Valuation of Environmental Goods

ENVIRONMENTAL ECONOMICS

Mrinal Kanti Dutta

[email protected]

Department of Humanities and Social Sciences

Indian Institute of Technology Guwahati
Guwahati – 781039
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Valuation of Environmental Goods
 Understanding value of Environmental Goods
requires understanding of the notion of “values”
of environmental goods
 There are two types of values:
 Use Value and Non-use Value

 Use Value: the value derived from the actual

use of a good or service
 Examples:
1. Raw materials from environment used in
production/consumption
2. Trekking through the woods
3. Rafting in the river
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Valuation of Environmental Goods

 In case of environmental goods, Use Value could

include current use (I am currently visiting the
park), expected use (I plan to visit the park later
this year) and possible use (I might visit the park
within next 10 years)

 Option Value: The value placed on a future ability

to use the environment people are willing to pay
for an option to use the environment in the future
even they are not currently using it.
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Valuation of Environmental Goods
Non-use Value:
It’s a gain in person’s utility without the person
actually using the good directly.

For example, one may value the wilderness

areas in the Seirra Nevada, not because
he/she plans to make use of the
wilderness but because others may, and that
may make him/her feel good

There are three basis types of non-use value:

Existence value, Altruistic vale and Bequest
value:
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Valuation of Environmental Goods
Types of non-use value:
 Existence value:
The value a consumer attaches to knowing
something exists ( e.g. One-horned rhinoceros in
Kaziranaga National Park)
 Altruistic value:
It’s a value that the consumers derive from not
consuming the goods themselves but from the fact
they derive the benefit when someone else gains
utility (e.g. If person A’s neighbor derives benefit
from cleaning his front yard, person A obtains utility
from the fact that his neighbours are better off.
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Valuation of Environmental Goods
Types of non-use value:
 Bequest value:
 This value arises when one intends to pass a
good or service on to the future generation
 It is associated with the well-being of the
descendants
 For example, if one values passing a
wilderness area on to the next generation that
wilderness area has a bequest value to the
person even if he or she never uses it or
intends to use it
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Valuation of Environmental Goods

TOTAL ENVIRONMENTAL VALUE

USE VALUE NON-USE VALUE

EXPECTED
CURRENT USE POSSIBLE USE
USE

EXISTENC ALTRUISTIC BEQUEST

E VALUE VALUE VLAUE
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Valuation of Environmental Goods
Why do we have to value the environment?
No price data exists for non-marketed environmental
resources (demand or prices for private goods can be
obtained from the market)
Need for information on benefits and costs of
protecting and restoring the environment to guide
policy makings
Need information on benefits and costs of protecting
and restoring the environment to guide budget
allocations
Need information to guide compensation setting for
victims
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Valuation of Environmental Goods

Why do we have to value the environment?

Need information on external costs of development

projects to guide development policies

Need information to guide setting of user

charges/fees/taxes for pollution control

Need information to guide efficient and fair resource

allocation
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Valuation of Environmental Goods
Methods of Measuring Environmental Values
Revealed Preference:
In revealed preference approach real choices of
people are observed in some market and
information are inferred on the trade-offs
between money and the environmental good.

Stated Preference:
It basically involves asking people how much an
environmental good is worth.

These information are collected through opinion

polls or surveys.
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Valuation of Environmental Goods
Methods of Measuring Environmental Values

Table 1: Methods of valuation of environmental goods

Methods Revealed Preference Stated Preference

Direct Contingent Valuation
Contingent Ranking

Indirect Hedonic Pricing

Travel Cost Method
Household Production Function
Averting Expenditure/Avoided
Cost Approaches
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Hedonic Pricing (HP) Approach is derived from the
characteristic theory of value first proposed by
Lancaster (1966) and Rosen (1974).

This seeks to explain the value of a commodity as a

bundle of valuable characteristics
(e.g. the price/rent of house depends on
number of rooms, availability of garden in the
campus, proximity to shops, noise level in the
neighborhood, air quality levels etc.)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

HP was first applied to environmental valuation by

Ridker and Henning (1967)

HP proceeds on three stages:

First, hedonic price function is estimated
Second, implicit prices are calculated
Third, a demand curve for this variable may be
estimated

Following example brings out these three stages.

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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Let’s now consider a simple structure that of a good
(house) with a single characteristics (pollution/air quality
level)

Now we are interested in knowing p(z), the house price

as a function of air quality levels (i.e. how p (z) changes
when air quality changes)

Since price function is an equilibrium concept, resulting

from the interaction of demand and supply function, we
need to look at both consumer and producer side of the
market. Assume that the market is competitive that is
both the consumers and producers take p (z) as given.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
A.The Consumer:

Suppose a typical consumer has utility function U and

income y. The consumer’s problem is to decide how
to allocate income between the house (given the air
quality z) and ordinary goods denoted by x (nominally
priced at 1).

The consumer’s problem is,

maxxz U (x, z) (1.a)
subject to,
x + p(z) = y (1.b)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
We can look at the problem in another way, i.e. for
particular level of z, to determine the amount of x that
needs to be consumed to achieve a particular level of
utility

This in turn determines how much money is spent on

x and how much income is available to spend on the
house.

Fixing z, we can solve the value of x that satisfies

U(x, z) =
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
This then defines a particular amount of income available for the
house:
y–x=θ
We can also find out θ solving,

U (y – θ,z) = (1.c)

So given the values of z, y and we determine how much

money is available for the house,
θ (y, z, )

Let us call this a bid function because it represents the amount

of money the consumer may bid for the house with
characteristics z, to keep the utility at the level assuming
income y. (consider this situation in diagram 1)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

In figure 1, θ (y, z, U0) and θ (y, z, U1) are two bid

functions. Lower bid function is associated with the
higher utility. p (z) is the hedonic price function
determined by the market.

For this consumer the point of choice is the point at

which bid function is just tangent to the price function
p(z) which gives maximum utility with the requirement
that the amount the consumer is willing to pay (θ)
must be equal to the price p(z).
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

B. The Producer:
Let’s consider a producer with a given cost structure
and facing constant returns to scale.

Suppose the producer faces input prices r, so that the

unit cost is given by c(r, z).

If the producer offers a price of Φ, then profits per

house are given by,
π = Φ – c(r, z) (1. d)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
B. The Producer:
We can rewrite this as the price necessary to obtain a
certain level of profit, given the level of the
characteristics z: Φ(r, z, π). Let’s call this as offer
function.
The offer function indicates the price at which the
producer will offer the house to obtain a particular profit
level π, given a particular value of input prices, r, and a
particular value of z.

If the producer wants to sell a house, this offer curve has

to intersect the price line. This is illustrated in figure 2)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Figure 2
P P(z)
R
I
C Φ(r, z, π2).
)
E
Increasing Φ(r, z, π1)
profit

Choice Point

AIR QUALITY Z
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

In figure 2, the hedonic price function is shown p(z)

as well as two offer functions for some particular firm,
one function for each of two profits levels π1 and π2.

The correct choice of z is one at which an offer curve

is just tangent to the hedonic price line.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Market Equilibrium:

Finally, we are now in a position to construct the

hedonic demand functions.

Hedonic price function corresponds to tangency

between the bid functions of some consumer and the
offer function of some producers (Shown in Figure 3).

The tangency determines a choice of z along with a

price p(z) and the price line is constructed.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Market Equilibrium:

At the tangency points slopes of the bid function, offer

function and the price line are equal.

This equality implies that the producers, the

consumers and the market all have the same
marginal valuation on a unit of the characteristics.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
p(z)
P Φ3 Fig. 3:
R
• Equilibrium in an
I E3 hedonic market
C
• Φi offer function for
E
three producers, i= 1,
Φ2 ө3 2, 3;
• өi bid functions for
Φ1 E2 three consumers, j = 1,
2, 3
• Ek equilibrium
E1 ө2 between producers k
and consumers k, k =
ө1 1,2,3;
• p(z) price of house
with air quality level z.
Air Quality z
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Willingness to Pay:

So far we have measured the hedonic price function

and thus, we know the marginal price/market of air
quality at different levels air quality (z).

