CHAPTER 5

Measuring the Benefits of

Environmental Protection
Introduction
 The benefits of pollution control can be
divided into two categories:
Market benefits
Nonmarket benefits

 Nonmarket benefits are determined by

inferring how much people would be
willing to pay or accept for these benefits
if a market for them did exist
 Symbolized by WTP and WTA
Examples of Market Benefits
 For example, cleaning up a river may
lead to increases in commercial fish
harvests, greater use of tourist services,
and fewer medical expenses and days
lost at work due to waterborne diseases.
 Measuring these market benefits in
dollar terms is a logical approach.
Examples of Nonmarket Benefits
 However, economists have also devised methods for
measuring nonmarket benefits.
 In our example, these would include increased recreational
use of the river (boating, swimming, and fishing), the
enjoyment of greater species diversity in the river, and a
reduction in premature death due to diseases contracted
from contaminated water.
 Nonmarket benefits are measured by inferring how much
money people would be willing to pay (or accept) for these
benefits if a market for them did exist.
 WTP or WTA
Use, Option, and Existence Value

 The nonmarket benefits of environmental

protection:
 Use: value in use
 Option: a resource has option value if the
future benefits are uncertain and resource
depletion is irreversible
 Existence: value from the existence of a
species

 Total Value = Use + Option + Existence

Nonmarket Use Values
 Use value is just that value in use.
Returning to our river example, if people
use a clean river more effectively for
swimming, boating, drinking, or washing
without paying for the services, then
these are nonmarket use values.
Nonmarket Option Value
 An environmental resource will have
option value if the future benefits it might
yield are uncertain and depletion of the
resource is effectively irreversible. In this
case, one would be willing to pay
something merely to preserve the option
that the resource might prove valuable
in the future.
Nonmarket Existence Value
 Finally, economists have indirectly included moral concerns
about environmental degradation, including empathy for
other species, in their utilitarian framework under the
heading existence value.
 For example, if a person believed that all creatures had a
“right” to prosper on the planet, then they would obtain
satisfaction from the protection of endangered species, such
as the spotted owl or the right whale, even if these species
had no use or option value.
 The desire to leave an unspoiled planet to one’s
descendants (a bequest motive) also endows species or
ecosystems with an existence value.
 → Reminds us of the sustainability standard.
Example of Nonmarket Existence Value

 As an example of the potential importance of

existence value, a survey-based study
estimated that Wisconsin taxpayers were
willing to pay $12 million annually to preserve
the striped shiner, an endangered species of
tiny minnow with virtually no use or option
value. As we will see, the results of this type of
study must be interpreted with care. However,
these results do seem to indicate a substantial
demand for the preservation of species for the
sake of pure existence.
Measuring Benefits:
Consumer Surplus
 The benefit measure for pollution
reduction is the increase in consumer
surplus due to such a reduction
 Consumer surplus is the difference
between what one is willing to pay and
what one actually has to pay for a
service or a project
Consumer Surplus from Preservation
Consumer Surplus
 To illustrate how one would apply the
consumer surplus concept to an
environmental good, Mr. Peabody has a
private demand for the preservation of a
trout stream in Appalachia.
 This demand may be based on his
expected use, option, or existence
value, or a combination of all three. His
demand curve is illustrated above.
Consumer Surplus: First Acre
 Initially, 10 acres of stream have been
preserved. Assume that Mr. Peabody did not
pay for this public good.
 Nevertheless, he still benefits from it.
 His consumer surplus from the first acre
preserved is his willingness to pay (WTP)
($60), less the price ($0), or $60.
 We can graphically represent this consumer
surplus area A, lying below the demand curve
and above the price (zero) for the first unit.
Consumer Surplus: Second Acre
 Similarly, for the second acre, he is willing
to pay about $59, which is also his
consumer surplus as the good has a zero
price. Consumer surplus from this unit is
graphically represented as area B.
 Peabody’s total consumer surplus from the
initial 10 acres is graphically represented
by the entire area A + B + C.
Willingness to Accept
 WTP is not the only way to measure
consumer surplus. An alternate
approach would be to ask an individual
his or her minimum willingness to accept
(WTA) compensation in exchange for a
degradation in environmental quality.
 In our example, Peabody could be
persuaded to give up the 11th acre of
stream in exchange for a little more than
$52.
Measuring Benefits:
WTP and WTA
 There are two ways to determine
consumer surplus:
 Willingness-to-pay (WTP) for improved
quality
 Willingness-to-accept (WTA) compensation
in exchange for degraded quality
 In theory, because income differences
are small, WTA should be only a bit
higher than WTP
Problem with WTA and WTP

 WTA values for things such as

preserving land from development are
typically 2 to 7 times as high as WTP
values!

 This difference persists even in tests

specifically designed to control for inflated
WTA figures
Explaining WTP/WTA Disparities:

1. Prospect theory: people may adopt the

status quo as their reference point and
demand higher compensation to allow
environmental degradation than they are
willing to pay to make improvements
 If prospect theory is correct, it would
reshape our marginal benefit curve for
pollution reduction
Prospect Theory and Marginal
Benefits of Cleanup
Explaining WTP/WTA Disparities:

2. Substitution. The degree of

substitutability between environmental
quality and other consumption goods
 If environmental goods really have no
good substitutes this could explain the
difference.
 But is this true?
Additional Concern
 Using either WTP or WTA as benefit measure generates one
additional concern.
 Rich people, by the simple virtue of their higher incomes, will
be willing to pay more for environmental improvement and
will require more to accept environmental degradation.
 In other words, using WTP or WTA to assess the benefits of
identical pollution-control steps in rich and poor areas will
lead to a higher benefit value for the wealthy community.
 As we will see later, the ethical dilemma posed by this
measurement approach appears to be strongest when
comparing WTP and WTA for reduction in the risk of death or
illnesses, between rich and poor countries.
Case Studies on Climate Justice
 Should rich countries pay the bill for
global warming?
 https://www.youtube.com/watch?v=Y5sn
-jMBUlg
 Climate change: how can poor
countries grow without pollution?
 https://www.youtube.com/watch?v=-
h6_hJFD7to
Risks of Equal Mangitude
 Risks of equal magnitude do not necessarily evoke similar
levels of concern. For example, although risks from exposure
to air pollution in California cities are somewhat smaller than
risks from cigarette smoking, as a society, we spend tens of
billions of dollars each year in controlling the former and
devote much less attention to the latter.
 As another example, airline safety is heavily monitored by
the government and the press, even though air travel is
much safer than car travel. The acceptability of risk is
influenced by the degree of control an individual feels over a
situation. Air pollution and air safety are examples of
situations in which risk is imposed upon an individual by
others; by contrast, cigarette smoking risks are accepted
“voluntarily.”
Update on Example from the
Textbook
 Governor Newsom Signs Sweeping
Climate Measures, Ushering in New Era
of World-Leading Climate Action |
Governor of California
WTP/WTA Disparities:
Which to Use?
 The standard practice is to use WTP
because WTA estimates may be less
reliable
 But if we think of common property as
belonging to “the people” then WTA may
be the best measurement
WTP/WTA Measures of Benefits:
BIG Ethical Question
 With either WTA or WTP, the use of consumer
surplus as our benefit measure automatically
leads to higher benefits for clean-up in wealthier
communities.
 The rich will both be willing to pay more for clean-
up, and also require higher levels of
compensation for degradation.
 This is especially apparent when we come to
putting a value on reduced risk of death: one of
the most important benefits of environmental
clean-up. Stay tuned.
Next Step: Risk Assessment and
Perception

 Step 1 in measuring the benefits of

pollution reduction: assess the risks
 Information on health risks come from two
sources:
 Epidemiological: studying past cases of
human exposure
 Animal studies from laboratories
Assessing Risk
 Epidemiological studies: expensive,
uncommon and hard to do well.

 Animal studies: require translating

information from high-dose animal
studies to low dose human exposure,
creating multiple uncertainties
Risk Comparisons:
peanut butter?!
Risk Example: PCBs
 Epidemiological studies have shown that (1)
PCBs cause developmental abnormalities such
as low birth weights and less developed
cognitive and motor weights; (2) exposure to
PCBs are correlated with certain cancers
 In animal studies PCBs have been found to
generate cancers
 EPA : PCBs are “probable human carcinogens”
Perceived Risk
 Individuals may perceive risk differently
than the actual risk for a few reasons:
 Voluntary vs involuntary risk
 Lack of knowledge
 Distrust of Experts
 People are risk averse
Risk Aversion
 An individual is risk averse if they prefer a “sure
thing” to a gamble with a higher expected payoff:
E.g.. If I prefer $50 for sure versus a 50% chance
for $110, I am risk averse.

 Risk aversion: people dislike exposure to

catastrophic events occuring w/ low probability
more than unpleasant events occurring w/ high
probability– even if they have the same average
cost.
Why is nuclear waste
at the bottom?
Measuring Benefits:
Three Methods
 Stated Preference: value of benefits obtained
from survey methods
 1. Contingent Valuation Analysis

 Revealed Preference: value of benefits inferred

from observed market data
 2. Travel Cost Analysis
 3. Hedonic Regression Analysis
Measuring Benefits:
Contingent Valuation
 Contingent valuation (CV Analysis):
 Survey methods used by economists to
determine the benefits of environmental
protection; the survey responses are
“contingent” upon the questions asked
 Basically, ask people their WTP and/or WTA
The CV Method: Oil Tank Clean-Up
Actual Cost is $4 vesus WTP: Positive and
Negative Consumer Surplus
The CV Method:
Oil tank clean-up
 Note that the surveyors reminded people how much they were
spending on gas per month ($Y) when they asked the respondents
for their additional WTP for the cleanup, so that the respondents
would think hard about opportunity cost.
 And as one would expect, the introduction of a personal cost to the
cleanup policy significantly reduced the number of yes votes—and
higher costs led to more and more no votes. By varying the amount
that people were required to pay in the survey (and also by
statistically controlling the factors such as income differences
between respondents and preexisting pro-environmental
sentiment), Johnson was able to construct a “demand curve” for
the cleanup that looked something similar to the one above.
Economic Riddle
Sources of Error in CVs
 Hypothetical Bias
 Hypothetical questions → hypothetical responses

 Free-riding
 May lead understatement of true WTP (hope that
others will “pick up the bill”
 Strategic Bias
 People might inflate their WTP to achieve greater
clean-up if they believe they will not have to pay their
WTP: In this case, a belief that big oil companies would
pick up the bill instead of individuals
 Embedding Bias
 Answers are strongly affected by the context provided
about the issue at stake: MAIN PROBLEM!
CV: useful or useless?
 Economists disagree about the reliability of
CV analysis. Doing a ‘state of the art’ job
can be very expensive

