UNIT SIX

6. Valuation, Cost-Benefit Analysis and the Environment

Introduction
Dear learner! Environmental resources supply a flow of direct and indirect services to society. These
services are numerous, ranging from basic life-support to the filtration (assimilation) of wastes
(pollution). While these resources provide a nearly limitless set of valuable attributes, many of their
services remain un-priced by the market. The services are rarely bought and sold, but in the most cases
they never enter into markets and remain un-priced by the public sector. In other words, these
environmental assets do not have the right value (price) for their services.

Measures of value are what economists would like to estimate so that environmental services and other
non-marketed goods can be included in policy decisions on how to prioritize and allocate public monies.
These measures are very helpful to make cost-benefit analysis and to guide policies. Thus, in one of the
sections of this unit we shall discuss how environmental resources are valued.

Further, in this unit we shall see also environmental impact assessment (EIA) which is the information
gathering and analytical process that helps to ensure environmentally sound development. The EIA
process attempts to identify potential problems so that economic feasibility (and environmental impact) of
alternative approaches can be assessed while there is still time to make changes. As such, EIA
complements the conventional package of engineering, socioeconomic, and financial and economic
analyses and provides practical advice to planners.

Objectives

At the end of this unit you will be able to:

 state how the utility function is applied to measure consumer welfare changes
 mention the willingness to pay (WTP) or a willingness to accept (WTA) compensation measures
 define the economic value of an increase in the level of the environmental good
 estimate the maximum WTP or the Hicksian compensating surplus (CS) and the minimum WTA
or Hicksian equivalent surplus (ES) for a certain change in environmental services (or quality)
 mention the components (dimensions) of value
 describe direct and indirect methods of environmental valuation
 discuss about the contingent valuation method (CVM) of environmental services
 list the main steps to estimate the CVM exercise
 explain the indirect or revealed preference approaches to environmental valuation
 define environmental analysis
 state what a project cycle is
 describe the contents of environmental impact assessment
 present how the environmental impact of a project is incorporated in the project cost-benefit
analysis
 to state weak and strong sustainability criteria to calculate environmentally adjusted NPV

8.1. Valuation and the Environment

Dear learner! Economists have a distinct definition of value based on the ideals of rationality and
consumer sovereignty-an individual consistently knows what he /she wants and needs (rationality) and is
best able to make choices that affect his/her own welfare (consumer sovereignty). If the individual prefer
improved air quality to a new dress, rationality requires her to consistently rank air quality over the dress.
Based on this foundation of rational choice, individuals are assumed to be able to value changes in
environmental services despite their absence from the market. If a change occurs such that the person
believes she is better off in some way, she may be willing to pay money to secure this improvement. This
willingness to pay (WTP) reflects her economic valuation of improved environmental services.
Alternatively, if the change makes her worse off, she might be willing to accept compensation to allow
this deterioration (WTP).

These WTP and WTA represent the two general measures of economic value for an environmental
service. These measures of value are what economists would like to estimate so that environmental
services and other non-marketed goods can be included in policy decisions on how to prioritize and
allocate public monies. These measures are very helpful to make cost-benefit analysis and to guide
policies. Thus, in this section we shall see how environmental resources are valued using various
methods.

8.1.1. Welfare Foundations

Dear learner! Can you recall some pointes about the theory of welfare economics and/or can you define
the concept welfare function? Let you put something below.
Dear learner! To get a better understanding of the way economists think about valuing non-market goods,
consider the following figure

Preferences Utility Consumer

Surplus

An individual is assumed to have a set of preferences over goods and services that can be ordered in a
logical and consistent manner. Axiomatic restrictions are usually imposed to define a consistent
preference ordering, and guarantee the existence of a utility function that serves as an index for the
preference ordering.

Dear learner! Believing that you do have a strong background in microeconomics, please try to write the
definition of utility and the assumptions underlie to analyze It.-- Have you answered? Excellent the utility
function is an ordinal representation of preferences. If we impose a policy that changes the consumption
bundle so that utility increases, then economists measure this change as consumer surplus the money
metric of changes in the unobservable utility function. Consumer surplus can be either a willingness to
pay (WTP) or a willingness to accept (WTA) compensation measure. Therefore, changes in utility are
captured by consumer surplus measures.

Dear learner! Consider an individual choosing between alternative consumption bundles defined by n
levels of environmental quality, Q1, Q2, … Qn. If we write Q1  Q2 (Q1 is preferred to or indifferent to
Q2); Q1 > Q2 (Q1 is strictly preferred to Q2): and Q1 ~ Q2 (indifference between Q1 & Q2). Further, assume
that the four axiomatic restrictions or assumptions (reflexivity, completeness, transitivity, and continuity)
on preferences are fulfilled; let us look at how we value environmental assets using the WTP and WTA
methods.

Dear learner! The four axioms (assumptions) allow the representation of preferences by a utility function,
U (Q1). If Q1 is preferred to Q2, then U (Q1)>U(Q2).Generally we assume that an individual’s utility (U)
increases at a decreasing rate as Q increases, i.e., the law of diminishing returns the more we have the less
we value an additional unit of the good. