ENVIRONMENTAL VALUATION

Environmental valuation is the process of putting monetary values on environmental

goods and services, many of which have no easily observed market prices.
Environmental valuation has traditionally been considered in the context of non-
market valuation. Its aim is to obtain a monetary measure of the benefit or cost to the
welfare of individuals and social groups of environmental improvement interventions
or the consequences of environmental degradation.

Economists recognize two broad categories of environmental values:

use values and

• Non-use values.

Use values flow from services that affect people directly, such as food production,
flood regulation, recreation opportunities, and potable water provision.

Environmental valuation techniques can provide useful evidence to support habitat

conservation policies by quantifying the economic value associated with the
protection of biological resources. Valuation methods have been used for five main
purposes in environmental decision-making.

• Cost-benefit analysis (CBA) of projects,

• CBA of new regulations,

natural resource damage assessment,

environmental costing, and

environmental accounting.

METHODS USED FOR THE ENVIRONMENTAL VALUATION

A. Contingent Valuation Method (CVM):

Contingent valuation frequently elicits information on willingness to pay or willingness

to accept compensation for an increase or decrease in some usually non-marketed
goods or services. This method puts direct questions to individuals to determine how
much they might be willing to pay for environmental resources or how much
compensation they would be willing to accept if they were deprived of the same
resources. This method is more effective when the respondents are familiar with the
environmental good or service and have adequate information on which to base their
preferences. The following are included in contingent valuation approach.
 trade-off game method,

costless-choice method, and

• Delphi method

1) Trade-Off Game Method:

Trade-Off Game method relates to a set of contingent valuation techniques that rely
on the creation of a hypothetical market for some good or service. In a single -bid
game the respondents are asked to give a single bid equal to their willingness to pay
or willingness to accept compensation for the environmental good or service
described. In an iterative (repeating) bid game the respondents are given a variety of
bids to determine at what price they are indifferent between receiving (or paying) the
bid or receiving (or losing) the environmental good at issue.

The trade-off game method is a variant of the bidding game wherein respondents are
asked to choose between two different bundles of goods. Each bundle might include
a different sum of money plus varying levels of an environmental resource. The
choice indicates a person's willingness to trade money for an increased level of an
environmental good. When no money is involved, the approach becomes similar to
the costless-choice method.

2) Costless-Choice Method:

The costless-choice method is a contingent valuation technique whereby people are

asked to choose between several hypothetical bundles of goods to determine their
implicit valuation of an environmental good or service. Since no monetary figures are
involved, this approach may be more useful in settings where barter and subsistence
production are common.

3) Delphi Method:

The Delphi method is a variant of the survey-based techniques wherein experts,

rather than consumers, are interviewed. These experts place values on a good or
service through an iterative process with feedback among the group between each
iteration. This expert-base approach may be useful when valuing very esoteric
resources.

The Delphi method was originally conceived in the 1950s by Olaf Helmer and
Norman Dalkey of the Rand Corporation. The name refers to the Oracle of Delphi, a
priestess at a temple of Apollo in ancient Greece known for her prophecies. The
Delphi method allows experts to work toward a mutual agreement by conducting a
circulating series of questionnaires and releasing related feedback to further the
discussion with each subsequent round. The experts' responses shift as rounds are
completed based on the information brought forth by other experts participating in
the analysis.
Several rounds of questionnaires are sent out to the group of experts, and the
anonymous responses are aggregated and shared with the group after each round.
The experts are allowed to adjust their answers in subsequent rounds, based on how
they interpret the "group response" that has been provided to them. Since multiple
rounds of questions are asked and the panel is told what the group thinks as a
whole, the Delphi method seeks to reach the correct response through consensus.

The Delphi method seeks to aggregate opinions from a diverse set of experts, and it
can be done without having to bring everyone together for a physical meeting. Since
the responses of the participants are anonymous, individual panelists don't have to
worry about repercussions for their opinions. Consensus can be reached over time
as opinions are swayed, making the method very effective.

