We assume in economic theory that the preferences of consumers will determine their welfare.

Student id: 324247

Part 1:

We assume in economic theory that the preferences of consumers will determine their welfare. It is sometimes necessary to place a value on those preferences. When an event occurs which has an effect which can’t solely be valued through market prices, another valuation method is required. This occurred in 1989, where an oil tanker, the Exxon Valdez, ran aground in Alaska spilling millions of gallons of oil into the sea. Fishing suffered as a result, but there were other consequences of the spill; these needed to be valued to get an accurate picture of any compensation levels. CVM’s ‘popularity’ as a valuation method has grown over recent years; the concept of this growth has been the acceptance that “preserving and improving the environment is never a free option” (Pearce et al 1989) in addition to the realisation that the environment does have an effect on peoples welfare, and to maximise people’s welfare, the environment becomes a major factor.

For any environmental resource, there are different use values; direct use values are those values which come from direct usage of the resource. Indirect use values refer to benefits people indirectly derive from the resource, for example through ecological functions. The value placed by people who don’t use a value now but would like to keep the possibility of future use are called option values. Altruistic values, where other individuals’ use of the resource is valuable; bequest values for leaving the resource for future generations; and existence values where we value just having the resource there all come into non-use values. The Contingent Valuation Method (CVM) is a method of placing a monetary value on non-market ones; otherwise known as passive use values.

The CVM is used to estimate economic values for environmental services. The method is essentially a direct approach - to ask people their valuation of an environmental good. This is done by asking what value they would be willing to pay for an environmental benefit, or willing to accept to receive as compensation to tolerate a cost. Evidently, people value environmental resources, and a valuation is needed if the resource is somehow violated, but because they are essentially public goods without a monetary market, we need to know what value we can place on it. Because the environment is public, it has non-rival and non-exclusive consumption properties. Everyone has free access to the good, as such their benefits would be treated as zero, unless people are actually asked what value they have. It is referred to as a stated preference method, because it asks people to directly state their values. The methods of surveying, interpretation and evaluation are discussed later, but the values given by those surveyed are used to give the monetary amount of the total economic value of the resource.

The CVM is an attempt to place a value on those aspects of people’s own preferences and valuations of an environmental resource which would otherwise monetarily be treated as zero. It can be argued that we can not place a monetary value on a clean and sustainable environment. Animals and environmental resources have a value which doesn’t apply to humans, their own intrinsic value; their right to exist. The environment is not a commodity and as such, can not be treated as one. However in the case of the Exxon Valdez oil spill, it was evident that the human, non human and environmental costs could not be accurately measured just by the cost of the clean up operation and loss to the fishing and shipping industries; the CVM had to be used, even if it could just be seen as an attempt to place monetary value on the total environmental damage caused by the spill. The aim of the CVM was to create valuations (estimations), which are close to those that would occur if the market existed.

Part 2:

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Part 2:

CVM was used in the evaluation of the Exxon Valdez spill, and due to the high interest in the case, it has become one of the most high profile, but most controversial valuation methods. The method of how the CVM is conducted is the first major discussion. CVM estimates the value of non-market goods by using surveys that directly ask the value of the good. In the market for a normal good, people have an idea of what value they can place on the good, and so we get their true Willingness To Pay (WTP) from their actions (with Exxon Valdez, the mean WTP was found to be $30 to stop it happening again). However no consumer will know what value they place on environmental resources; they do not know if £30 is or £1000 is appropriate when considering the protection of an environmental resource.

CVM attempts to give consumers a good starting place for a value. The first step of the CVM is to define the valuation problem. This would be determining exactly what services are being valued, and who the relevant population is. They are establishing a hypothetical market. They have to make preliminary decisions about the survey itself, deciding how the CVM will be conducted, how large the sample size will be, who will be surveyed, and other factors. Person to person interviews are seen as the most effective, however they are very costly. Telephone interviews, mail questionnaires and other methods may be used, but the results attained through this method may not be as accurate as the personal interviews, which will be more effective in description and setting up of the survey. The surveyors will need to make sure those surveyed will be exactly clear on what they are valuing; the location, the effects of the hypothetical market and so on. An exact method of payment, be it a one off payment, taxes, price increases, also need to be decided. The CVM is also tested on small groups to assess the quality of the survey, before it is used on the relevant survey population. Evidently a poorly designed study will produce unreliable estimates of the valuation. What is unknown is if the weaknesses that are apparent with CVM are because of the actual calculation method, or if they could be fixed with an appropriately designed survey.

