Chapter six

Valuation of Natural & Environmental

Resources
Lecture Note
Instructor: Derese G. (Assistant professor)
Email:dereget21@gmail.com

Derese G. (Assistant Professor) 1

 Introduction
Economists attach values to nonmarketed/unpriced/ goods & services that are
provided by the natural environment.

• Unlike market goods, the value of environmental goods and natural resources
goes largely unmeasured or Markets fail to capture the value because of
environmental and natural resources are :

 public goods (non-rival and non-excludable). They are not traded in markets and
hence they do not have readily available prices that can be used in CBA.

 External costs created by the production or consumption of market goods are not
reflected in the market prices.

 No market for some of natural &environmental resources

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 Cont’d…
What is Environmental Valuation?

Figuring out what people would be Willing to Pay for

environmental benefit or changes in quality

For example: What’s an improvement in water quality

worth?
 May generate an increase in property values

 May generate increases in recreational value

 May generate improved drinking water quality

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 Cont’d…

Environmental goods are public goods (non-rival and non-

excludable).

 They are not traded in markets and hence they do not

have readily available prices that can be used in CBA.

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 Cont’d…

What is value?

How can we measure value?

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 Cont’d…
Economic Value: what people are willing and able to give up for the good
or service in addition to what they are actually pay.

If people are not willing to pay or trade something to obtain a

particular good, economists say that good has zero value

For economists, the values an individual associates with different

commodities are expressions of that individual’s preferences

Value is a measure of peoples preference. People express their

preference through their choice and the trade off that they make
given certain constraint

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 Cont’d…
Economic value is an expression of individual preferences (what
people want)

Values express tradeoffs – how much of one thing to give up for

another

Value – expressed in monetary terms for the seek of comparison

 is the amount of money an individual would give up to obtain

something

 is the amount of money accepted in compensation to give-up

something

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 Cont’d…
Total Economic Value (TEV) or Economic Value (EV)
• total values including direct, indirect, option, and
existence values of the natural resources; a concept in
cost-benefit analysis that refers to the value derived by
people from a natural resource, a man-made heritage
resource, or an infrastructure system, compared to not
having it. It appears in environmental economics as an
aggregation of the (main function based) values
provided by a given ecosystem. Those include use and
non-use values.
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 Cont’d…

Economists measure TEV in terms of :

Willingness to pay (WTP) for a certain environmental
benefit or

Willingness to accept (WTA) compensation for a welfare

loss (due to a decreased utility), or an incurred cost.

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 Cont’d…
“value” can be understood as willingness to pay to avoid loss, or
willingness to accept compensation for loss. Or willing to pay for
improvement in attributes of goods and services.

Value = WTP or WTA( area under the demand curve)

Willingness to pay (WTP): the maximum amount of income the individual will pay in
exchange for an improvement in circumstances or The maximum amount he will pay to
avoid a decline in circumstances

• Willingness to accept (WTA): the minimum amount of income the individual will
accept in exchange for a decline in circumstances. Or It can also be used to elicit what
people are willing-to accept (WTA) to forgo a change or tolerate a change.

 The minimum amount he will accept to forego an improvement in circumstances

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 Equivalently, WTP  m( p, q, u )  m( p, q* , u )
when u  V ( p, q, y ) and y  m( p, q, u )

WTP for a price change :

m( p, q, u )  m( p* , q, u ) when u  V ( p, q, y )

WTA: change in income that makes the individual indifferent between

income y + WTA and public good q (initial state) & income y and public good
q* (final state)

WTA  m( p, q, u* )  m( p, q* , u* ) when u*  V ( p, q* , y )
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 Cont’d…
WTA and WTP differ in terms of:
WTP is limited by one’s income and WTA is
unbounded.

Many environmental goods are public goods, that is

improvements in environmental quality is measured as
WTP and reductions in environmental quality is
measured as WTA.

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 Cont’d…

Important: WTP and WTA are use full mesures for

computing environnemental values for
aménités (positive affects) or négative effets on
the environnemental damage

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 What to value ?(in environment &natural
resources)
 Services of natural & environmental resources

 Source of material inputs (fuels, minerals, wood, water, fish)

 Amenity services (recreation, scenic view, existence value)

 Life support services (breathable atmosphere, climate.)

 Dispersion, transformation and storage of residuals of economic activities

 Public values about the environment

 generally expressed in the market place, nonmarket valuation

has become an important source of information for

environmental decision making .

