Evaluation of green economy I

Dr. G. Liobikienė
Content:

• Cost benefit analysis;

• Multi-criteria environmental evaluation (rank
method, compensatory and non-
compensatory weight methods);
• Environmental values;
• The main indirect methods applied to evaluate
environmental damage (travel cost, hedonistic
pricing method);
• The linkage between ecology and economics can be made by describing our
physical surroundings as possessing environmental functions. As soon as the uses
of these functions compete with each other, the environment has an economic
aspect. The main conflict boils down to using environmental functions, such as an
unsustainable way by maximising production in the short run, on the one hand,
and using functions sustainably in order to benefit from them in the long run, on
the other.

• The evaluation of environmental goods poses a major new challenge to

economics. It is not possible to simply apply, without extension, existing theory
about demand for private goods to environmental goods and other public goods.
Indeed, it is possible that demand for private goods will turn out to be the trivial
case for some new theory of demand in which the demand for public goods is the
general case.

• The environment often displays the characteristics of a public good, in these cases
there is open access (as when the public cannot be precluded from enjoying fresh
air because they have not paid for it), and is not apparently depleted (there is no
less water at a seaside resort because someone has swum in it). These public
goods aspects of the environment are obvious sources of social utility, but they
appear to command a price of zero in the market. Even where the environment
can be depleted (fish stocks decline) and the public can be excluded (no access to
a beach spot unless one pays the entry fee), the prices that result often reflect
administered powers rather than market forces.
Cost-benefit analysis:
the comparison of costs and benefits of
public goods projects to decide if they
should be undertaken
Approaches:
• cost-benefit analysis examines the trade-offs in terms of the costs and benefits of a
policy; and
• cost-effectiveness analysis determines the least-cost option of attaining a pre-
defined target.

• CBA is a quantitative analytical tool to aid decision-makers in the efficient

allocation of resources. It identifies and attempts to quantify the costs and benefits
of a programme or activity and converts available data into manageable
information. The strength of the method is that it provides a framework for
analysing data in a logical and consistent way. CBA helps managers answer
questions such as:
• Does the proposal provide a net benefit to the community as a whole?
• Should the proposed project, programme or policy be undertaken?
• Should the project or programme be continued?
• Which of various alternative projects or programmes should be undertaken?
• Social and environmental costs and benefits are not
included in Market analysis. Only private costs and benefits
are included, as they have monetary value.
• Environmental assets also have value, and degradation of
the environment leads to various dis-benefits. Economic
activity creates environmental costs, preserving the
environment creates environmental benefits. These have
to be measured to ascertain the environmental CBA of
economic activity.
• Conventional CBA operates on the premise that market
efficiency is a pointer to social efficiency if one can simply
spot the market’s failures and correct for them.
Environmental impacts are one source of missing markets
(i.e. externalities) . In evaluating a project or policy, the
environment can be treated as a free factor of production,
even though real costs may be involved.
Steps of cost benefit analysis:
• Evaluating the environmental values it is very
important the discount rate, however there
are several problems:
– Inflation;
– The money could be devaluated;
– People in the future could be richer and the
importance of money can reduce;
– People tend to use money now, but not after
several years.

Zero discount rate reveals that the current and

future environmental values are equal.
• Discounting is applied to benefits received and costs incurred in the future
for two reasons. First, people generally prefer to receive benefits sooner
rather than later, and to pay costs later rather than sooner. Second, money
that is available now can be invested and earn a return. Thus, money
available now is worth more to people than money received in the future.
• High discount rates imply giving low values to future damages, and thus,
betting against the environment and future generations. A distinction can
also be made between public or social discount rates and private discount
rates. Both sectors use a positive discount rate (that is r > 0), but there is a
difference in the fact that the social discount rate is lower than the private
discount rate. This is because individuals (private sector) are mostly
concerned with their own welfare in the very short term, and they are risk-
averse, discounting future benefits heavily. On the other hand, the public
sector (society as a whole) tends to have a longer-term perspective, entailing
lower discount rates.
• Discount rates of even 1–2 percent per year shift the costs of environmental
degradation to later generations, and reduce incentives for long-term
environmentally favourable projects. From the environmental point of view,
instead of exponential discounting when assessing future costs and benefits,
a slowly declining rate of discount (reaching zero percent per year) could be
used to give more value to the future. However, sometimes it is argued that a
low discount rate (equivalent to a low rate of interest, therefore cheap loans
from the banks) will promote investments that might be environmentally
damaging.
Discounting value depend on:

• a) Current level of income;

• b) Redistribution of future incomes;
• c) Information about environmental impact in
future;
• d) The level of responsibility;
• e) Moral values.
Cost benefit analysis example

• MD – marginal damage, MAC- marginal abetment cost, e1-current emission level.

• In the case of e2, the benefit of project to reduce damage is equal to a+b, meanwhile the cost is equal b, thus
pure benefit is equal to a.
• In the case of e* MD=MAC, pure benefit will be equal to d+a
Principles of cost benefit analysis:
• 1) optimal analytic cost – cost of analysis
should be less than benefit of receivable
information;
• 2) Particularity – methods should evaluate the
major share or environmental impact;
• 3) comprehensibility and transparency –
method should be easily understandable and
applied;
• 4) democracy – analysis should include and
single people choices.
CBA is a quantitative analytical tool to aid decision
making. It helps management in the efficient
allocation of resources for the project. It identifies and
attempts to quantify the costs and benefits of a
project and converts available data into manageable
information. The strength of the method is that it
provides a framework for analyzing data in a logical
and consistent way. CBA helps management to know:
• (i) whether the project proposal provides a net
benefit to the organization,
• (ii) whether the proposed project is to be
undertaken,
• (iii) whether the project is to be continued,
• (iv) which of various alternatives of the project is to
be undertaken.
 Criticisms of the cost–benefit approach
• a) How evaluate monetary value of environmental
resources as clean weather.
• b) How evaluate irreversible changes of environmental
impact, which deny the assumption of cost benefit
analysis that benefit could be shifted in time.
• c) How to evaluate the complication of ecosystems and
the turn point when the environmental damage could be
too big.
• d) How to choose the discount rate to evaluate the
environmental problems. Ecological investments for which
is characterized long term and vague benefit and big and
short term cost, monetary discount flows reduce
investment pure value (f.e. climate change)
Multi-criteria analysis (MCA) methods:
• These methods can help to evaluate and compare quantitate and
qualitative variables. Evaluation perform applied matrix analysis
where is evaluated an alternatives according gm criterions.

• This matrix is defined as table of evaluation. This method can

encompasses quantitate criterions (measured using intervals
or ratio scales), qualitative criterions (measured using nominal
or ordinal scales) and both types of criterions.
Criteria used should be:

• internal consistency and logical soundness;

• Transparency;
• ease to use;
• data requirements not inconsistent with the
importance of the issue being considered;
• realistic time and manpower resource
requirements for the analysis process;
• ability to provide an audit trail;
• software availability needed.
• If the evaluation results are vague, we can evaluate them using probability and
sensitive analysis.

• A key feature of MCA is its emphasis on the judgement of the decision making
team, in establishing objectives and criteria, estimating relative importance
weights and, to some extent, in judging the contribution of each option to each
performance criterion. The subjectivity that pervades this can be a matter of
concern. Its foundation, in principle, is the decision makers’ own choices of
objectives, criteria, weights and assessments of achieving the objectives,
although ‘objective’ data such as observed prices can also be included.

MCA techniques commonly apply numerical analysis to a performance matrix in

two stages:
• 1. Scoring: the expected consequences of each option are assigned a numerical
score on a strength of preference scale for each option for each criterion. More
preferred options score higher on the scale, and less preferred options score
lower. In practice, scales extending from 0 to 100 are often used, where 0
represents a real or hypothetical least preferred option, and 100 is associated
with a real or hypothetical most preferred option. All options considered in the
MCA would then fall between 0 and 100.
• 2. Weighting: numerical weights are assigned to define, for each criterion, the
relative valuations of a shift between the top and bottom of the chosen scale.
Steps in a multi-criterian analysis
The main categories of MCA techniques

• Range method which referrers to comparison of two alternatives.

General relationship between preferences could be applied
presented partial or fully analyzed order of alternatives according to
aspect of goodness.
In the scale form to 1 presented not the goodness of alternatives
according to used criterion, but the level of strength of preferences
comparing analyzed alternatives. The general feature of range method
is that preferences of people to very preferred and indifferent.

• Compensatory MCA techniques since low scores on one criterion

may be compensated by high scores on another. The most common
way to combine scores on criteria, and relevant weights between
criteria, is to calculate a simple weighted average of scores.
• Non-compensatory MCA techniques that does not permit trade-
offs between criteria, i.e., poor values for an option on one criterion
cannot be offset by better values on another criterion.
Comensatory multicriteria methods:
a) Compromise – the point of this method is the comparison of two
alternatives using two criterions. By conducting survey initially is asking for
respondents to choose between two alternatives which criterion is more
important. In next stage is asking how much they prefer not evaluate first
criterion that they reach the best level of other criterion. The answers let
compare and evaluate criterions according to their importance.

a) Swing weighting – refers to creation of two scenarios W and B. Scenario W

is the situation when all meanings of criterions are the worst, and scenario
B is situation when all meanings of criterions are the best. For respondents
is stated that current situation correspond W scenario and asked to
evaluate potential advantage by shifting from W to B, and decided what
criterion they would like to shift to B scenario. Assuming that this first
shifting is equal to biggest value 100. In turn there is asking of respondents
which criterion they would like to shift which value is less from 100.
Therefore Swing weighting requires judgements of the swing in preference from
0 to 100 on one preference scale as compared to the 0-to-100 swing on another
preference scale. The judgements are made by considering the difference
between the 0 and 100 positions, and how much that difference matters. Those
two considerations take account of the range of real-world difference in the
options on the criteria, and the importance of that difference to achieving the
overall objective. Swing weighting results in ratio scale numbers that reflect the
relative importance of the criteria.
• c) SMART – is simpler range methods of criterions
encompassing and evaluation of criterions which is
performs via two steps. Firstly for respondents is asked to
range changes in importance of criterions from the worst
to bets, that is assessed the relative importance of all
criterions comparing with the least important criterion.
The received sum of weights is equal to 1.
• d) Conjugate choice method – is typical overall procedure,
when is asked of respondents to rage or to evaluate
alternatives according all pack of criterions. Later this
preferences by applying regression analysis is decomposed
in order to evaluate the function and importance of single
value. This method is very simple whereas the
respondents rage choices between two alternatives
indicated each value of tools. The problem of this method
is that people choosing the alternative of political tools
sometimes degrade their value.
The main methods of non-compensatory multi-criteria analysis:

• a) direct allocation of points- when respondents are

asked to allocate the fixed number of points between
criterions. Usually 100 % of points are divided between
all criterions;
• b) relational weight method is parallel for direct
allocation of points method, where respondent firstly
have to rage criterions according to the level of
importance and when asked of them to weight
according to necessity;
• c) Analytic hierarchy methods encompasses multi-
criteria elements of value theories and rage methods.
The features of MCA evaluation:

• 1) set of alternatives: discrete (finite) or

continuous (endless);
• 2) Scale of measurement: quantitative of
qualitative;
• 3) The rules of decision making: priorities of
price;
• 4) Function of evaluation: standartization or
evaluation.
Schema of evaluation:
Alternatives →(continuous) Leaner forecasting; interactive
methods
↓ (discrete)
Measurement →(qualitative) regime, Evamix, inversion, graphical
methods
↓ (Quantitative)
Rule of decision making →(price) Cost benefit analysis, cost
effectiveness analysis
↓ (priorities)
Standardization →(functional) value function, benefit function
↓ (leaner)
Sum of weights
Ideal point method
Graphical evaluation
Methods of evaluation:
• Sum of weights is rather simple and usually applied evaluation
method. For all alternative is assessed scores by multiplying from
corresponding weights and in turn summing weighted results
according to all criterions. If the scores of single criterion is
measured in different scale, before assessment of sum of weights
the scales should be standardize including unidimensional scales.
• Values and benefit function is evaluated performing benefit
analysis. There the important element is value and benefit. If in the
case of sum of weight is usually used leaner function, in this case
the type of function depends on criterions attribution. Value
function can be related physical scores to index revealing these
scores value.
• Ideal point method refers to assumption that there is ideal level of
selecting objectives and accepting the decision the benefit reduce if
our decision deviate from ideal point. In the environmental
strategies we reach to achieve wanted level of environmental
quality but not maximize the results of all alternatives.
• Analytic hierarchy process - the fundamental input to the AHP is
the decision maker’s answers to a series of questions of the general
form, ‘How important is criterion A relative to criterion B?’. These
are termed pairwise comparisons. Questions of this type may be
used to establish, within AHP, both weights for criteria and
performance scores for options on the different criteria. In this case
decomposing the problem levels the decision-maker can pay
attention to elaboration of solutions
• Regime method refers to comparison pair alternatives. In separate
criterion case all pair of alternative are comparing. For the best
alternative is allocated +1, for the worst - -1 for both alternatives -
0, if they are equal. What alternative is better is decided by
evaluating the sum of all criterions. This simple way is applied for
quantitative data. If the data is qualitative they are interpreted as
unknown quantitative weights. The defined set S encompasses all
sequences of weights corresponding qualitative information of
priorities. The distribution of weights is uniform in set S, therefore
the rational extent could be interpreted as probability. The
probabilities are summed in order to range alternatives.
• Inversion method is applied solving the question which sequences of
alternatives ranges correspond to the place showing the place in table of
effects the best. In the case of I alternatives, the possible score of
inversions is equal to I! All inversions could be numbered as p(p = 1,...,I!),
their level of rages is comparing with place showing the information.
Statistical coefficient of correlation between I! sequences of range and
tables of effects J graph to evaluate, Kendal correlation coefficient is used.
• Evamix metod is a generalization of concordance analysis in the case of
mixed information on the evaluation of alternatives on the judgement
criteria. Thus a pairwise comparison is made for all pairs of alternatives to
determine the so called concordance or discordance indices. The
comprehensive ranking of alternatives is the results of combination of the
concordance and discordance indices for the qualitative and quantitative
criteria. The set of criteria in the multi-criteria evaluation table is divided
into a set of qualitative (ordinal) criteria O and a set of quantitative
(cardinal) criteria C. It is assumed that the differences between
alternatives can be expressed by means of two dominance measures.
These scores represent the degree to which alternative dominates
another alternative.
• Graphical evaluation the usage of graph in order to evaluate the structure
and relationship. Beside the results presentation in graph could be the
best presentation of received results for society.
Why estimate natural resource values?
• Government agencies must make decisions about
how to allocate public investments to protect and
restore the natural environment.
• Environmental program managers have to
consider many objectives, including environmental
quality, threats to natural resources, and impacts
on people’s quality of life.
• Agencies must justify their decisions, not only in
terms of benefits to the natural environment, but
also in terms of fiscal accountability and public
support.
Why do we need to estimate environmental
benefits?
• To justify and decide how to allocate public
spending on conservation, preservation, or
restoration initiatives.
• To consider the public’s values, and encourage
public participation and support for
environmental initiatives.
• To compare the benefits of different projects or
programs.
• To prioritize conservation or restoration projects.
• To maximize the environmental benefits per euro
spent.
Environmental values
• Values is divided to:
– Primary or values of market goods and services;
– Secondary or values of non market goods and services

Also values could be divided to :

- direct use values;
- indirect use values;
- potential use values – value which could be paid the
future generations to save environment.

General environmental value=use value + non use

value
 Use environmental values:
Direct use is most obvious value category, as the economic benefits can be calculated by
making use of market information. The outputs of the resource can be directly consumed:
• - a forest may yield annually a certain amount of wood that can be sold or used for heating
and construction;
• - pastures provide space for some livestock
• - a lake provides fish to fisherman;
• - enjoying nature (recreation).
Many studies show that cleaner air (a natural resource) leads to less respiratory diseases and
considerably less mortality. So health costs can be influenced positively by improving air
quality. As the output (clean air) directly can be consumed, it is still classified as “direct use”,
but assessing the money value will already be more difficult than

Indirect use of natural recourses relates to functional benefits, the outputs provide a social
benefit from ecosystem functioning (e.g. water purification, erosion protection or carbon
sequestration).