This is not a demand function because one individual

chooses only one consumption point along the
hedonic price function, not several consumption
points. One point does not make a demand function.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Willingness to Pay:

The distinction between the marginal price of z as a

function of z and the marginal willingness to pay for z is
shown in figure 4.

In fig. 4, p`(z) is the slope of a hedonic price line.

MWTP1(z) and MWTP2(z) are the marginal willingness
to pay functions for the two persons.

The point of intersection of the MWTP functions with

the marginal price line gives us the choice of z for the
individual. But how much?
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

Fig. 4:
• Marginal willingness
to pay for z.
• P`(z) slope of hedonic
price line with respect
to z (marginal value
of z)
• MWTPi(z) , marginal
willingness to pay for
one unit of z,
consumers i = 1, 2.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

Assume that different individuals making choices

along the hedonic price function are variants of the
same person, simply with different incomes and
characteristics (call these differences £).

Thus we can translate the many observations on

choice of z into a set of data on how marginal
willingness to pay varies with z, and thus statistically
infer a marginal willingness-to-pay function.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

Similarly, MWTP function can be derived for the

producers denoting the differences as β.

We thus have the following equations for demand and

supply:

p`(z) = f (z, £) (1.e)

p`(z) = g( z, β) (1.f)
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Since, the slope of the hedonic price function is
analogous to the price of the characteristics or
marginal willingness to pay for the characteristics,

Equation 1.e states that MWTP depends on the level

of the characteristics and other variables such as
income.

Similarly, equation 1.f is analogous to an inverse

supply function, with the price related to the
quantity supplied (in this case quantity of the
characteristics) and factors that reflect the cost of the
industry β.
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Valuation of Environmental Goods
HEDONIC PRICING METHOD
Limitations of Hedonic Pricing Method:
1. Omitted variable bias: if some variable that
significantly affects house price is omitted from the
HP equation and is in addition correlated with one
of the included variables, then the coefficient on
this included variable will be biased.

2. Multi-collinearity: some environmental variables

(such as alternative air pollution indicators) may be
highly collinear. This means that separate
equations for each may need to be estimated,
otherwise the implicit prices will be difficult to
entangle
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Valuation of Environmental Goods
HEDONIC PRICING METHOD

Limitations of Hedonic Pricing Method:

3. Choice of functional form for the HP function.

Economic theory does not specify which non-linear
function should be used for the HP equation.

4. Expected versus actual characteristics levels:

house sale may be a function of expected future
environmental conditions in addition to current
observed conditions.
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Valuation of Environmental Goods
DOSE RESPONSE METHOD

Dose response method involves finding a link

between environmental change and production
conditions for some marketed goods.

Depending on the behavioral assumptions made and

the statistical techniques employed, welfare estimates
are then calculated using changes in, e.g., profits from
the production of marketed goods.
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Valuation of Environmental Goods
DOSE RESPONSE METHOD
For example, Ellis and Fischer (1987) estimated the
contribution that wetland protection makes to the
production of shellfish.

They estimated a production function for Florida blue

club off the Florida Gulf Coast which includes wetland
acreage as an input along with labour and capital.

They found the implied value of an increase in the

wetland acreage from 25000 acres to 100000 acres
to be $ 192658.
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Valuation of Environmental Goods
AVERTING EXPENDITURE AVOIDED COST METHOD
This method tries to measure welfare loss to a
household due to increase in averting or preventing
expenditure arising out of decrease in environmental
quality .

The main notion is that a household produces flow of

certain services or goods combining various inputs,
one of which is environmental quality. For example, a
rural household might combine water taken from its
well with purification equipment to produce water
potable.
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Valuation of Environmental Goods
AVERTING EXPENDITURE AVOIDED COST METHOD
Now, if water quality in the well declines, the
household must increase its expenditure on other
inputs to maintain quality of drinking water constant.
This averting expenditure, as Cournot and Potter
(1981) showed, can be used to measure welfare loss
to the household of the decline in environmental
quality.