The CVM is a stated preference model where people state what they would pay. This is seen as a major weakness of the model as it is only hypothetical. Those surveyed will have no reference to guide them as to how much to state. The way in which the survey is designed may have an effect on how much the people will state as their valuation, possibly through leading questions. Also, the people know themselves that they won’t actually have to pay the money, and so will be more willing to state a higher preference value. To get a value of WTP or WTA, an individual may be asked to name an amount; an open ended survey. This is comes with the problem of individuals not knowing how much they should state. Secondly, they could be given an amount, and they respond with a yes or no. Values rise until a maximum WTP or fall until a minimum WTA is reached. There is often starting point bias here as the initial value given by the survey may influence what value the person may eventually accept.

The wording of the questions would be an important factor. One concern could be who actually conducts the survey. Had the oil company produced it, it could have been worded in such a way as to bias any results toward a low compensation. The opposite could occur if the surveyors were environmentalists. With Exxon Valdez, if the individuals were asked their WTP to avoid the spill and were also told the spill was could indirectly effect their water supplies or could alternatively increase oil prices, this would affect their valuation compared to if they had simply been asked for their valuation without the extra information about the spill. The individuals must also be sure of what they are being asked. They may express a WTP for a question because they believe the aim of the question to be something else, talking generally about an area, not for the desired subject.

The hypothetical bias comes from the fact that the survey and payment is actually hypothetical. They do not actually have to pay, and so their WTP will be different to if it was an actual market. They may give high answers, especially if they believe that their answers may influence the future government policies for the environmental quality of that resource. The “warm glow” effect could also come into play here as people may give high values because giving ‘for the social good’ is morally good. Low results could be achieved if they believe their answers will affect how much they will eventually have to pay for the resource. For example, if individuals are told that a service will be provided if the total aggregated sum they are willing to pay exceeds the provision costs, and that each will be charged a price according to their respective WTP, each individual would have an incentive to understate their valuations.

The embedding effect is where the specific and wider issues become confused. In our case, this could have been where values given for the conservation of the specific oil spill area and Alaska as a whole would have been almost equal. The order in which questions are asked is important as studies have found for example, that WTP to preserve whales and seals will be different, depending on whether individuals were asked to preserve whales or seals first in the survey. Information bias could also be a CVM problem, as this leads from starting point bias, where the survey informs the individual of a starting price and moves on from there.

Methods of payments are a major stumbling block for CVMs, as the method by which the individuals would pay has a significant effect on the WTP stated. For example, people are more sensitive to tax rises and so would give a lower WTP if taxes were the payment method. The people asked and their involvement with the resource will surely affect WTP. Someone who fished in the waters of southern Alaska will surely give a high WTP to avoid the oil spill. Linked to this, those who have little experience of the Alaskan economy and environment will essentially be forced to give a value which may be inaccurate as they are unaware of the full effects, especially as these hypothetical markets would have a very limited effect on them; those who choose not to respond to questions would appear to hold an extremely low valuation compared to those who faced direct use values.

One of the final major criticisms of the CVM is seen when considering which mode is used, either Willingness To Pay or Willingness To Accept. They should, in theory, be approximately the same, however, the Pearce and Barbier study in 2000 found that the WTA is typically between five and fourteen times higher than WTP. Others have decided that the use of either WTP or WTA should depend on property rights – if the individual has right to access or benefit from the environmental good then WTA should be used, if not, then WTP is more suitable (Hanley et al 2001). WTP is essentially concerned with environmental benefits, while WTA is associated with accepting cost. There is normally a higher value associated with reducing the environment ten there is when trying to improve it.

The effects of these criticisms of CVM are debated, whether they are overstated or understated, they do have some effect on the outcome of a CVM. The results of any study will always be contested, usually by the party who has to pay for the compensation, who will try to identify flaws with the study. With Exxon Valdez, the initial value placed for compensation by the courts was eventually slightly reduced through this very reason, settling eventually on an out of court settlement of Exxon paying $1.1billion plus the clean up costs, and $3billion in non use values. Despite the possible pitfalls with the CVM, there are remedies for most of the potential problems, and with a stringently designed survey, the CVM can become a good reference point for any environmentally related valuations.