This is really a specialized survey technique designed to overcome the speculative

and isolated nature of expert opinions. A sufficiently large sample of experts is
presented individually with a list of events on which to attach probabilities and to
which other events, with probabilities may be added. Some recent Delphi exercises
have been recreation-specific. But testing the accuracy of their forecasts is not yet
possible, especially since the predictions are only meant to be general perspectives.

Delphi Method Process

First, the group facilitator selects a group of experts based on the topic being
examined. Once all participants are confirmed, each member of the group is sent a
questionnaire with instructions to comment on each topic based on their personal
opinion, experience, or previous research.

The questionnaires are returned to the facilitator who groups the comments and
prepares copies of the information. A copy of the compiled comments is sent to each
participant, along with the opportunity to comment further. At the end of each
comment session, all questionnaires are returned to the facilitator who decides if
another round is necessary or if the results are ready for publishing.

The questionnaire rounds can be repeated as many times as necessary to achieve a

general sense of consensus.

Advantages

The Delphi method seeks to aggregate opinions from a diverse set of experts, and it
can be done without having to bring everyone together for a physical meeting. Since
the responses of the participants are anonymous, individual panelists don't have to
worry about repercussions for their opinions. Consensus can be reached over time
as opinions are swayed, making the method very effective.

Disadvantages

The Delphi method does not result in the same sort of interactions as a live
discussion. A live discussion can sometimes produce a better example of
consensus, as ideas and perceptions are introduced, broken down, and reassessed.
Response times with the Delphi method can be long, which slows the rate of
discussion. It is also possible that the information received back from the experts will
provide no innate value.

(B) The Revealed Preference Methods

The demand for environmental goods can be revealed by examining the purchases
of related goods in the private market place. There may be complementary goods or
other factor inputs in the household's production function. There are a number of
revealed preference methods such as

travel- cost method,

hedonic price method and

property value method.

(1) Travel-Cost Method:

The travel-cost method is a widely used surrogate market approach that relies on
information on time and travel costs to derive a demand curve for a recreational site.
This curve is in turn used to estimate the consumers' surplus or value of the site to
all users. This approach is widely used to value the recreational benefits of public
parks and other natural areas.

This method seeks to determine the demand for a recreational site as a function of
variables like price, visitors' income, and socio- economic characteristics. The price
is usually the sum of entry fees to the site, cost of travel, and opportunity cost of time
spent.

The consumers' surplus associated with the demand curve provides an estimate of
the value of the recreational site in question.

The most common forecasting technique for a specific site is the Clawson- Knetsch-
Hotelling method. It is a technique commonly associated with benefit estimation in
recreation cost- benefit analysis. This method uses information on travel costs to
generate a final demand curve for a recreation outlet. Henre it is most appropriate for
those outlets where travel cost is a major component of total visit costs typically to
free countryside outlets.

According to Clawson and Knetsch, outdoor recreation activities satisfy individual

needs, such as physical, social or psychological. It is necessarily a kind of package
deal involving anticipation, travel to the site, the activity itself, the return travel and
finally recollection.

The travel-cost method is explained in Figure below.. Suppose there is a single lake
in a city, where the entry fee is OP which is fixed per visit. Initially, recreational
demand for the lake is shown by the demand curve BD0, and the environmental
quantity level is E0
If there is an improvement in environmental quality of lake, then the demand curve
will shift outward as AD, and environmental quality level to E₁. With this effect, there
is an increase in the number of visits to PK. The gain in consumers' surplus is equal
to the area PAK. The net gain in consumers' surplus after improvement in
environmental quality of the lake is shown as:

PAK-PBC = ABCK.

The travel-cost approach looks at the pattern of recreational use of a lake and uses
this information to derive a demand curve to estimate the total amount of consumers'
surplus. To do this, visitors are divided into a number of origin zones of increasing
distance from the lake. Then a survey is used to determine the time and monetary
cost involved in reaching to the lake.

Criticism:

1. This approach is most successful where there is wide variation in the travel cost of
various users and where recreation at the site in question will be the primary
objective of visits. But wide variations in tastes and preferences and substitute
availability at different distances from the site, distort demand estimates.

