Environmental Economics: Valuing the Environment

The Contingent Valuation Method • Stated preference technique • Questionnaire based • Direct method • Valuation of a hypothetical scenario - It is called “contingent valuation” because

Environmental Economics II

Dr Anil Markandya

Room 3E 4.31b

Categories of environmental

benefits

• Use Value (UV)

• Existence Value (EV)

• Option Value (OV)(Option Price = Expected

Use Value + OV.

• Quasi Option Value (QOV)

• Bequest Value (BV)

• Total Economic Value (TEV)

• TEV = UV+EV+OV+QOV+BV

The Contingent Valuation Method

• Stated preference technique

• Questionnaire based

• Direct method

• Valuation of a hypothetical scenario

- It is called “contingent valuation” because

the valuation is contingent on the

hypothetical scenario put to respondents

• Non Use Values + Use Values

• Willingness To Pay (WTP) question

Stated Preference Techniques: CVM

An interview is used to create the hypothetical market within these questions are

asked The hypothetical market comprises two key parts:

a statement of the proposed change; and

an institutional mechanism through which the proposed change is to be

provided/avoided and financed

The challenge in conducting a CV is to make the market as realistic as possible.

The process of directly questioning a sample group to ascertain their valuation of a change can be divided into six stages These are (each with a number of steps):

definition of survey objectives;

design of the questionnaire;

surveying the sample population;

creating a database and performing an exploratory data analysis;

estimating WTP values; andreporting the survey results

CVM: Stage 1 - Project Definition - Theoretical Model

CV study should begin with a basic theoretical model: two purposes:

Identifies the information required from questionnaire Generates predictions allowing results to be checked Number of sources of information that can be used to construct the

model, including:

predictions of economic theory and existing literature,

discussion/meetings with focus groups/affected parties.

Participants discuss understanding of the context of the good/service in question, the good/service itself, its “value”, who should provide it,

how it should be paid for, whether they would contribute, etc.

The information from the focus groups is particularly valuable in

designing the CV survey.

CVM: Stage 1 - Project Definition - Sample Design

For a site-specific resource, the sample may be drawn from:

Visitors to the site (‘on-site’ sample)

• does not elicit information on the WTP of ‘non-users’; •

interviews must be kept short; • procedure is needed to select

among visitors to a site

Households within a certain radius of the site (‘off-site’ sample)

• geographical boundaries need to be defined; • a larger sample required, many households may not visit the site

It is also important to carefully select the size of the sample:

A larger means more confidence that the sample mean WTP/WTA is a reliable estimate of the ‘true’ mean WTP/WTA (Balance precision and cost)

CVM: Stage 2 - Questionnaire Design - Background Questions

General background: Questions on general characteristics of the

respondents – information for checking the validity of the valuation

results

Respondents’ tastes and socio-economic characteristics (is the

sample representative?) Personal details - should , come at the end of the questionnaire

Respondent’s knowledge of the commodity in question, e.g

background questions concerning the respondent’s visits to a recreation site should cover such issues as:

• attitudes towards environmental issues; • proximity of their home to the site; • frequency of visits; • duration of trip; • reason for visit, etc.

These questions should be asked at the beginning of the interview as they are relatively straightforward to answer, and will help to build-up the respondent’s confidence.

CVM: Stage 2 - Questionnaire Design - Preparation Questions

To avoid bias, interviewer must make sure the respondent is aware of:

budget constraints (you cannot spend more than you have!)

their right to refuse to pay for the good

If the event of a negative response, the reason must be recorded

a ‘zero valuation’ is implied if:

the respondent may not be able to pay anything; or the respondent may not be willing to pay anything.

a ‘protest bid’ is implied if:

the respondent may find it too difficult to establish a monetary valuation;

the respondent may disapprove of the concept of expressing environmental resources in monetary terms; or may be hostile towards the institutional context.

– 1) “Are you willing to pay X for public good A?”

– 2a) If Yes to (1), “Are you willing to pay Y for public good A?” (Y>X) – 3a) If Yes (2a), “Are you willing to pay Z for public good A?” (Z>Y) – 4a) if Yes to (3a) …

– If No to (Na), WTP questions stop

– 2b) If No to (1), “Are you willing to pay T for public good A?” (T<X)– …

• Payment Cards:

– choose a WTP point estimate from a list of values

• Dichotomous or Discrete Choice CV (Referendum format):

– “Are you willing to pay X for public good A?” => STOP

• Dichotomous or Discrete Choice CV with follow-up:

1) “Are you willing to pay X for public good A?”

2a) If Yes to 1, “Are you willing to pay Y for public good A?”

Respondent simply asked to state maximum WTP for a specific

environmental change

The advantages of the open ended:

Quick and easy to administer and analyse;

Can be performed with a smaller sample size;

Avoids ‘anchoring’ effects - respondents influenced by suggested starting value.

Main drawbacks:

Makes strategic bias, more likely

The respondent may need a reference point to bound value judgement

Respondent must be familiar with the affected commodity in question

CVM: Stage 2 - Survey Design - “Open-ended” Elicitation Format

range of values for the max WTP of individuals pre-set.

sample of respondents is divided into sub-samples.

value within the pre-set range is assigned to each sub-sample (the

source of he so-called ‘anchoring effect’).

Each respondent asked whether WTP assigned value for proposed change

Answer not the max WTP – only consent or refusal to pay a given amount

Random utility theory (logit model) are required to estimate the respondent’s mean and median WTP values Requires large sample.

No Incentive to engage in strategic behaviour.

Easier to convey decision rule - >50% say “yes” ⇒ change provided Realistic – individuals typically make decisions faced with fixed

prices.

CVM: Stage 2 - Questionnaire Design - “Dichotomous Choice” or

“Referendum” Elicitation Format

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CVM: Stage 2 - Survey Design - “DC” Format: An Example

After describing their illness, the respondent was given the following valuation question:

We are now going to ask you a hypothetical question Suppose you were told that, within the next few days, you would experience a recurrence of the illness episode that you have just described for us What would it be worth to you – that is, how much would you pay – to avoid the illness episode entirely?

Remember that you are paying to eliminate all of your pain and suffering, your medical expenditure, the time you spent visiting the doctor or clinic, your missed work, leisure or daily activities.

Bear in mind if you pay to completely avoid being ill this time, you have to give up some other use of this money For example, you may reduce your expenditures for entertainment or education.

Would you pay dollars to avoid being sick at all?

[If NO] Would you pay dollars to avoid being sick at all?

[If YES] Would you pay dollars to avoid being sick at all?

300

100 1,000

“suppose you were told that within the next few days you would have a

recurrence of the respiratory condition that you have just described Would you be willing-to-pay $10 to avoid the illness episode entirely?”

1 “NO”, I would not be willing-to-pay $10

2 “YES”, I would be willing-to-pay $10

If “NO”, would you be willing-to-pay $…

1.a $9 If “YES”, then stop; if “NO”, then go to 1.b

1.b $8 If “YES”, then stop; if “NO”, then go to 1.c

1.c $7 If “YES”, then stop; if “NO”, then go to 1.d

1.k $0.25 If “YES”, then stop; if “NO”, then explain why

CVM: Stage 2 - Questionnaire Design - “Iterative Bidding”

Elicitation Format

NOAA Panel Guidelines

• Conservative design => better to underestimate WTP

• WTP, rather than Willingness to Accept (WTA)

• Referendum format (i.e Yes/No Questions)

• Accurate description of the good/scenario => use of focus

groups and pretest of the survey instrument

• Reminder of substitute commodities

• Yes/No follow ups

• Checks on understanding and acceptance

• Cross tabulations

• Sample size circa 500 is a minimum.

Other important aspects for questionnaire

development (1)

• Mail / In Person / On the Phone interview

• In person => costly, interviewer bias, time consuming,

more accurate, better option if it is difficult to explain the scenario (need pictures), only users if on site

• Mail => low response rate, sampling bias => who takes

the survey? Those who are interested in the topic?,

limited information, relatively inexpensive

• Telephone => relatively inexpensive, limited information,

not accurate, response rate, developing countries?

• Mail + Telephone

• Internet

• Computer based instruments

• Questions on the knowledge of the problem / experience with

the environmental good => USE values, etc

• Description of the scenario

visit the park, etc.

• Attitudinal questions

• Socio – demographic questions Ask questions on Income at

the end of the questionnaire!!! => we don’t want to irritate the respondent

Other important aspects for questionnaire

development (3)

• Identify protest respondents after the WTP questions (ask why the

respondent voted YY, NN, NY, YN)

• Analyze the data for the full sample of respondents, then delete those

respondents that show protest behaviours

• Income Try to get an answer to the income question In developing

countries, sometimes researchers (Cropper, Alberini) ask a list of

expenditures If you have no information on income from some

respondents, don’t loose those observations Add a dummy equal to 1 for those that did not answer the income question, and 0 otherwise Set equal to 0 the income of those respondents that did not answer the

income question In your regression the coefficient of the dummy for those that did not answer the income question tells if they are

statistically different from those that reported income In this way you don’t loose the observations!

• Clearly define the population of interest

• Consider your budget constraint

• Make sure that your referendum question avoids free rider behaviours!