 Improvement or reduction in environmental quality

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 Classification of Natural Resource Values
 Economists have decomposed the total economic value Natural
Resource conferred by resources into three main components:

1. Use value,

2. Option value, and

3. Non-use value/ passive-use value/

 Since nonuse values are derived from motivations other

than personal use, they are obviously less tangible than use
values.
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 Cont’d…
1. Use value:
reflects the value derived from current use of the environment.

Example: include fish harvested from the sea, timber harvested

from the forest, water extracted from a stream for irrigation,

even the scenic beauty conferred by a natural outlook.

 If you use one of your senses to experience the

resource: sight, sound, touch, taste, or smell-then you have
used the resource.
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 Cont’d…
Direct values

Directly consumable outputs (fish, agriculture, fuel-wood,

recreation, transport, fodder, timber, wildlife harvesting &
energy).

USE VALUES
Indirect values

Functional benefits ( ecological functions, flood

control, storm protection, nutrient retention,
groundwater recharge, climatic stabilization).

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 Cont’d…
2. Option value:

reflects the future direct and indirect use values

(biodiversity & conserved habitats).
 It reflects the willingness to pay to preserve the
option to use the environment in the future even if
one is not currently using it.
i.e. option value reflects the desire to preserve the
potential for possible future use
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 Cont’d…
3. Nonuse value
reflects that people are more than willing to pay for improving or preserving resources that they
will never use.
Non use values= Existence values + Bequest values
Existence values: Value of knowing that the environmental good exists even if no one in this
generation or in the future generations will ever use it. E.g. Welfare from just knowing forest exists.
People wish to maintain or improve environmental assets out of sympathy for nature or from moral
conviction.

 is measured by the willingness to pay to ensure that a resource continues to exist in the
absence of any interest in future use.

Bequest values: is the willingness to pay to ensure a resource is available for your children and
grandchildren = values of leaving use and non-use environmental assets for the enjoyment of
future generation (other people).

 It is based on the desire to make current sacrifices to raise the wellbeing of one’s
descendants.
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 Cont’d…
Total economic value = Use values +Option value+
Non use values

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 Why valuation Natural resources?
Demand
1. Cost benefit analysis: CBA is an economic tool for government policy and investment

project analysis, used for efficient allocation of scarce resources.

2. For different decision in economic analysis involves valuation of the environment.

- Public investments decisions (to improve the quality of environmental resources).

- To Incorporate env’tal impacts (both positive & negative) of policies/projects within

CBA to ensure efficient allocation of env’tal and economics resources

2. To develop regulatory standards for environmental qualities (better resource

management and policy making).

 Developing Regulatory Policy (Standards) need assigning

value to pollution caused by firms and individuals

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 Cont’d…
3. Natural resource allocation
 to decides how much resources to use

 to develop parks and recreation areas (Design of pricing

policies- What should be the gate fees of a national parks)

4. To make compensation and determine liability of peoples for

change in environmental quality (Natural Resource Damage
Asssessmennt (NRDA))
5. To include environmental degradation and resource depletion in
(
national income accounting Environmental accounting (at firm level
and ”green national accounts)

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 Valuation Methods/ techniques
1.Revealed preference
Travel cost method

hedonic pricing

defensive cost

change in productivity

replacement cost

2. Stated preference method

contingent valuation method

choice experiment

3. Market based valuation

market price

increase in productivity

replacement cost (estimate by the cost incurred to restore the e

damage ) Derese G. (Assistant Professor) 23
 1. Revealed Preference Techniques
Revealed Preference Techniques:
Make use of individuals' behavior in actual or simulated markets
to infer the value of an environmental good or service

Involve actual behavior and “indirect” because they infer a

value rather than estimate it directly i.e.
Inference from market behavior to elicit willingness to pay):

Link changes in the environmental resource and changes in the

observed behavior of people.

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 Cont’d…
It is estimating the willingness to pay of individuals for the
environmental goods by observing their behavior in related
market. Such method includes

A. Travel Cost Methods

B. Hedonic Pricing

C. Cost (or Expenditure) Methods

D. Benefit Transfer Methods

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 A. Travel cost model (TCM)
Travel cost methods are often used to value ecosystem services associated with
recreational sites. These methods estimate the value of the ecosystem services
based on the amounts consumers may be willing to pay, as reflected in the costs
of visiting a recreational site (i.e., transport costs, travel time, visiting time).

The underlying assumption of the travel cost method (TCM) is that if an individual
is willing to pay (WTP) the cost of visiting a recreational site then he should
value that site at least as much as what he paid to visit it.

This approach uses travel cost as a proxy for estimating consumer’s surplus and
extracting it via changes in admission fees.