2. The travel-cost method is of limited value if congestion is a problem. Small

changes affecting recreational quality may be difficult to evaluate using this method.
3. The basic assumption of travel-cost method is that consumers treat increase in
admission fees as equivalent to increase in travel cost. This is subject to question.

4. Another problem associated with this method is that it assumes recreational

quality remains constant over the range from zero use to full present use at the going
admission fee. This is highly hypothetical.

5. Bateman is of the view that the travel-cost method measures only the use value of
recreation sites. Underestimation of site value due to the truncation of non-visitors
would be made worse if the non-use value of both visitors and non-visitors were
relevant. This method is not capable of producing any total economic value estimate
in that it cannot estimate non- use items such as existence value.

(2) The Hedonic Price Method:

The underlying assumption of the hedonic price method is that the price of a property
is related to the stream of benefits to be derived from it. The method relies on the
hypothesis that the prices which individuals pay for commodities reflect both
environmental and non-environmental characteristics. The implicit prices are
sometimes referred to as hedonic prices, which relate the environmental attributes of
the property.

Therefore, the hedonic price approach attempts to identify how much of a property
differential is due to a particular environmental difference between properties, and
how much people are willing to pay for an improvement in the environmental quality
that they face and what the social value of improvement is.

The hedonic price method is based on consumers which postulates that every good
provides a bundle of characteristics or attributes. Again, market goods can be
regarded as intermediate inputs into the production of the more basic attributes that
individuals really demand.

The demand for goods, say housing can, therefore, be considered as a derived
demand. For example, a house yields shelter, but through its location it also yields
access to different quantities and qualities of public services, such as schools,
centres of employment and cultural activities etc. Further it accesses different
quantities and qualities of environmental goods, such as open space parks, lakes
etc.

The price of a house is determined by a number of factors like structural

characteristics, e.g. number of rooms, garages, plot sizes etc. and the environmental
characteristics of the area. Controlling the non-governmental characteristics which
affect the demand for housing, permits the implicit price that individuals are willing to
pay to consume the environmental characteristics associated with the house to be
estimated.

The hedonic price function describing the house price Pi of any housing unit
is given below:
S represents structural characteristics of the house i i.e. type of construction, house
size and number of rooms;

Pi = f [S1i………………Ski , N1i , ………….Nmi , Z1i……………Zni ]

S represents structural characteristics of the house i i.e. type of construction, house
size and number of rooms;

N represents neighbourhood characteristics of house i, that is accessibility to work,

crime rate, quality of schools etc.

It is assumed that only one environment variable affects the property value i.e. air
quality (Z).

For example, if the linear relation exists, then the equation becomes

There is a positive relation between air quality and property price as shown below.
The figure indicates that house price increases with air quality improvement.

Figure given below indicates that the implicit marginal purchase price of Za (air
quality) varies according to the ambient level (Za) prior to the marginal change.
The hedonic price method has become a well-established technique for estimating
the disaggregated benefits of various goods attributes. In the case of housing, these
attributes include not only basic structural and amenity characteristics but also
environmental characteristics such as clean air, landscape and local ecological
diversity. Thus, when a particular policy is implemented which will have a very great
effect on the local environment, the hedonic method offers a useful way of estimating
the change in amenity benefits.

Criticism:

1. This method is of no relevance when dealing with many types of public goods i.e.
defence, nation-wise air pollution and endangered species, etc., as it prices are
available for them.

2. The hedonic price method may be used to estimate the environmental benefits
provided to local residents by an area as it exists today. But in fact, it cannot reliably
predict the benefits which will be generated by future improvements because those
improvements will have the effect of shifting the existing function.

3. Another problem is whether an individual's perceptions and consequent property

purchase decisions are based upon actual or historic levels of pollution and
environmental quality. If expectations are not the same as measured by present
pollution estimate, then there are clearly problems relating to values derived from
purchases.

4. Moreover, expectations regarding future environmental quality may bias present

purchases away from that level dictated by present characteristic levels.
5. This method has been criticised for making the implicit assumption that
households continually re-evaluate their choice of location.