Other examples may include: the value of reduced

risks of car accidents (Blomquist 1979), value of
reduced risk of death as the result of fitting smoke
alarms and noise nuisance from airports (layard
1972)
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Valuation of Environmental Goods
AVERTING EXPENDITURE AVOIDED COST METHOD
The conditions under which changes in averting expenditure
(AE) produces exact welfare measures are-

1. The AE must not be a joint product (i.e. it must not generate

other benefits apart from offsetting the change in
environmental quality)
2. The AE must be perfect substitute for the change in
environmental quality
3. The change in AE must be entirely due to the change in
environmental quality
4. None of the inputs must enter directly in to the persons’
utility function
5. Expenditure must not yield benefits outliving the pollution
incident.
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Valuation of Environmental Goods
AVERTING EXPENDITURE AVOIDED COST METHOD
These conditions could be summarized as follows:

V(W Q1, Y) = V(WQ2, Y – AE)

Where, V is indirect utility, WQ is well water quality,

Y is income, AE measures Averting Expenditure
and W Q1 > W Q2 .

In other words, utility with the higher level of well

water quality and no averting expenditure is equal
to utility with a lower level of well water quality and
AE.
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Valuation of Environmental Goods
TRAVEL COST METHOD
One of the oldest approaches to environmental valuation
Proposed in a letter from Harold Hotelling to the US Forest
Service in the 1930’s, first used by Wood and Trice in 1958,
popularized by Clawsen and Knetsch (1966)
Premises
• People bear cost to visit regions or sites (national park or
estate)
• Hypothesis : These costs are at least equal to the minimum
value of the benefit people get when visiting the sites and their
environmental goods or services. Thus these travel costs can
be used as a proxy for the price of visiting outdoor recreational
sites . (In other words, the recreational benefits at a specific site
can be derived from the demand functions that relate observed
user’s behaviour to the cost of visit.)
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Valuation of Environmental Goods
TRAVEL COST METHOD
Steps of analysis
• Estimate the cost of travel and visit for each regions
of origin

• Questionnaire : visitors trip, expenses and

characteristics

•Estimate of the demand for the site (and

environmental goods and services) depending on
the cost of travel and visit and other characteristics
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Valuation of Environmental Goods
TRAVEL COST METHOD
Options for Applying the Travel Cost Method

1. A simple zonal travel cost approach, using mostly secondary

data, with some simple data collected from visitors. The
zonal travel cost method is applied by collecting information
on the number of visits to the site from different distances.

2. An individual travel cost approach, using a more detailed

survey of visitors. The individual travel cost approach is
similar to the zonal approach, but uses survey data from
individual visitors in the statistical analysis, rather than data
from each zone. This method thus requires more data
collection and slightly more complicated analysis, but will
give more precise results.
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Valuation of Environmental Goods
TRAVEL COST METHOD

3. Hedonic Travel Cost Model which attempts to place

values on the characteristics of recreational resources.

4. A random utility approach using survey and other data,

and more complicated statistical techniques. The
random utility approach assumes that individuals will
pick the site that they prefer, out of all possible sites.
Individuals make tradeoffs between site quality and the
price of travel to the site. Hence, this model requires
information on all possible sites that a visitor might
select, their quality characteristics, and the travel costs
to each site.
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Valuation of Environmental Goods
TRAVEL COST METHOD
The travel cost method is applied by collecting
information on the number of visits to the site from
different distances. Because the travel and time costs
will increase with distance, this information allows the
researcher to calculate the number of visits purchased
at different prices: the demand function and the
consumer surplus or economic benefits, for the
recreational services of the site.
Step 1: The first step is to define a set of zones
surrounding the site. These may be defined by
concentric circles around the site, or by geographic
divisions that make sense, such as metropolitan areas
or counties surrounding the site at different distances.
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Valuation of Environmental Goods
TRAVEL COST METHOD
Step 2: The second step is to collect information on the
number of visitors from each zone, and the number of
visits made in the last year.