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 Cont’d…
A Bit of History
In 1947, the US National Parks Service needed to prioritize park areas that
would qualify to be declared ‘protected’. It then solicited the advice of
experts about the value of the country’s national parks and methods to elicit
such values. Harold Hotelling responded with a very original representation
of how the recreational value of a park could be measured, setting the
stage for the ‘travel cost method’. Hotelling’s idea is based on the fact that
people pay to visit the park, notably the cost of traveling. Since people
come from different locations, they incur variable costs for enjoying the
park. This information can be linked to the number of visits that people
make to obtain a demand curve for recreation

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 Cont’d…
If a person travels to a recreation site that can be
entered free of charge, then this person values the site
at least as much as the cost of getting there. If there is
an admission charge this must be added on to the cost
of travel to obtain the willingness to pay for the
experience.

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 Cont’d…
Estimating use values, the recreational benefits
of environmental resources.
Requires observations of number of trips to
environmental amenity from a number of regions,
estimates of opportunity cost of time and travel
costs.
Observations on travel cost and quantity of visits
can be used to estimate a demand curve.
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 Cont’d…
Methodology

Collect data on visits, costs of visits and socioeconomic

variables
Number of visits to the site in the past one year
questions on current visit (cost, number of people travelling with,
starting point, arrival, length, goal of the visit, place of residence,
travel mode (bus, rail, air own vehicle etc.), whether trip from their
point of departure involves visiting any other destination, etc.)
socio-demographic and other socioeconomic characteristics of the
respondent
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 Cont’d…
The survey might ask for the following information:

location of the visitor’s home – how far they traveled to the site

how many times they visited the site in the past year or season

the length of the trip

the amount of time spent at the site

travel expenses

the person’s income or other information on the value of their time

other socioeconomic characteristics of the visitor

other locations visited during the same trip, and amount of time spent at each

other reasons for the trip (is the trip only to visit the site, or for several purposes)

perceptions of environmental quality

substitute sites that the person might visit instead of this site
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 Cont’d….
Steps in TCM
Step 1: Gathering information on travel cost, number of
visits and other variables

Step 2: Estimate the trip generating function

Step 3: Derive the demand curve for each zone

Step 4: Derive the ‘willingness to pay’

Step 5 : Calculate the welfare loss

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 Cont’d…
Step1:Gathering information on travel cost, number of visits and other variables
Questionnaires are used to ask visitors to the recreational sites where they have traveled
from. From visitors’ responses one can estimate their travel costs and relate this to the
number of visits per year.

The ‘travel cost’ data should include all explicit and implicit costs related to visit a park. It
is possible to identify at least the following categories:

Explicit costs necessary to reach the site, e.g. gasoline and vehicle maintenance relative to
a particular trip, train or bus ticket.

Time cost of travel. The time spent traveling cannot be used for other activities (e.g. work)
thus representing an opportunity cost. A common problem is how to value time. Many
studies use the wage rate as an approximation. Cost of time spent on site. The time
necessary to visit the site has also an opportunity cost.

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 Cont’d…
Step 2: Estimate the trip generating function
After collecting the relevant data, a trip generating function is
estimated. Each zone represents an observational unit.

The trip generating function used for the study is an additive

function of travel cost, household income, household’s
socioeconomic characteristics (which determine the
preferences of a household), and the travel cost to substitute
sites.

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Cont’d…

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 Cont’d…
Step 3: Derive the demand curve for each zone
To obtain the household demand curve, we
substitute the parameters obtained in the
estimation process and the values for travel
cost, income, education, and substitute sites for
each household

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 Cont’d…
 define Number of visit per year by individual i to site j as a
function of travel cost TC, other determinants like socioeconomic
variables S, environmental quality Q

Vij  f (TCij , Si , Q j )

A demand curve can be derived using this information(Regress visit

rates on travel costs and obtain the parameters)
 Total benefits of the park is the area under the demand curve-
Consumer Surplus

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 What determines the number of visits (r)
• In equation (1) we assumed that only the cost affects the number of visits. Other
elements, such as age of the respondent, income, experience, availability of
substitute sites may affects the number of visits:
r  f (tcr , tcs , y, z )
tcs = price of trip to substitute site s
y = income
z = vector of socio-demographic characteristics of the respondent (age, experience,
etc.)
‘choke price’
r   tcr tcr   tcs tcs   y y   z z tcr
f (tcr , tcs , y, z )
B = total trip cost A+B = Willingness to pay
A = consumer surplus A
tcr 0
A = Access value
B
The ‘choke price’ is the minimum price
at which the number of trips falls to zero. r
r0
The consumer surplus is equal to:

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 Cont’d…
The price at which demand for an asset drops to zero. That i
s, when a company charges the choke price or higher for a g
ood or service, all potential customers believe that the price
is too high and, as a result, do not buy. Most often, the chok
e price is associated with natural resources. For example, ec
onomists may discuss the price per barrel of oil at which co
nsumers simply no longer buy oil. Colloquially, a choke may r
efer to a price at which demand drops, but it is important to
note that the choke price refers to no demand at all.
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 Cont’d…
Hotelling’s idea - From the cost of traveling to the demand for recreation

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 Cont’d…
Step 4: Derive the ‘willingness to pay’

Once a demand curve has been estimated, the value of

the site to an individual can be estimated by computing
consumer surplus for each individual in the survey,
calculating an average consumer surplus and then
multiplying by the estimated number of recreationists.
The TC demand curve is often expanded to include other
explanatory variables such as age, income, family size,
education level, personal interests and so on

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 2. Hedonic Pricing Method (HP)

When renting or buying an apartment we will usually consider its

size, number of rooms, neighborhood, distance from commercial
centers, and distance from public schools.

The same can be done for environmental aspects, such as the

quality of the air around the apartment, or the level of noise.

Hedonic pricing is based on the idea that an individual’s decision to

buy goods or services is based on this bundle of characteristics.
Uses market price of a good to estimate the value of an environmental
attribute which is embedded in the price of the marketed good.

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 Cont’d…
Demand for natural resources will be reflected in the prices people
pay for associated goods such as housing.

Example: People pay more for housing located closer to the sea. By
comparing prices and characteristics of similar houses, we can derive
the value of the coastal amenity.

The hedonic price method essentially consists of estimating a demand

for environmental quality by observing the value people place on
environmental attributes when buying a good or service

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 Cont’d…
Methodology HP: the following steps
a. Specify the hedonic price function

b. Data collection

c. Estimation of the correlation between

environmental quality and market price for good

d. Derivation of a demand curve for environmental

quality
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 Cont’d…
a. Specify the hedonic price function
Property price = f(property (physical) attributes, neighborhood attributes,
accessibility variables, environmental variables).
• the derivative of the estimated equation w.r.t. environmental quality, tells us
about the change in price as environmental quality is increased a small
amount or marginal willingness to pay for environmental quality.
Hedonic equation for house h in neighbourhood i and environment k :
Phik  F  S h , N i , Z k 

House characteristics Environmental variables

Neighbourhood characteristics

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 Cont’d…
b. Data collection: By data we usually mean observations on price and
characteristics of different properties in a given period (cross-section
data). We may also use information on properties over time (time
series) but this information may be more difficult to gather. Data may
be collected using surveys and censuses.

c. Estimate the implicit price of air quality: Each parameter

relates a characteristic of the apartment to its price. Take for
example the parameter for ‘air quality’. It is basically telling
us how a change in air pollution changes the value of
property

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 Cont’d…
Figure: The relationship of property prices and air quality

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 Cont’d…
d. Derive a demand curve for environmental quality
The demand curves for air quality for the two individuals are represented in
Figure below. The demand curve for air quality allows us to calculate the
amount of money an individual is willing to trade for a change in the level
of air quality, while keeping his utility constant. Individual 1 is more likely to
choose to live in a neighborhood with better air quality (and higher rents)
than individual 2.

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 Cont’d…
Figure: Implicit price and willingness to pay for air quality

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 2. Stated preference methods
Stated preference method measure individual value for environmental
quality directly, by asking them to state their preference for the
environment
Based on people’s responses to survey questions regarding willingness
to pay, willingness to accept or hypothetical choices between
alternatives to understand value.
Elicit environmental values directly from respondents using survey
techniques. Includes:
a. Contingent Valuation Method
b. Choice experiment
c. Conjoint Analysis
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 a. Contingent valuation method(CVM)
Economists can elicit the value that individuals place on a good or service by
observing purchasing behavior.
However, in some cases there are simply no market proxies to observe. In such
circumstances, it is possible to ask a sample of people what they would be
willing-to-pay (WTP). In this situation, economists rely on people to “state” their
preferences.
Ask individuals what they are WTP for a change in environmental attribute based
on hypothetical market
Requires that respondents understand well the good they are being offered and
that they answer truthfully
The term 'contingent' in CVM suggests that it is valuation is dependent on a
hypothetical scenario put to respondents.

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 Cont’d…
The CVM enables economic values to be estimated for a wide range of commodities not

traded in markets. This method uses survey techniques to establish the value of goods and

services that are not exchanged in markets and therefore have no prices associated with them.

The CVM involves asking a randomly chosen sample of people what they are WTP for a

clearly defined change in the provision of a good or service, or to prevent a change. It can

also be used to elicit what people are willing-to accept (WTA) to forgo a change or tolerate a

change. The most commonly applied approach in the CVM is to interview people and ask them

what they are WTP towards the preservation of that asset. Analysts can then calculate the

average WTP of respondents and multiply this by the total number of people who enjoy the

environmental site or asset in question to obtain an estimate of the total value which people

have for the asset.

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 Cont’d…
CVM is major tool of analysis in different fields to determine total
economic value

• Environmental Economics • Cost-Benefit Appraisal (CBA) &

• Health Economics Environmental Impact

Assessment (EIA)
• Transportation Safety
• Outdoor Recreation
• Cultural Economics
• Biodiversity and Species
• Waste Management
Preservation
• Natural Resource Damage
• Forest Protection
• Water and Air Quality Issues
• Environmental Risk Reduction,
etc.
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 Willingness to pay to
preserve cultural
heritage monuments
(churches, monasteries,
archaeological sites,
ancient bridges) & the
surrounding
environment

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 Cont’d…
As compared with indirect methods it asks hypothetical questions, whereas indirect

methods exploit data on observed, actual behavior.

CVM has two advantages over indirect methods.

1st , it can deal with both use and nonuse values, whereas the indirect

methods cover only use value, and

2nd , unlike the indirect methods, CVM answers to WTP or WTA questions.

For either an improvement or a deterioration, the individual can be asked about

willingness to pay (WTP) or accept (WTA).

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 Steps involved in conducting a CV
Study
1. Setting up the hypothetical market (scenario)

2. Obtaining bids: Elicitation format

3. Analyzing/ Evaluating responses (Estimating

mean WTP/WTA)

4. Aggregation Total WTP

5. Evaluating the CVM reliability and validity test

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 Cont’d…
1. Setting up the hypothetical market (scenario)

A hypothetical description (scenario) of the terms under which the

good or service to be offered is presented to the respondent

Define the good and the change in the good to be valued-

scenario setting (setting up the hypothetical market)- story

• For example it could be a scheme to improve environmental quality

or reduce pollution levels or avoid loss of an endangered species,

etc.

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 Cont’d…
Issues should be considered when setting up the hypothetical scenario.
Well description of the good to be valued

 Written text, drawings, pictures, video

 Conduct focus groups on components of the survey

 For example Plot for community plantation actually identified including distance, size, existing use.

The institution responsible for providing the good must also be identifiable and believed to be capable
of providing it.

Provision rule

- Important to explicitly state how the change will be provided.

- Free-rider problem if incentive incompatible.

- Rule could be delivery if WTP covers cost or majority accepts vote.

Made clear how the payment will be made (Payment vehicle)

- Tax or fee, Lump sum or monthly, Money, labor or In kind ?

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 Cont’d…
Example of a well-defined scenario
“The old civic building in the city center is a unique example of
architecture from its period (1600s).Over the past 10 years
it has fallen into disrepair (show photograph of before and
after). Without intervention it will deteriorate further and in
five years will fall down. The local government will have to
spend money if it is to restore the building to its state ten
years ago. These extra funds will be generated by raising
income tax.” Then follow WTP questions…

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Generally the scenario contained three parts:

A detailed description of good(s) being valued and the hypothetical

circumstance under which it is made available to the respondent;

Questions which elicit the respondents’ WTP (WTA) for the good(s) being
valued;

Questions about socioeconomic characteristics of respondents (age,

income), their preferences relevant to the good(s) being valued, and
their use of the good(s)

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 Cont’d…

In scenario setting need to check does the story make

sense?

 Policy relevant?

 Plausible?

 Understandable?

 Meaningful?

 Pre-test, pre-test, pre-test (focal group)

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 Cont’d…
2. Obtaining bid: Elicitation format
The respondent is asked questions to determine how much he would
value a good or service if confronted with the opportunity to obtain it
under the specified terms and conditions.
How much an individual is WTP or WTA for some change in provision.
Depending on the preferred elicitation format such as:

 Open ended :

Payment card

 Bidding game

 Binary/dichotomous choice

 double bounded, spike, triple bounded

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 Cont’d…
Open ended: ask ‘what is your maximum WTP for...?’ directly ask maximum
WTP for env’ntal improvement (or to avoid a loss).
 How much would you at most pay as solid waste management fee in order for
you household to participate in the solid waste management program? Express in
per month and per household….... birr per month