6. Further, there is considerable doubt that such an assumption can hold in the
context of spatially large study areas. If people cluster for social or transportation
reasons, the results of this method will be biased.

(3) Preventive Expenditure Method:

The preventive expenditure method is a cost based valuation method that uses data
on actual expenditures made to alleviate all environmental problems. Often, costs
may be incurred to mitigate the damage caused by an adverse environmental
impact. For example, if drinking water is polluted, extra purification may be needed.
Then, such additional defensive or preventive expenditure could be taken as a
minimum estimate of the mitigation of benefits beforehand.

In the preventive expenditure method, the value of the environment is inferred from
what people are prepared to spend to prevent its degradation. The averting or
mitigating behaviour method infers a monetary value for an environmental externality
by observing the costs people are prepared to incur in order to avoid any negative
effects.

These methods assess the value of non-marketed commodities such as cleaner air
and water, through the amount individuals are willing to pay for market goods and
services to mitigate an environmental externality, or to prevent a utility loss from
environmental degradation, or to change their behaviour to acquire greater
environmental quality.
(4) Surrogate Markets:

When no market exists for a good or service and therefore, no market price is
observed, then surrogate (or substitute) markets can be used to derive information
on values. For example, travel- cost information can be used to estimate value for
visits to a recreational area; property value data are used to estimate values for non-
marketed environmental attributes such as view, location or noise levels.

The effects of environmental damages on other markets like property values and
wages of workers are also evaluated. Valuation in the case of property is based on
risks involved in evaluating the value of property due to environmental damage.
Similarly, jobs with high environmental risks will have high wages which will include
large risk premiums.

(5) Property-value Method:

In the property-value method, a surrogate market approach is used to place
monetary values on different levels of environmental quality. The approach uses
data on market prices for homes and other real estates to estimate consumers'
willingness to pay for improved levels of environmental quality, air, noise etc.
In areas where relatively competitive markets exist for land, it is possible to
decompose real estate prices into components attributable to different characteristics
like house, lot size and water quality. The marginal willingness to pay for improved
local environmental quality is reflected in the increased price of housing in cleaner
neighborhoods.

(6) Wage-differential Approach:

The wage-differential approach is a surrogate market approach that uses information
on differences in wage rate for similar jobs in different areas to estimate monetary
values for different levels of environmental quality. This approach has been used to
estimate values for such environmental variables as different levels of congestion, air
pollution and aesthetics.

Wages also vary in response to various factors such as education and training,
natural dexterity, experience, demand and supply in each labour market area,
occupational risks to health, probability of death, and associated living conditions
including environmental ambience etc.

The hedonic wage approach has also been used in the wage- risk analysis to
determine the value of life and limb in relation to the hazards faced at work. The
general hedonic wage equation can be expressed as

P = P (J, R, S)

Where, P is the payment rate for a given job, Y is a vector of another job-related
attributes e.g. working hours, holiday, sickness benefits etc., R is the risk of death
and S is a vector of skills required to do the job. The hedonic wage approach has
traditionally been used to measure employment attributes, principally risk of death or
injury in particular labour markets. However, by observing variations in wage levels
over space, and netting out the influence of other attributes, they have also been
used to value the quality of life over large areas such as countries or continents.

(C) Cost-Based Methods:

Cost-based methods are discussed below:

(1) Opportunity Cost Method:

This method values the benefits of environmental protection in terms of what is being
foregone to achieve it. This forms the basis of compensation payments for the
compulsory purchase by the government of land and property under eminent domain
laws. Further, it assumes that the land owner or user has property rights over the
use of the land or the natural resource, and that to restrict these rights the
government, on behalf of the society, must compensate the owner.
The opportunity cost method is useful in cases where it is difficult to enumerate the
benefits of an environmental change. For example, rather than comparing the
benefits of various alternative conservation schemes in order to choose between
them, the method can be used to enumerate the opportunity costs of foregone
development associated with each scheme with the preferred option, being the one
with the lowest opportunity cost.