Option value, where individuals are willing to pay for the future use of the resource (e.g.
future visits to national parks, clean surface and ground water, avoiding of erosion to enable
future use of pastures).
 Non use environmental values
• Traditionally economic value of environmental goods and
services has been associated with direct consumption of
marketed items, like e.g. timber harvesting or grazing. Yet,
the growth in demand for non-market environmental
goods and services (like e.g. recreation, wilderness or
natural beauty) has led to the recognition that many
aspects of environmental goods and services “produce
benefits that extend well beyond their simple, direct use”.
In order to encompass them in the economic analysis,
economists have broadened the spectrum of economic
values associated with environmental goods and services
to two main categories, namely, use values and non-use
values.
• There is very important ecocentric values. Meanwhile due
to the anthropocentric attitude the Earth is depleted.
Two types of non-use value of environment can be
distinguished:

• Bequest values - this reflects the publics’ willingness to

pay to ensure future generations to enjoy the same
environmental benefit in the years to come. This
relates to the willingness to pay for preserving existing
habitats, species and ecosystems. It also includes the
willingness to pay to prevent for irreversible changes
(for example: extinction of species).
• Existence value - this non-use value reflects the
“moral” or philosophical reasons for environmental
protection, unrelated to any current or future use. It is
related to the for example the scientific society and the
value from knowledge of continued existence of
species, habitats and ecosystems.
The economic approach to evaluate the environment
• Market failures
–(i) environment provides services that are public goods;
–(ii) many environmental services are affected by externalities;
–(iii) property rights related to natural resources and their services are often
not clearly defined.

• Valuation of natural resources and of the environment can help resource

managers to deal with the effects of market failures, by measuring their
costs to society, in terms of lost economic benefits.
• The costs to society can then be imposed, in various ways, on those who
are responsible, or can be used to determine the value of actions to
reduce or eliminate environmental impacts.
• Values of natural and environmental resources are measures of how
important they are to people –what they are worth.
• It is not necessary for natural and environmental resources to be bought
and sold in markets in order to measure their value in euros
Environmental evaluation according monetary
expression:
• The environmental features is valuable only than, when
is including at the least in one individual benefit
function or at least one enterprises production
function.
• Peoples directly and indirectly pay for environmental
“capital”. Directly peoples pay their money that see the
unique environmental places, assign money for
environmental organizations. Indirectly people pay
money for environment referring to willingness to pay
more for environmental friendly goods and services.
• Economists declare that the maximum sum of money
which individuals are willing to pay for particular
environmental facility is the perfect evaluation of
environment showing its components impact on
people well-being.
Environmental evaluation according market based changes

• Do – current demand function, D1- demand function in the case of changes in environmental goods
quantity.
 Market prices
• The most obvious way of measuring the value of nature is to see how
much crop, fish, wood, livestock, etc. can be obtained by sustainable use
of the natural habitat. By surveying crops, woodcutting, cattle breeding,
etc., in combination with (local) market prices, the direct use value can be
measured.

• This method can of course only be applied if direct use values are to be
estimated, the production (and surpluses) and market prices are known.

• In principle the application of the method is rather straight forward,

measuring production (surplus), observing prices and multiplying the
quantities with the prices.

• The method of using “market prices” is often used to assess the (a part of
the) value of natural habitats (wetlands, forests, pastures, etc.).
Application
• To apply this method basically two types of information are needed: - production
quantities of marketable goods (on the precondition, that the level of production is
“sustainable”, that is to say, does not exceed the carrying capacity of the natural
habitat) - local market prices.
• Once these two issues are know, the total value of direct use for a certain category
can be estimated. The method is very applicable in regions where not all products
are sold for money (partly exchanged and partly consumed by the producer).

To apply the methodology, first an overview must be made of the potential direct use
values. This may include:
• - crop growing (at small and integrated scale), including non cultivated picking herbs,
medical herbs, fruits, etc.;
• - cattle breeding (also taking into account the carrying capacity);
• - fish;
• - hunting of mammals and birds;
• - firewood;
• - wood for construction;
• - (clean) water extraction;
• - recreation (or economic activities related to recreational activities)
Production function method
• The productivity method is used to estimate the economic
value of ecosystem products or services that contribute to the
production of commercially marketed goods.
• Water quality affects the productivity of irrigated agricultural
crops, or the costs of purifying municipal drinking water.
• The economic benefits of improved water quality can be
measured by the increased revenues from greater agricultural
productivity, or the decreased costs of providing clean drinking
water.
• Example: A reservoir that provides water for a city’s drinking
water system is being polluted by agricultural runoff. Agency
staff want to determine the economic benefits of measures to
eliminate the runoff.
• The productivity method is selected because this is a
straightforward case where environmental quality directly
affects the cost of producing a marketed good—municipal
drinking water. Thus, the benefits of improved water quality can
be easily related to reduced water purification costs.
Applying the production function method
• Collect data regarding how changes in the quantity or
quality of the natural resource affect:
–costs of production for the final good
–supply and demand for the final good
–supply and demand for other factors of production