Step 3: The third step is to calculate the visitation rates

per 1000 population in each zone. This is simply the
total visits per year from the zone, divided by the
zone’s population in thousands.

Step 4: The fourth step is to calculate the average

round-trip travel distance and travel time to the site for
each zone, using average cost per mile (km) and per
hour of travel time. What is the opportunity cost of
time?
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Valuation of Environmental Goods
TRAVEL COST METHOD

Step 5: The fifth step is to estimate, using regression

analysis, the equation that relates visits per capita to
travel costs and other important variables.

From this, the researcher can estimate the demand

function for the average visitor. In this simple model,
the analysis might include demographic variables,
such as age, income, gender, and education levels,
using the average values for each zone
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Valuation of Environmental Goods
TRAVEL COST METHOD
Step 6: The sixth step is to construct the demand
function for visits to the site, using the results of the
regression analysis. The first point on the demand
curve is the total visitors to the site at current access
costs (assuming there is no entryfee for the site)

Step 7: The final step is to estimate the total economic

benefit of the site to visitors by calculating the
consumer surplus, or the area under the demand
curve.
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Valuation of Environmental Goods
TRAVEL COST METHOD
Simple Travel Cost Model:
If the price (p) is the only sacrifice made by a
consumer, the demand function for a good with no
substitutes is x=f(p), given income and preferences.
However, the consumer often incurs other costs (c),
such as travel expenses and loss of time. In this
case, the demand function is expressed as x = f(p, c).

Under these conditions, the utility maximising

consumer’s behaviour should be reformulated in
order to take such costs into account.
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Valuation of Environmental Goods
TRAVEL COST METHOD
Simple Travel Cost Model:
Given two goods or services (x1, x2), their prices (p1, p2), the
access costs (c1, c2) and income (R), the utility maximizing
choice of the consumer is:
MaxU = u(x1,x2)
Subject to: (p1 + c1) x1 + (p2 + c2)x2 = R (1)

Now, let 'x1' denote the aggregate of priced goods and

services, x2 the number of annual visits to a recreational site,
and assume for the sake of simplicity that the cost of access to
the market goods is negligible '(c1=0)' and that the recreational
site is free (p2=0).
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Valuation of Environmental Goods
TRAVEL COST METHOD
Under these assumptions, equation [1] can be written
as:
MaxU = u(x1,x2))
Subject to: p1x1 + c2x2 = R (2)
Under these conditions, the utility maximizing
behaviour of the consumer depends on:
a) His preferences [u(x1, x2)],
b) His budget (R),
c) The prices of the private goods and services
(p1) and
d) The access cost to the recreational site (c2).
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Valuation of Environmental Goods
TRAVEL COST METHOD
The TCM is based on the assumption that changes in the costs
of access to the recreational site (c2) have the same effect as a
change in price: the number of visits to a site decreases as the
cost per visit increases.
Under this assumption, the demand function for visits to the
recreational site is x2=f(c2) and can be estimated using the
number of annual visits as long as it is possible to observe
different costs per visit and up to the cost at which visits
become equal to zero.
This simple model can be extended to include the effect of
other substitute sites.
Alternatively, same model can be used to estimate visits per
time be an individual to site with c and p becoming specific to
the individual only.
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Valuation of Environmental Goods
TRAVEL COST METHOD
The basic TCM model is completed by the weak
complementarity assumption, which states that trips
are a non-decreasing function of the quality of the site,
and that the individual forgoes trips to the recreational
site when the quality is the lowest possible
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Valuation of Environmental Goods
TRAVEL COST METHOD

c2 The Figure depicts

cp the expected
relationship
between the
number of visits
and cost per visit,
c2p given other
variables, showing
that the number of
visits decreases as
c2c
the cost per visit
increases.
o x2p x2c
x2
 55
Valuation of Environmental Goods
TRAVEL COST METHOD
Hedonic Travel Cost Model:
On many occasion, we are interested in the value of
changing characteristics of a site rather than in the
value of the site in toto.
In this respect, hedonic travel cost model attempts
to place values on the characteristics of recreational
resources.
Hedonic travel cost model was first proposed by
Brown and Mendelsohn (1984) and was later
applied to forest characteristics by Englin and
Mendelsohn (1991) and coastal water quality by
Bockstael et. al. (1987)
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Valuation of Environmental Goods

