)
and q & x are not perfect
substitute.

Indifference curve should be

curved or DD curve for
environmental good is downward
slopping.
Question:
Suppose Jose consumes only housing (H) and air quality (A) so that
U(H,A) = A.H
His Income = Rs. 10, PH = Rs. 2

a) If air quality is 2, how much housing does he consume? Plot his IC

and budget constraint.
b) If air quality rises to 4, how much housing does he consume?
Plot his IC and budget constraint.
c) How much he is willing to pay for this improvement in air quality from
2 to 4?