• Need to link the effects of changes in the quantity or

quality of the resource to changes in consumer surplus
and/or producer surplus, and thus to estimate the
economic benefits.
• Example: the resource is a perfect substitute for other
inputs. Increased water quality in a reservoir means that
less chlorine is needed for treating the water. The benefits
of increased water quality can be directly measured by the
decreased chlorination costs.
Travel cost method
• Part of economic behaviour can be measured by looking
at how individuals spend their money and time. The
Travel Cost method aims at measuring travel costs in
relation to visits to for example natural habits. As it
measures the actual travel expenditures of individuals (as
a function of distance) in relation to for example the visit
to a natural habitat, the recreational value of the natural
habitat can be measured.

• The basic assumption behind this valuation method is

that someone who has low expenditures to make a visit
to the natural habitat, has a higher “consumer surplus”
than the visitor of the habitat that pays a lot to get there
(due to longer distance).
Assumption of travel cost method:
• People visit one place;
• The time spend in recreation places is equaled
to wage.

• This method is suitable to evaluate the

changes in indicators of environmental quality.
• In the case of current water quality demand is D0, if the
water quality was improved, the curve of demand have
been moved to D1.
Travel cost method including price:

• D-demand curve, P- price, colored area – the recreation benefit due to the
improvement of water quality.
The steps of travel cost method:
• 1) Identification of environmental good or
service, which will be evaluated;
• 2) Arrangement of survey, scenarios and variables
which will be used for evaluation;
• 3) Performance of survey (by internet, telephone,
directly) choosing randomly the respondents,
sample size and considering to season;
• 4)Data gathering – removed incorrected
questionnaires;
• 5)Analysis of data;
• 6) evaluation of willingness to pay.
• Disadvantages of travel cost method;
– Inconvenient;
– Not evaluate the alternatives;
– Researches not encompass visitors which had no
expenditure;
– Comparison is impossible;
– Not evaluate the situation when is observed the
reduction of visitors due to the overcrowding;
– Evaluate only the recreation but not
environmental value;
– Problems of discount rate.
• Hedonic pricing is a valuation method making use of
revealed preferences. For example, the prices of
property is compared with certain environmental
characteristics like noise, vicinity of nature, valuable
ecosystems, natural habitats, biodiversity, clean water,
etc. By statistical analyses the environmental or nature
valuation attributes in the price of property can be
separated (for example, price of property decreases by
0.5% by an increase of the noise level with 1 dB(A)).
This method is mostly applied to noise, but it can also
be applied to nature by looking at values of property
near natural areas (for example the price of dwelling)

• When all determinants of dwelling price are equal but

the value increase due to environmental quality, this
change in these prices reveals environmental value.
Applying hedonic pricing requires access to and capacity to
process large amounts of real estate market information,
environmental characteristics of property, etc. So normally,
such projects can only be undertaken by statistically well
educated researchers.

Often, researchers make use of earlier estimates. For example, if

the relationship between the value of property and a change
in noise level of 1 dB(A) is established in general terms (for all
property applicable), this relationship can be applied in other
situations as well, if certain demands are met (see paragraph
on benefit transfer for further reading).

The assumption of hedonistic pricing:

– People should know the environmental quality in particular zone;
– Hedonistic pricing method encompasses real (dwelling) markets.

The hedonistic pricing method is based on consumer behavior.

Disadvantages of hedonistic pricing method:

– The method is inconvenient and requires difficult

empirical models;
– Need comprehensive data, which is not sufficient
or inacceptable;
– The reduction of environmental interest can
distort the results;
– The environmental pollution is diffusive and
people should know the real level of pollution.