CHAPTER SIX

VALUATION AND COST

BENEFIT ANALYSIS OF
ENVIRONMENTAL
RESOURCES
 Valuation of the environment
• From an economic perspective, values can be associated
equally with the consumption of goods and services purchased
in markets and with the services from environmental amenities
for which no payments are made.
• In this sense, anything from which an individual gains
satisfaction is deemed to be of value, so long as the individual
is willing to give up scarce resources for it.
• The total economic value of environmental amenities
comprises explicit use value as well as implicit non-use value.
• 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 includes 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.
• Option value is the value an individual places on the potential
future use of the resource.
• 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.
• The intrinsic value of nature reflects the belief that all living
organisms are valuable regardless of the monetary value
placed on them by society.
 Categories of environmental values
1. Direct use values; goods and services directly consumed by
users
A. Products
B. Recreation
C. Waste assimilation
D. Research
E. Education
2. Indirect use values; indirect benefits arising from ecological
system
A. Biological support
B. physical protection
C. climate regulation
D. Global life support
3. Non use value
A. Option value
B. Existence value
Bequest motive
Stewardship motive
Benevolence motive
4. Intrinsic value
Economic valuation techniques
• 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.
• Environmental economists have developed a number of
market and non market based techniques to value the
environment. Some of these techniques are classified based on
monetary valuation, either market-based, or non-market-base.
1. Market pricing approach
2. Replacement cost approach
3. Hedonic pricing method
4. Household production function approaches
4.1. Aversive expenditures
4.2. Travel cost method
4.3. Contingent valuation method
1. Market pricing approach
• The market pricing approach is used when the environmental
improvement under consideration causes an increase or
decrease in real outputs and/or inputs.
• For example
1. Consider a decrease in timber harvest that can effectively
expand a wilderness area
2. Expected increase in fish harvest due to the implementation
of a new water pollution control technology
3. An increase in crop yield arising from a legislative mandate
of a higher air quality standard.
In the above examples, benefits from environmental
improvement (avoided damage) are identified in terms of
changes in outputs or inputs.
• Thus, where environmental improvement is directly associated
with changes in the quantity or price of marketed outputs or
inputs, the benefit directly attributable to the environmental
improvement in question can be measured by changes in the
consumers‘ and producers‘ surpluses.
• Let us consider the pervious example about the effect of a
higher air quality standard on crop yield.
• The actual effect of the higher air pollution standard can shift
the supply curve from S0 to S1, indicating an improvement in
crop yield.
• In other words, since improved air quality enhances crop
yield, other things equal, at every level of output farmers are
now willing to sell their crop at a lower price than prior to the
legislative enactment to improve environmental quality.
• As a result of the shift in the supply curve, the market price for
the agricultural commodity will fall from P0 to P1.
• Obviously this would lead to an increase in consumers‘
surplus. Furthermore, if the shift in supply is associated with
significant cost saving, the producers‘ surplus will also be
rising.
• P
• A S0
• E S1
• B F
• D0
• D Q
• Initially at point E the social surplus was measured by the area
of triangle ABE. And with the rise in supply the social surplus
will increase to area DAF.
• The net gain in the social surplus which is area DBEF is the
value of the increased environmental quality.

