Unit 4.1, 4.2,4.

3 Total economic value

Synopsis:

· Total economic value

· Hedonic price

· Contingent valuation method

· Travel cost model

A) Total economic value (TEV):

It is a concept in cost–benefit analysis that refers to

the value derived by people from a natural resource, a

man-made heritage resource or an infrastructure

system, compared to not having it. It appears in

environmental economics as an aggregation of the (main

function based) values provided by a given ecosystem.

The value of an ecosystem can be distinguished as: Use

Value – Can be split into Direct and Indirect use values:

· Direct use value: Obtained through a removable

product in nature (i.e. timber, fish, water).

· Indirect use value: Obtained through a non-removable

product in nature (i.e. sunset, waterfall).

Non-use value – Values for existence of the natural

resource. For example, knowing that tigers are in the

wild, even though you may never see them.

Option value: Placed on the potential future ability to

use a resource even though it is not currently used and

the likelihood of future use is very low. This reflects

the willingness to preserve an option for potential

future use.

Bequest value or existence value: Placed on a resource

that will never be used by current individuals, derived

from the value of satisfaction from preserving a

natural environment or a historic environment (i.e.,

natural heritage or cultural heritage) for future

generation
Altruistic value: Value of knowing that other

individuals in this generation benefit from the

environmental good

Existence value: Value of knowing that the

environmental good exists even if no one in this

generation or in the future generations will ever use it.

Stewardship is defined as the “conducting, supervising

or managing of something, especially the careful and

responsible management of something entrusted to

one’s care." "The responsible use of resources,

especially money, time, and talents.”

"Economic Value Management is an integrated approach

to managing any organization, one that is based on the

principle of stewardship (and the inexorable

consequences of failed stewardship)."

All three

words, economic, value and management speak to the

concept of stewardship and to its consequences.

Stewardship is defined as the “conducting, supervising

or managing of something, especially the careful and

responsible management of something entrusted to

one’s care." "The responsible use of resources,

especially money, time, and talents.”

Economic implies not accounting or record keeping, but

rather means a process “marked by careful, prudent

use of resources”, “yielding advantageous returns or

results”.
Value is defined as something “held in high esteem or

appreciation”, “having worth”, something that is “valid,

sound”. It is a “measurement of relative worth”, “the

estimate in which something is held related to

principles or standards of what is valuable in life”, and

“the quality of a thing considered in respect of its

power and validity for a specified purpose or effect”.

Management is defined as “judicious use of means to

accomplish an end”, “the application of skill or care in

the conduct of an enterprise”, “the exercise of

executive, administrative and supervisory direction”,

and “the taking of control of the course of affairs by

one’s direction.” It is “the fulfilment of duties,”

“handled or directed with a degree of skill”, “treated

with care”, “carried on successfully” “to achieve one’s

purpose”.
B) Hedonic Pricing: Hedonic pricing evaluates the

benefit of a non-market characteristic (e.g.,

pollution, fatality risk) on market prices. It is

most commonly applied to variations in

residential prices reflecting the value of local

environmental attributes.

Examples:

1. Value of sound walls:

The difference in price between houses adjacent to

a freeway with a sound wall and similar houses

adjacent to a similar freeway without a sound wall.

2. Value of reduced travel time to central city:

The difference in price between similar houses

located at different travel time distances from

the central city.

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, safety features, fuel economy, etc.

The individual characteristics of a car or other good

can be valued by looking at how its price people changes

when controlling for other characteristics.

Uses of Hedonic Pricing:

Hedonic pricing is a convenient method for estimating

transportation-related benefits and disbenefits

affecting residential property values. These can be

negative benefits of transportation facilities such as

freeway noise, or positive benefits such as improved

access to activities.
Application of the Hedonic Pricing:

Method Using Residential Prices

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:

o selling prices and locations of residential properties

o property characteristics that may affect selling

prices, such as lot size, number and size of rooms, and

number of bathrooms

o neighbourhood characteristics that may affect

selling prices, such as property taxes, crime rates, and

quality of schools
o accessibility characteristics that may affect prices,

such as distances to work and availability of public

transportation

o environmental characteristics that may affect prices

Data on housing prices and characteristics are available

from municipal offices, multiple listing services, and

other sources.

Step 2

Once the data are collected and compiled, the next

step is to statistically estimate a function that relates

property values to property characteristics.

Regression analysis is typically used to estimate the

influence of various property characteristics.