The opportunity cost method does not include non-marketed public good values of
land. The fact that land and its attributes produce externalities is explicitly recognised
in regulatory land- use planning controls, which seek to minimize external bads
through development control and land-use class orders, by separating externality
producing land uses spatially.

Thus planning controls seek to preserve amenity benefits by restricting the

development of land. However, by imposing such restrictions, the price of land, such
as green belt land, has a lower financial value than its opportunity cost value.

(2) Relocation Cost Method:

This is a cost-based technique used to estimate the monetary value of environmental

damages based on the potential costs of relocating a physical facility that would be
damaged by a change in environmental quality. This method relies on data on
potential expenditures.

(3) Replacement Cost Method:

This is a Cost-based technique that measures the potential expenditures that would
be required to replace or restore a productive asset that would be damaged by some
project or development. These costs are then compared to the costs of preventing
the damage from occurring to determine which is more efficient.

If an environmental resource that has been impaired is likely to be replaced in future

by another asset that provides equivalent services, then the cost of replacement may
be used as a proxy for the environmental damage, assuming that the benefits from
the original resources are at least as valuable as the replacement expenses.

A shadow project is usually designed specifically to offset the environmental damage

caused by another project. For example, if the original project was a dam that
inundated some forest land, then the shadow project might involve the replanting of
an equivalent area of forest elsewhere. It values an environment good by the cost
incurred in restoring the environment to its original state of level after it has
damaged.

In figure, the benefits and costs per unit are measured on the vertical axis while the
level of restoration is at the horizontal axis. The restoration level means to replace
the lost environmental good. The slope of curve B indicates that with the increase in
restoration level, benefits increase at a decreasing rate.
The slope of curve C indicates that the restoration costs are an increasing function of
the level of restoration. The economic efficiency is achieved at the restoration level
ORE, where the difference between curve B and curve C is the maximum. The net
gain is NG at this level of restoration.

(D) Other Methods:

There are some other methods of valuing the environment.

(1) Dose-Response Method:

This method requires information on the effect that a change in a particular chemical
or pollutant has on the level of an economic activity or a consumer's utility. For
example, ground levels of air pollution, such as ozone, affect the growth of various
plant species differentially. Where this results in a change in the output of a crop, the
loss of output can be valued at market or shadow (adjusted or proxy) market prices.

Dose-response relationships or production function approaches, are perhaps the

most familiar valuation techniques. Essentially, a link is established between say, a
pollution level and a physical response, for example, the rate at which the surface of
a material decays. The decay is valued by applying the market price (costs of repair)
or by borrowing a unit valuation from non-market studies.

Notable examples include the valuation of health damage. Once air pollution is
linked to morbidity and morbidity is linked to days lost from work, the days lost can
be valued, perhaps using a market wage rate. The main effort of the analysis is
devoted to identifying the link between dose and the response.
(2) Human Capital or Foregone Earning Approach:

The human capital approach values environmental attributes through their effects on
the quantity and quality of labour. The loss earnings approach focuses on the impact
which adverse environmental conditions have on human health and the resultant
costs to society in terms of income lost through illness, accidents and spending on
medical treatments.

The principle involved in this approach is that of valuing life in terms of the value of
labour. Given adequate data regarding lifetime earnings, participation rates in the
labour force mortality rates, etc., it is possible to estimate the value of the expected
future earnings of individuals in any age-group.

On the assumption that wage rates are a precise indicator of productivity, the same
measure with some adjustment to allow for social preferences being different from
private preferences can be used as a measure of the value of the future output of the
individual to society

The social values emerging are usually referred to as the economic value of life. The
other being non-economic or intangible aspects which are additional to that part of
life which the method has been able to measure. This type of valuation system is the
one most commonly found in practice.

The adjusted stream of life-time earnings has to be discounted to convert it to

present value terms. This present value stream of future earnings with these various
adjustments made, represents the human capital value of life span. In some cases,
the measurement of lost output is taken net of consumption and in others a gross
figure is used.

The reasoning behind the adoption of a net of consumption estimate is that when a
worker dies due to an accident that occurs in a factory, the earnings of the workers
will be stopped. The society loses the difference between what he would have
produced and what he would have consumed.