Part 3:

We will now consider other valuation methods which can be used. The Hedonic Pricing (HP) method is based on the idea that the value of an asset is derived from benefits which are associated with that asset, including the benefit of environmental properties. In our context, the HP is applied to asses what proportion of the value of house prices is made up from the environmental benefits gained from the location of the housing. There are problems with HP, in so far as we can have omitted variable bias, whereby we do not include all relevant variables into the equation, which will affect the emphasis given to other possibly less important variables. Linked to this, there should not be multicollinearity; the variables should not be linked, if they are, this will again bias the results. The choice of how results are presented will also affect results, with the choice of using logs or natural logs as an example.

Markets inside the model can also be segmented, for example, the rental market, low and high house price market all have different demand levels. Future expectations with new environmental issues also affect the prices of houses, depending on the type of expectation.

The Travel Cost Method (TCM) works on the premise of valuing time. This is normally used when placing a value on public sites, which have a free admission. It works on the premise that cost of using a site is more than admission, this includes monetary and time valued costs. It also assumes that individuals will have a different TC for a site dependant on where they live. The TCM is undertaken by examining distance from a site, number of visits, and all relevant costs incurred. This method also has its weaknesses. The TCM requires a large amount of data to be a respectable and accurate valuation. Data collection is very time consuming and expensive. The method also has no way of accounting for multipurpose trips, where the use of the site is not the only reason for travel. Despite these limitations, the TCM can be seen as a valid valuation method, with the correct data.

Each different valuation method has its merits and limitations, and there are clearly situations where certain methods will not be appropriate. HPA would not be a good method for valuing visibility values in Alaska; TCM is certainly good at attaining values for recreational sites, but evidently has no scope for considering non use values. CVM is only essentially a good method when considering a hypothetical market. A real market, where prices are pre-determined, would already show WTP and so disregard the need for the study. When considering use values with CVM, it has been found that it relates closely to those values found under the TCM and HP methods.

All the different methodologies have their drawbacks. None can be seen as ‘correct’, but just because they are imperfect doesn’t mean they should be disregarded. CVM does have the added benefit of being able to combat most of its apparent deficiencies, while also being the only study to take into account non use values. The ‘Blue Ribbon’ Panel recommended certain aims for each CVM, assessing if the CVM was a good, legal possibility. They recommended certain guidelines, for example; a sample size of at least 1000 for a single open ended study; high non response rates would render the survey unreliable; a face to face interview being preferred; full reporting of data is required with test surveys going ahead; the WTP format is preferred with a design which is more likely to underestimate WTP than overestimate it. The Panel found that if these guidelines were adhered to, and could be proved in a Court of Law that the study was a fair and true one, it could be used in court as a valid valuation method and guide.

It is apparent that a valuation method is required in certain instances where the market value cannot be determined, or indeed where there isn’t a market. In the Exxon Valdez case, the effect of the spill were more than just the clean up operation costs and the like; the environmental damage caused by that leaked oil was far reaching and needed to have some sort of valuation placed on it to ensure possible correct compensation could be achieved. The valuations which can be achieved through these studies are essentially a guide as to the value people place on environmental resources.

References:

Current issues in environmental economics: P Johansson, B Kristrom, K Maler;
Natural Resource and Environmental Economics: Perman, Ma, McGilvray & Common;
Environmental Economics and Policy: Lesser, Dodds, Zerbe;
Economics of Natural Resource and Environment: Pearce, Turner;
Environmental Economics: Kolstad;
Journal of Environmental Economics;

Smith and Osbourne, vol. 31.3

Diamond vol. 30.3

Journal of Economic Perspectives, vol. 8 no 4.
Lecture Handouts.

Environmental Economics Assessment 2:

Contingent Valuation Method, and its use in quantifying environmental damage.

(1) Outline the rationale for the use of the CVM. Why do we need to use a method of this nature? What does the CVM actually identify? Does it try to value something which is inherently invaluable?

(2) Provide a detailed examination of the alleged methodological weaknesses with the CVM.

(3) Provide Conclusions. Should the CVM be used in a court of law? If not, what alternatives are there?

Student I.D. 324247