Payment vehicle

• Whose welfare are we interested in?

=> Important for sampling plan

• TAX => One time Tax is incentive compatible

• How do we choose the tax level? Focus groups, previous

research, pretest, optimal bidding design literature, cost of the public program

If Data are not as

Shown, use

Non-Parameteric

Methods

CVM: Stage 2 - Questionnaire Design - Payment Vehicle

Valuation question needs a realistic institutional context - usually an

appropriate payment (or bid) vehicle (instrument) The payment vehicle is

the mechanism through which the WTP/WTA values are to be

raised/distributed.

Key considerations when selecting a payment vehicle are:

familiarity – does the respondent understand the payment vehicle? credibility – does the payment vehicle represent a realistic situation? empathy – is the respondent favourably or unfavourably disposed

towards the recipient of the funds?

feasibility – is the recipient of the funds capable of delivering the

improvement?

universality – would all the respondents be affected by the payment

vehicle?

WTP and WTA

• The goal of contingent valuation is to measure the compensating

or equivalent variation for the good in question Both

compensating and equivalent variation can be elicited by asking a person to report a willingness to pay amount For instance, the

person may be asked to report his WTP to obtain the good, or to avoid the loss of the good Formally, WTP is defined as the

amount that must be taken away from the person’s income while keeping his utility constant:

where V denotes the indirect utility function, y is income, p is a

vector of prices faced by the individual, and q 0 and q 1 are the

alternative levels of the good or quality indexes (with q 1 >q 0 ,

indicating that q 1 refers to improved environmental quality) Z is a vector of individual characteristics

• (Compensating variation is the appropriate measure when the

person must purchase the good, such as an improvement in

environmental quality Equivalent variation is appropriate if the person faces a potential loss of the good, as he would if a

proposed policy results in the deterioration of environmental

quality.)

)

; , , ( )

; , , (y WTP p q1 Z V y p q0 Z

1)

• Willingness to accept (WTA) is defined as the amount of money

that must be given to an individual experiencing a deterioration

in environmental quality to keep his utility constant:

• Where q 2 indicates a deterioration in quality compared to the status quo, q 0

• In equations (1) and (2), utility is allowed to depend on a vector

of individual characteristics influencing the tradeoff that the individual is prepared to make between income and

environmental quality An important consequence of equations (1) and (2) is that WTP or WTA should, therefore, depend on (i) the initial and final level of the good in question; (ii) respondent income; (iii) all prices faced by the respondent, including those

of substitute goods or activities; and (iv) other respondent

characteristics

• Internal validity of the WTP responses can be checked by

regressing WTP on variables (i)-(iv), and showing that WTP

correlates in predictable ways with socio-economic variables

)

; , , ( )

; , , (y WTA p q2 Z V y p q0 Z

2)

Dichotomous-Choice Contingent Valuation

• When dichotomous choice questions are used, the researcher does

not observe WTP directly: at best, he can infer that the respondent’s WTP amount is greater than the bid value (if the respondent is in

favor of the program) or less than the bid amount (if the respondent votes against the plan), and form broad intervals around the

respondent’s WTP To estimate the usual welfare statistics, it is

necessary to fit binary data models.

• The simplest such models assume that an individual’s response to

the WTP question is motivated by an underlying, and unobserved, WTP amount, which is normally (logistically) distributed Formally, let WTP* be the unobserved WTP:

(logistic) error with mean zero The model is completed by specifying the mapping from the latent variable to the observables:

4) WTP i =1 iff WTP i *>B and WTP i =0 iff WTP i *≤B

• where B is the bid that was assigned to respondent i, WTP = 1 means

that the response is a “yes,” and WTP = 0 means that the response to the payment question is a “no.”

i i

3)

• Because we observe discrete outcomes, we must derive the

probabilities of “yes” and “no” responses When attention is

restricted to a normal latent WTP, the probability of a “yes”

response is, therefore:

• Because ε/σ is a standard normal variate,

• where Φ(⋅) is the standard normal cdf If we define α=μ/σ and

β=-1/σ, the probability of a yes response can be rewritten as:

6)

Equation (6) is the contribution to the likelihood by a “yes”

observation (or a one) in a probit model with the intercept and one

which requires that the bid amount be varied to the respondents in the survey, so that it becomes a legitimate regressor in the probit

model—mean/median WTP is estimated as:

7)

) Pr(

)

| 1 Pr(

)

|

i i

i i

σ

ε µ

i i

B

B ) Pr Pr(

= 5)

−

σ

µ σ σ

µ σ

)

|Pr(yes B i = Φ α + β ⋅ B i

β α

µ ˆ = − ˆ / ˆ