Dichotomous or discrete choice: Single-bounded

 Only one amount is presented and respondents either agree
with it or not(yes/no approach).
If the solid waste management fee for your household is ....... birr per month would
your household participate in the solid waste management program?
1. Yes 2. No

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 Cont’d…
Double-bounded
Double bounded dichotomous choice: if respondent says ‘yes’ to
$X, $X + $Y? If ‘no’ to $X, $X $Y?.
 10a. If the solid waste management fee for your house hold is x birr
per month would your household participate in the solid waste
management program?
1. Yes if yes go to 10b
2. No if no go to 10c
 10b. What if the fee for your household instead was birr 2*X Per
month, would your household participate in the solid waste management
program?
1. Yes 2. No
 10c. What if the fee for your household instead was birr 0.5*X per
month, would your household participate in the solid waste management
program?
1. Yes 2. No
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 Cont’d…
• Bidding game: Respondent are iteratively asked
whether they would be willing to pay a certain
amount. Bidding stops when the iterations have
converged to a point estimate of WTP (WTA).
Are you willing to pay X? If yes, X+d?, x+2d, If no,
X-d?
• Payment cards: Provide a list of possible payment
amounts (or a range of estimates) and ask respondent to
circle one that is closest to their max WTP

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 Cont’d…
Format Description
Open ended What is the maximum amount that you are willing to pay
every year, for the good described above
Bid game Would you pay US$ 5 every year, through a Tax for waste
management as described above

If Yes: Interviewer keeps increasing the bid amount until the

respondent answers No. Then maximum WTP is elicited.

If No: Interviewer keeps decreasing the bid amount until the

respondent answers Yes
Then maximum WTP is elicited.
Payment card Which of the amounts listed below best
describes your Maximum WTP for the scenario described
US$ 1 US$ 2 US$ 3
US$ 4 US$ 5 US$ etc, etc
US$ 100 US$ >100 and so on
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 Cont’d…
Advantages and Disadvantages of Different Questionnaire’s Formats

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Cont’d…

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 Cont’d…
3. Analyzing/ Evaluating responses (Estimating mean WTP/WTA)
Once bids (WTP or WTA) have been gathered, an average bid can be
calculated. Average WTP or WTA can be used to have a quick
assessment of the value a resources has for a particular population.

Estimate the mean WTP using appropriate econometric models

depending up on the type of elicitation technique used

Response Validity is tested by relating WTP responses to respondent

socio-economic and demographic characteristics (such as age, education,
gender, household income, attitudes towards the environment and other
factors, etc).

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 Cont’d…
Note: “Protest” bids are usually omitted from the calculation.
Protest bids are zero bids given for reasons other than a
zero value being placed on the resource in question. For
example, a respondent may refuse any amount of
compensation for loss of a unique environmental resource
as they believe it is the government’s responsibility to
protect it, or simply that they do not wish to take part in
the survey. A decision must also be taken over how to
identify and treat outliers. The follow-up questions can
help with this.
Derese G. (Assistant Professor) 70
 Cont’d…
 The estimation of the valuation function takes:
 the WTP response as the dependent variable in a
regression
 demographic, socioeconomic and attitudinal indicators
as explanatory variables.

 If the estimated parameters are consistent with economic

theory and previous experience, this is taken as evidence that
some confidence may be placed in all of the survey results,
including estimated average WTP.
 If this is not the case, then the inference would be that the
survey had not worked well.
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 Cont’d…
Method of Analysis
Appropriate method for analysis depends on how responses
generated – elicitation method:

 For open-ended questions:

 use a spread sheet

 For referendum dichotomous choice questions

 Parametric Estimation

o Random Utility Model /RUM/ &

o Random Expenditure Function /REF/

 Non-parametric Estimation (The Turnbull estimator)

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 1. Parametric Models for Dichotomous Choice Questions

 Its goal is to calculate willingness to pay for the services described.

 In addition, parametric models allow for the incorporation of

respondent characteristics into the willingness to pay functions.

 There are two distinct but linked parts to the task of estimating
parametric models for dichotomous choice CV questions:

 parameter estimation in the WTP function, and

 calculating WTP given the estimated parameters.

 Estimating parameters is not a necessary step in the calculation of

WTP = non parametric estimates of WTP is also possible.

 It is not necessary to estimate covariate models to expand a

6/1 0 /2 019 22
s a m plemean to a population.
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6/10/2019 23
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 Based on this model, respondent j answers yes to a required
payment of t if the utility with the CV program, net of the
required payment, exceeds utility of the status quo :
U 1 ( ( y  t )  x)  1  U 0 (y )   0

 Indirect utility is the sum of a deterministic component that are

important to the CV scenario and the stochastic component.
 However, researchers do not know the random part of preferences
and can only make probability statements about yes and no.
 The probability of a yes response is the probability that the
respondent thinks that he is better off in the proposed scenario,
even with the required payment, so that U1 > U0.
 For respondent j, this probability is:
Pr( Yes j )  Pr( U 1 (  ( y  t )   x )   1  U 0 (  y )   0 )
6/10/2019 24
Derese G. (Assistant Professor) 75
 e (  t )
Pr( Yes ) 
1  e (   t )
 which is the Logit model. Assuming ε normally distributed leads
to the Probit model. In either case α and β can be estimated using
a standard statistical package
 The parameter α represents the extra utility generated by the
provision of the environmental good whereas
 β = the negative of marginal utility of income.
 The coefficient on the bid variable, t is negative indicating that
as the implied tax liability increases the probability of saying
“Yes” will decline.
 Irrespective of whether the data has been analysed using the Logit
or the Probit model mean (and median) WTP is given by:

E [WTP ]  


6/10/2019 25
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 Cont’d…
4. Aggregation Total WTP and derivation of dd curve
 The final task of any CV exercise is to aggregate mean or median WTP values
over the target population.
 If the sample is representative of the target population then aggregate WTP is
simply mean or median WTP multiplied by N, the number of observational units
in the target population
Aggregate WTP  N WTP
 If the sample is not representative of the target population then the appropriate procedure is
either to stratify the sample and calculate a mean WTP appropriate for each householdtype
 Mean WTP for each household type is then multiplied by Ni, the number of observational units
of each type present in the targetpopulation

 This procedure is especially important if the sample is geographically unrepresentative and

WTP for the project depends on distance to the site.

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 Cont’d…
The aggregate demand curve is derived using the mid willingness to pay amount along the
vertical axis and the number of households' willingness to pay at least that mid value per
month per household along the horizontal axis

Demand curve for improved SWM services

100
90
Class Mark of WTP in Birr/month

80
70
60
50
40
30
20
10
0
0 5000 10000 15000 20000 25000

Number of households WTP at least the given interval

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 Cont’d…
5. Evaluating the CVM reliability and validity test
 the success or failure of a CV study involves validating the results
(there is usually no entirely satisfactory way).
 CV surveys ought to be reliable in the sense that administering the
same survey to a different sample of respondents or the same sample
of respondents at a later date should yield similar results.
 Surveys designed & undertaken by d/t researchers but claiming to
measure the same thing should also produce similar results.
 Face validity – does the survey ask the right questions about the right scenario?
 Criterion validity – compare with actual referendum outcome.
 Convergent validity – compare with results from another valuation method.
 Theoretical validity – estimate a bid function ( a regression equation).
 Do the coefficient signs agree with theory/expectations? Is, eg, WTP related to
income? 29
Derese G. (Assistant Professor) 79
 Common Mistakes in valuation
Case I : private goods + open ended question
Ask for the respondent’s maximum WTP Without clearly specifying in the
CV scenario the quantity of the good or service that the respondent is to
assume.
Case II is a mistake: public goods +open ended question
The problem is that a respondent needs to know what others are going to
pay for the public good before he can determine what he would be willing
to pay. The issue is one of fairness: individuals in similar circumstances
should share the costs of the public good and pay the same. (fair of division
– to be fair)
Case II will seem very hypothetical because there is no politically realistic
payment vehicle for such a scenario
Derese G. (Assistant Professor) 80
 Cont’d…

Case III: Close ended + private goods

CV researcher may forget the basic point that the research objective
is to obtain a demand curve and thus fail to clearly specify the
quantity of the (private) good or service to be purchased at the
stated price. (same as case I)

Case IV : close ended + public goods

A common mistake is to use an open-ended maximum WTP question

to determine the range of prices to use for the closed-end discrete
choice valuation questions.

Derese G. (Assistant Professor) 81

 Criticisms of CVM
1. Respondents fail to take CVM questions seriously because they
are non-binding

2. Respondents do not understand what they are being asked to

value

3. Respondents strategically manipulate the process by distorting

their true WTP

4. Respondents give answers that are inconsistent with economic

theory

– Discrepancy in WTP/WTA was long thought to be evidence

of this
Derese G. (Assistant Professor) 82
 Biases in CVM
Strategic Bias:
• This occurs when the respondent tries to understate or overstate the
bid value so as to influence the outcome. For instance if the CVM
requires payment of a tax the respondent may strategically understate
the bid value to influence the outcome.
• Remedies : - deleting protest bids and outliers
- Stress that others will pay too
• Compliance bias
• Sponsor bias: Attempt to comply with the presumed expectations of
the sponsor
Remedies : Neutral survey organization/university.