2. Replacement cost approach

• This approach is used as a measure of benefit when the damage
that has been avoided as a result of improved environmental
conditions can be approximated by the market value of what it
cost to restore or replace the damage in question.
For example, acid rain, among its other effects, is known to
accelerate the deterioration of a nation‘s infrastructure, such as
highways, bridges and historic monuments.
• Suppose a given nation passed a bill that reduces the emissions
of acid rain precursors (sulfur and nitrates) by 50 per cent. And
for the sake of simplicity, assume that all the sources of these
pollutants emanate from within the boundary of the nation.
• One obvious outcome of a legislative mandate of this nature is
to slow down the deterioration of the nation‘s physical
infrastructure.
• If the replacement cost approach is used to measure this
benefit from avoided environmental damage, it will be
assessed on the basis of the savings realized from reduced
expenditures on repairing, restoring and replacing the
nation‘s infrastructure.
3. Hedonic pricing approach
• Environmental features can increase land and house values if they
are viewed as attractive or desirable, or they can reduce values if
they are viewed as nuisances or dangerous, and therefore
undesirable.
• Given a choice between two houses offered for the same price and
identical in every other respect, except that one is closer to a landfill
site, home buyers will choose the house that is further away.
• At some lower market price of the closer house, home buyers will
become indifferent in choosing between that site and a higher-priced
one further away from the landfill site.
• In this way, then, people are implicitly revealing their willingness to
pay for avoiding the nuisances associated with a landfill by paying
higher prices for houses located further away from such a site.
• This is the typical case of a hedonic price where the value or price of
an environmental feature is imputed by looking at the effect that its
presence has on relevant market priced goods.
The household production function approaches
1. Aversive expenditures
• In the household production function approach benefits from
improvement in environmental quality are measured by looking at
households‘ expenditures on goods and/or services that are substitutes
or complements for the purpose of avoiding environmental damage.
• Examples of such types of household expenditure include installing
soundproof walling to reduce noise; purchasing radon-monitoring
equipment to protect oneself from exposure to radon gas; purchasing
water filters to reduce the risk of drinking contaminated water;
frequent hospital visits to reduce the chance of serious ailments from
prolonged exposure to air pollution; frequent painting of residential
dwellings due to smoke emissions from a nearby factory; and so on.
• In each of these cases, we observe that households are willing
to pay a certain amount of money (price) to avert specific
environmental damage(s). Therefore, these expenditures,
commonly known as aversive expenditures, can be used as a
measure of households‘ willingness to pay for a certain level
(standard) of environmental quality (quietness, clean water,
clean air).
2. Travel cost method
• Another variation of the household production function
approach involves the valuation of environmental services
from recreational sites, such as national parks.
• A special technique that is used to estimate the benefit from
changes in the environmental amenities of recreational sites is
known as the travel cost method.
• This method measures the benefit (willingness to pay)
stemming from a recreational experience, by looking at
households’ expenditures on the cost of travel to a desired
recreational site.

3. Contingent valuation method

• The approaches considered so far share two common features.
First, willingness to pay is measured by using market prices
either explicitly (in the case of the market pricing approach) or
implicitly, such as via the prices of substitutes and
complementary goods and services traded through the
ordinary market.
• Second, in these approaches the stress has been exclusively on
estimating use values. These are benefits or satisfactions
received by individuals who are directly utilizing the services
(amenities) provided by the natural environment.
• However, there are several attributes of the natural
environment from which individuals obtain satisfaction and
hence benefits. For example, the value of wilderness cannot be
measured only by its recreational values to current users; it has
nonuse values to the extent that there are people who are
willing to pay to preserve wilderness for future uses.
• Such nonuse value may not be captured by approaches that are
anthropocentric in their focus and confined to measuring the
willingness to pay of resource users at a particular point in
time.
• This could be a serious problem when the resources under
consideration involve long-time horizons, considerable
uncertainty and/or irreversibility. Unfortunately, these are
characteristics common to many environmental assets.
• Contingent valuation represents the general techniques or
procedures used to elicit willingness to pay in this broad and
inclusive sense.
• In the contingent valuation approach, willingness to pay is
elicited by conducting a survey.
• A carefully selected sample from the relevant population is
asked to respond to a series of meticulously worded questions
about their willingness to pay, contingent on changes in the
availability and/or quality of an environmental amenity.
• The survey is designed in such a way that individuals are
faced with a hypothetical market-like choice and are then
asked about their willingness to pay for a specific end.
• In the contingent valuation method, the design of the
questionnaire is crucial. It requires an in-depth knowledge of
statistical survey methods, economics, ecology and, most
importantly, a good deal of creativity and imagination.
• Hence, normally, a good contingent valuation survey involves
a collaborative effort of people from different fields of studies;
environmental scientists, economists, policy analysts and
statisticians.