Hedonic Travel Cost Model:

Steps:
1. Respondents to a number of sites (e.g. forest) are
sampled to determine their zone of origin.
The levels of physical characteristics are recorded
for each site
A travel cost function is estimated for each zone, as

C(Z) = c0 + c1z1 + c2z2 + … cmzm (1)

Where, C(Z) are travel costs, z1 . . . zm are

characteristics and c0 . .. cm are coefficients to be
estimated.
 57
Valuation of Environmental Goods
TRAVEL COST METHOD
Hedonic Travel Cost Model:

Steps:

A separate regression is performed for each zone

of origin such that each will have a vector of
coefficients {c0… cm}. For a given characteristics m,
the utility maximising individual will choose visits
such that the marginal costs of characteristics (the
coefficient cm) is just equal to the marginal benefit
to him.
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Valuation of Environmental Goods
TRAVEL COST METHOD
Hedonic Travel Cost Model:
Steps:
2. Estimate a demand curve for each
characteristics regressing a site characteristic
levels (dependent variable) against the predicted
marginal cost of that characteristic and
socioeconomic variables for each zone of origin.
A separate regression is run for each
characteristics.
The expectation is that the coefficient on the
marginal cost variable will be negative implying that
as the level of a characteristics rises people are
unwilling to pay as much for each further increment.
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Valuation of Environmental Goods
Issues and Limitations of the TRAVEL COST METHOD

The travel cost method assumes that people perceive and

respond to changes in travel costs the same way that they
would respond to changes in admission price.
Defining and measuring the opportunity cost of time, or the
value of time spent on traveling, can be problematic. Because
the time spent on traveling could have been used in other
ways, it has an "opportunity cost." This should be added to the
travel cost, or the value of the site will be underestimated.
However, there is no strong consensus on the appropriate
measure: the person’s wage rate, or some fraction of the
wage rate and the value chosen can have a large effect on
benefit estimates.
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Valuation of Environmental Goods
Issues and Limitations of the TRAVEL COST METHOD

If people enjoy the travel itself, then travel time

becomes a benefit, not a cost, and the value of the
site will be overestimated. The availability of
substitute sites will affect values.
The most simple models assume that individuals
take a trip for a single purpose: to visit a specific
recreational site.
Interviewing visitors on site can introduce sampling
biases to the analysis.
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Valuation of Environmental Goods
Issues and Limitations of the TRAVEL COST METHOD
Measuring recreational quality, and relating
recreational quality to environmental quality can be
difficult.
Standard travel cost approaches provide information
about current conditions, but not about gains or losses
from anticipated changes in resource conditions.
In order to estimate the demand function, there needs
to be enough difference between distances travelled
to affect travel costs and for differences in travel costs
to affect the number of trips made. Thus, it is not well
suited for sites near major population centers where
many visitations may be from "origin zones" that are
quite close to one another.
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Valuation of Environmental Goods
TRAVEL COST METHOD
The travel cost method is limited in its scope of
application because it requires user participation. It
cannot be used to assign values to on-site
environmental features and functions that users of the
site do not find valuable.
Most importantly, it cannot be used to measure non-
use values. Thus, sites that have unique qualities that
are valued by non-users will be undervalued.
As in all statistical methods, certain statistical
problems can affect the results. These include choice
of the functional form used to estimate the demand
curve, choice of the estimating method, and choice of
variables included in the model.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
Contingent Valuation Method (CVM) was first used
by Davis (1963) in a study of hunters in Maine and
it was widely developed with Bohm (1972), Randal
et.al. (1974), Brookshire et. al., (1976) etc.
The essence of CVM method involves asking
individual to imagine some situation that is
typically outside the individual’s experience and
speculate on how he or she would act in such a
situation.
It is called 'contingent valuation' because the
valuation is contingent on the hypothetical
scenario put to respondents.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD

CVM exercise can be split in to five stages:

Setting up the hypothetical market
Obtaining bids
Estimating mean WTP and or WTAC
Estimating bid curves
Aggregating the data
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
As Carson (1991) noted, there are six main
component of a successful CV study:

1. Define Market Scenario

2. Choose elicitation method
3. Design market administration
4. Design sampling
5. Design of experiment
6. Estimate willingness-to-pay function
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
1. Define Market Scenario:
Is the information to be conveyed to a respondent?
(i.e. one who will be asked about willingness to
pay)
To place the respondent in the right time frame of
mind to give meaning response to questions
Description of the market should be realistic to the
respondent and
Defining appropriate payment mechanism
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
2. Choosing Elicitation Method:
Having properly defined the market scenario, the next step is
to decide how best to obtain the valuation process.
There are four ways of eliciting value: direct question, bidding
game, payment card and referendum choice.
2.1 Under direct questioning the main task is to ask the
respondents about their willingness to pay for the good.
However, this suffers from a great demerit in the sense that
there are few real markets in which we ask the respondent
to generate data and in most occasion people may not
spend much effort in determining their willingness to pay
which may result in extreme response (either zeroes and
very large numbers)
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
2.2 Bidding Game:
Bidding game approach was first used by Randal
et.al (1974).
This approach involves a WTP number and seeks a
yes-no response.
If the respondent replies yes, the amount is gradually
increased until a no response is received. Similarly, if
the respondent replies no, the amount is gradually
decreased until a yes is received. The main problem
with this approach is the starting-point bias.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
2.3 Payment Card: A card with a number of figures, spanning
the range of responses that might be expected. Each card has
payment amounts along with several reference expenditure
amount.
The basic problem with the payment card is that they can not be
used for telephone surveys.
2.4 Referendum or discrete choice:
Under this approach a willingness to pay figure is offered to the
respondent who is asked if he or she would be willing to pay that
amount, ‘yes’ or ‘no’.
This approach although has the merit of minimizing possible
bias and is also familiar to the people in that people often vote
yes/no on public referenda. One problem with referenda is that
more data are needed to obtain statistically significant results
which raised cost of the survey.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
3. Design Market Administration:
Three approaches to survey administration: mail,
telephone and in-person
Mail Survey: cheaper to administer but suffers from
the problem of acute non-response
Telephone Survey: relatively inexpensive to
administer but limited by the availability of telephone
within the population being surveyed.
In-person Survey: Most expensive to administer but
can be more reliable. However it suffers from the
problem of interviewer bias.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
4. Sample Design:

It involves two steps: First, select the group (relevant

for the study) from which to draw the sample.
Second, draw the random sample.

5. Experimental Design:

Experimental design requires careful design of

survey instrument, its administration and its ultimate
statistical analysis.
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Valuation of Environmental Goods
CONTINGENT VALUATION METHOD
6. Estimation of Willingness to Pay Function:
The last step of the Contingent Valuation Method is
to take the survey results and correctly estimate the
WTP functions.

Problems with the Contingent Valuation Methods:

Despite significant application of CV technique in
eliciting values of environmental goods, the method
has been scrutinized and found to suffer from a large
number of limitations. Following are the important
limitations of this method:
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Valuation of Environmental Goods
The value elicited in CV surveys are not based on real
resource decisions - they are hypothetical.

Presence of ambiguity in what people are valuing

Problem of embedding. This problem generally pertains

to the inconsistencies that people face when they are to
value an environmental good (e.g. park) versus a group
of environmental goods (several parks in our case) when
they are substitutes.

Another related problem is the valuation of existence

value.