 CVs provide the only available means for

estimating the existence value component of
nonmarket benefits, so they are widely used
Conclusion of Contingent
Valuations
 Despite these criticisms, the CV approach is increasingly
being used by economists, policymakers, and courts. This is
because it provides the only available means for estimating
nonmarket benefits primarily based on existence value, such
as the benefits of preserving the striped shiner.
 These existence benefits are potentially quite large. In the
case of the Exxon Valdez oil spill in Alaska, CV estimates of
damages were on the order of $30 per household, for a total
of $3 billion. This is roughly three times what Exxon actually
paid out in damages.
 Exxon Valdez Oil Spill - 1989, Effects & Location | HISTORY
Measuring Benefits:
Travel Cost
 The travel-cost method measures the
amount of money that people expend to
use the resource (parks, rivers, or
beaches)
 By relating differences in travel cost to
differences in consumption, a demand
curve for the resource can be derived
and consumer surplus estimated
Demand Curve Derived from
Travel-Cost Data: example
Travel Cost Explanation
 Assume that 1,000 people live in each of three concentric
rings, areas A, B, and C, surrounding a national forest. All
these people are identical in terms of their income and
preferences.
 People in area C live farthest from the forest and face travel
costs of $50 to use the resource for a day; they take only one
trip per year. Folks in area B must pay $25 to visit the forest;
they take six trips per year.
 Finally, area A people can wander in for free, and they do so
15 times per year.
Demand Curve Derived from
Travel-Cost Data
 Total Consumer Surplus
= Area A surplus + Area B surplus + Area
C surplus
= 1,000 people * (d + e + f)
+ 1,000 people * [(d + e) – 6 * 25]
+ 1,000 people * (d – 50)
Problems With the
Travel Cost Method
 People have different opportunity costs
 Some may have alternative recreational
opportunities that others do not
 The travel cost method has been extended to
address both of these issues
Example: What’s a Beach Worth?
 The value of Florida Beaches (Bell and Leeworthy)
 Survey 826 tourists: days spent at the beach and
expenses incurred to use the beach, meals, travel
and access fees, initial travel costs in and out of
the state, length of stay, age, income, and other
control data.
 Hypothesis: holding all the other factors constant,
lower beach expenses --> greater number of days
at the beach.
 Results: a 10% increase in “price” lead to a 1.5%
decrease in time on the beach. Average CS per
day of $38. Over 2 million tourists: $2.37 billion per
year.
Measuring Benefits:
Hedonic Regression
 Hedonic regression uses the change in
price from related (complementary) goods
to infer a WTP for a healthier environment
 Confusing label! Hedonic=“pertaining to
pleasure”
 A hedonic regression estimates the
pleasure or utility associated with an
improved environment
Hedonic Regression Example 1:
Property Values and Pollution
 PCB contamination in New Bedford
(Mendehslon et al)
 Compare change in prices for houses sold
before and after contamination became
public. Control for all other factors affecting
home costs.
 Houses closest to the contaminated area:
price declines of $9,000; in area of
secondary pollution, declines of $7,000.
Total damages to home-owners: $36
million
Hedonic Regression Example 2:
The Value of Human Life
 The most ethically charged aspect of
benefit-cost analysis is its requirement that
we put a monetary value on human life
 Old approach, still used in court
settlements: lifetime earnings.
 Can be discriminatory against retired or
disabled person
 Economic Approach: “wage-risk studies.”
Hedonic Regression Example 2:
The Value of Human Life
 Isolate the wage premium people are paid to
accept risk jobs--police officer, firefighter, coal
miner
 With this it is possible to estimate a WTA a
reduction in the risk of death, and implicitly, the
value of life
 Holding all else equal, suppose we observe that
police officers receive extra pay of $500/yr. If the
excess risk of death is 1/10,000 per year then
collectively, 10,000 officers trade one of their
lives each year for $700*10,000=$7 million.
Problems:
1. Accurate information
 Individuals might underestimate or overestimate
risk of death

2. Sample selection bias

 People accepting risky jobs are not likely
representative of the “average” person with
preference toward risk-aversion

3. Involuntary nature of risk

 People may require more to accept risk imposed
upon them without their consent
The Value of a Life
 The value obtained from a hedonic
regression is not the value of a specific life
 We would pay just about anything to save our
own life or that of a loved one!

 Instead, this is the amount of money the

average individual in a society requires to
accept a higher risk of death
Morally OK?
 As with any measure of consumer surplus,
this method will put a much larger value on
life for folks from rich than from poor
countries. Used in court settlements.

 USA: $7 million
 Poorer Countries: $300,000
Review of Measuring Benefits
1. Is consumer surplus a good measure of
benefits, especially for valuing life?
2. Which measure should be used: WTP or
WTA?
3. How reliable is the risk assessment?
4. How broad a scope of benefits should be
included?
5. How precise and reliable are the benefit
measures?
 APPENDIX 8A

WTA and WTP Redux

WTA/WTP: Perfect Substitutes
WTA/WTP: Poor Substitutes
Prospect Theory
or Substitutability?
 One study using candy bars and risk of
salmonella from sandwiches, to determine
peoples’ WTA and WTP. Provided support
for the “no-good substitutes” explanation
for the WTA/WTP discrepancy
 Advocates of prospect theory argue people
do not become as attached to a candy bar
or sandwich as they do to a grove of trees
in a local park
Prospect Theory
or Substitutability?
 People are attached to the status quo
because there are no good substitutes
for environmental degradation from the
status quo
 In this sense, the two explanations
converge