A model for a set of factors determining house prices

could be: P = f (D, S, V, E, H, T)

P = Price
D = Distance from the nearest central business district

S = Size of house

V = Rating of view

E = School quality

H = Proximity to highway

T = Proximity to transit This is called a hedonic price

function.

The regression typically uses the logarithms of the

values for the various factors.

A statistical analysis package such as the Regression

function in Microsoft Excel or SPSS can be used for

the computations of the following type of equation:

ln (P) = ln β0 + β1 ln (D) + β2 ln (S) + β3 ln (V) + β4 ln (E)

+ β5 ln (H) + β6 ln (T) + e
The β values represent the role that each factor plays

in the value of the residence.

For example β5 is the value of each unit of proximity

to the highway.

Advantages of the Hedonic Pricing Method

o The method's main strength is that it can be used to

estimate values based on actual choices.

o Property markets are relatively efficient in

responding to information, so they can be good

indications of value.

o Property records are typically very reliable.

o 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.

o The method is versatile, and can be adapted to

consider several possible interactions between market

goods and transportation benefits.

Issues and Limitations

o The scope of benefits that can be measured is

limited to things that are related to housing prices.

o The method will only capture people's willingness to

pay for perceived differences in attributes.

o The method assumes that people have the

opportunity to select the combination of features they

prefer, given their income. However, the housing

market may be distorted by outside influences, like

taxes or interest rates.

o The method is relatively complex to implement and

interpret, requiring a high degree of statistical

expertise.
o The results depend heavily on model specification.

o Large amounts of data must be gathered and

manipulated.

C) Contingent valuation:

Contingent valuation is a method for estimating the

value of benefits that do not have an established

monetary value. It utilizes surveys that ask people how

much they would be willing to pay for specific benefits.

It is called "contingent" valuation, because people are

asked to state their willingness to pay, contingent on a

specific hypothetical benefit.

Examples

o Value of traveller information: Survey travellers to

determine what they would be willing to pay for a

specific, but not yet available, type of information.

o Value of highway landscaping: Survey travellers to

determine what they would be willing to pay for

highway landscaping, or how they value it relative to

other trip characteristics with established values, such

as travel time.

o Value of a wilderness area: Survey constituents to

determine what they are willing to pay to have this

wilderness area even if they may never use it. This is

sometimes referred to as the "existence value."

Contingent valuation is especially useful for valuing: o

Benefits that cannot be bought and sold, such as scenic

views o Things that people may never use, such as

wilderness areas (often referred to as existence value)

o Things that benefit others, such as highway

overpasses to preserve wildlife habitat o Services or

products that do not yet exist.

Key Issues: Contingent valuation is based on what

people say they would do (stated preference), as

opposed to what people are observed to do (revealed

preference). What people say something is worth to

them may not be the same as what they would actually

be willing to pay for it. Therefore, contingent valuation

is not an appropriate method if the value can be

estimated based on outside, quantifiable factors.

Unless the contingent valuation survey is carefully

designed and executed, the results may be significantly

biased. The survey must be designed to provide value

estimates that are either representative of the people

to whom the benefit will accrue, or in the case of

products that don't exist yet or that would benefit an

absent group, are pertinent to the situation. Also, the

benefit should be presented so that respondents

understand exactly what they would entail.

Designing and analysing a contingent valuation survey

requires specialized skills, and the execution of the

survey can be expensive. Therefore, a contingent

valuation study is only justified when the benefits that

it is intended to measure are expected to be important

or are common benefits that would be similarly valued

across many sites thus allowing for value transfer.

Contingent Valuation Method:

Step 1

The first step is to define the valuation problem. This

would include determining exactly what benefits are

being valued, and who the relevant population is. In the

case of traveller information, the nature of the

information, its accuracy, frequency of updating,

method of dissemination, and cost to user would be

among the relevant characteristics of the benefits. In

the cases of a scenic view or highway landscaping, the

benefits should be shown visually. The relevant

populations in the case of traveller information would

be those people who could avail themselves of the

information. Similarly the relevant population for the

scenic views and landscaping would be travellers on the

roads where these were located.

Step 2

The second step is to make preliminary decisions about

the survey itself, including whether it will be conducted

by mail, phone, internet, in person, or in groups; how

large the sample size will be, who will be surveyed, and

other related questions. The answers will depend,

among other things, on the importance of the valuation

issue, the complexity of the question being asked, and

the size of the budget available to do the contingent

valuation study. In-person interviews are generally the

most effective for complex questions.

Step 3

The next step is the actual survey design. This is the

most important and difficult part of the process. It is

accomplished in several steps. It usually starts with

initial interviews or focus groups with the types of

people who will be receiving the final survey. The

survey designers would ask these people general

questions, including ones that dealt with peoples'

understanding of the issues related to the benefit. In

later focus groups, the questions would get more

detailed and specific, to help develop specific questions

for the survey, as well as decide what kind of

background information is needed and how to present

it. Then the survey would be pre-tested to determine

if people understand the hypothetical benefits and if

the survey questions elicit clear, reasonable answers.

Step 4

Next is the sample design. The sample can be randomly

selected from the relevant population, using standard

statistical sampling methods. It may be preferable to

use a stratified sample if different sub-populations are

expected to respond differently or to have a different

response rate. Because the purpose of the survey is to

estimate some mean or median value, the required

sample size will depend upon the variation in valuations

by respondents. The pre-test results can be used to

estimate this variation, which can then be used to

determine the sample size needed for the desired

confidence interval.

Step 5
The final step is to compile, analyse and report the

results. The data must be analysed using statistical

techniques appropriate for the type of question. Non-

response bias can be dealt with in a number of ways.

The most conservative way is to assume that those who

did not respond have zero value for the hypothetical

benefit. The average value for the survey respondents

can be calculated and applied to the total relevant

population to obtain a value for the total benefit.

D) Travel-cost method

The travel-cost method (TCM) is used for calculating

economic values of environmental goods. Unlike the

contingent valuation method, TCM can only estimate

use value of an environmental good or service.

It is mainly applied for determining economic values of

sites that are used for recreation, such as national

parks.

For example, TCM can estimate part of economic

benefits of coral reefs, beaches or wetlands stemming

from their use for recreational activities (diving and

snorkelling/swimming and sunbathing/bird watching).

It can also serve for evaluating how an increased

entrance fee a nature park would affect the number of

visitors and total park revenues from the fee.

However, it cannot estimate benefits of providing

habitat for endemic species.

TCM is based on the assumption that travel costs

represent the price of access to a recreational site.

Peoples’ willingness to pay for visiting a site is thus

estimated based on the number of trips that they make

at different travel costs. This is called a revealed

preference technique, because it ‘reveals’ willingness to

pay based on consumption behaviour of visitors. The

information is collected by conducting a survey among

the visitors of a site being valued.

The survey should include questions on the number of

visits made to the site over some period (usually during

the last 12 months), distance travelled from visitor’s

home to the site, mode of travel (car, plane, bus, train,

etc.), time spent travelling to the site, respondents’

income, and other socio-economic characteristics

(gender, age, degree of education, etc).

The researcher uses the information on distance and

mode of travel to calculate travel costs. Alternatively,

visitors can be asked directly in a survey to state their

travel costs, although this information tends to be

somewhat less reliable. Time spent travelling is

considered as part of the travel costs, because this

time has an opportunity cost.

It could have been used for doing other activities (e.g.

working, spending time with friends or enjoying a

hobby).

The value of time is determined based on the income of

each respondent. Time spent at the site is for the

same reason also considered as part of travel costs.

For example, if respondents visit three different sites

in 10 days and spend only 1 day at the site being valued,

then only fraction of their travel costs should be

assigned to this site (e.g. 1/10).

Depending on the fraction used, the final benefit

estimates can differ considerably. Two approaches of

TCM are distinguished – individual and zonal. Individual

TCM calculates travel costs separately for each

individual and requires a more detailed survey of

visitors.

In zonal TCM, the area surrounding the site is divided

into zones, which can be either concentric circles or

administrative districts. In this case, the number of

visits from each zone is counted.

This information is sometimes available (e.g. from the

site management), which makes data collection from

the visitors simpler and less expensive.

The relationship between travel costs and number of

trips (the higher the travel costs, the fewer trips

visitors will take) shows us the demand function for

the average visitor to the site, from which one can

derive the average visitor’s willingness to pay.

This average value is then multiplied by the total

relevant population in order to estimate the total

economic value of a recreational resource. TCM is

based on the behaviour of people who actually use an

environmental good and therefore cannot measure non-

use values.

This method is thus inappropriate for sites with unique

characteristics which have a large non-use economic

value component (because many people would be willing

to pay for its preservation just to know that it exists,

although they do not plan to visit the site in the

future).

The travel-cost method might also be combined with

contingent valuation to estimate an economic value of a

change (either enhancement or deterioration) in

environmental quality of the NP by asking the same

tourists how many trips they would make in the case of

a certain quality change.

This information could help in estimating the effects

that a particular policy causing an environmental quality

change would have on the number of visitors and on the

economic use value of the NP.