• Interviewer bias: Response to please or gain status in the eyes of a

particular interviewer .
• Remedies : Training and stick to the text!
Derese G. (Assistant Professor) 83
 Cont’d…
Information Bias:

The quality of information given in a hypothetical market scenario almost certainly affects the
responses in a CVM survey. Inadequate or improper presentation of information on the
good or service to be valued can bias the quality of the CVM study.

Design bias

– Starting-point bias: respondents might interpret starting point in bidding game as

conveying information about value of the good

– Vehicle bias: choice of payment vehicle (e.g., entrance fee vs. higher taxes to fund
park) might affect stated WTP

Starting Point Bias:

The suggestion of an initial starting point in a bidding game can significantly influence the
final bid. For example choosing a low (high) starting point leads to a low (high) mean WTP.

Derese G. (Assistant Professor) 84

 CVM study in developing countries

CVM study in developing countries conducting poorly because of the following reason

1. poorly administered survey

poorly trained enumerator which result enumerator bias : Best CVM scenario may make little sense to
respondent if a well trained enumerator does not deliver it smoothly and sensitively

R: training and incentivizing enumerators and managing / controlling them

2. poorly crafted scenarios

- Crafting good CVM scenario is the key things to achieve a

high quality CV study.

- Little attention to economic theory

- problem of creating linkage between CV scenario and selection of an elicitation procedure

(correctly identifying elicitation procedure used for public goods and private goods)

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 Cont’d…
3. few study test the key assumptions and robustness of
the result with respect to research design and survey
method (absence of split sample test)

- Split sample experiment should be used to in order to

understand how respondents may reacting to CVM
scenario and elicitation procedure

Derese G. (Assistant Professor) 86

Summary flow chart of designing a contingent
valuation study

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 b. Choice Experiment (CE)
CE is similar to CVM, as it a survey based, hypothetical
method, which can be used to estimate economic values
for environmental good and service.

However, it differs from contingent valuation because it

does not directly ask people to state their valuation in
monetary terms. Instead , values are inferred from the
hypothetical choices or tradeoffs that people make
among many alternatives.

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 Cont’d…
A CEM will ask each respondent a series of choice
questions, each presenting different combinations of
the level of attributes of the environmental good or
service at different cost to the respondent.
 In a CE respondent is presented with two or more
alternatives of the environmental good with
different levels of its attributes at different prices
and asked to choose their most preferred
alternative in each set of alternatives.
Derese G. (Assistant Professor) 89
 Cont’d…
Choice experiment method –Design steps
 The first step in CE study is to define the valuation
problem. This would include determining exactly what
services are being valued, and who the relevant population
is
 The second step is to make preliminary decisions about the
survey itself, including whether it will be conducted by mail,
phone or in person, how large the sample size will be, who
will be surveyed, and other related questions

Derese G. (Assistant Professor) 90

 Cont’d…
The third step is the actual survey design. It is accomplished in several steps.

 The survey design process usually starts with initial interviews and/or focus groups with
the relevant population and also with experts and scientists who can help identify the
important attributes of the environmental good/service and the levels the levels these can
take under different scenarios.

 In the initial focus groups, the researchers would ask general questions, including questions
about peoples’ understanding of the issues related to the environmental good or service
being valued, whether they are familiar with the good or service and what are the
important attributes of the environmental good or service to the respondents and to what
levels they might fall to when deterioration/degradation of the environmental good or
service continue or increase.

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 Cont’d…
When applying CE the following points should be taken into consideration
The choice scenario must provide an accurate and clear description of
the change in environmental good or service associated with the event,
program, investment, or policy choice under consideration.
If possible, convey this information using photographs, videos, or other multi-
media techniques, as well as written and verbal descriptions
The nature of the good and the changes to be valued must be specified
in detail.
The respondent must believe that if the money was paid, whoever was collecting
it could effect the specified environmental change.

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 Cont’d…
Respondents should be reminded to consider their budget constraints.
Specify whether comparable services are available from other sources, when the
good is going to be provided, and whether the losses or gains are temporary or
permanent.
Respondents should understand the frequency of payments required, for example
monthly or annually, and whether or not the payments will be required over a long
period of time in order to maintain the quantity or quality change.
Respondents should also understand who would have access to the good and who
else will pay for it, if it is provided
The scenario should clearly indicate whether the levels being valued are
improvements over the status quo, or potential declines in the absence of sufficient
payments.
Derese G. (Assistant Professor) 93
Thank you!

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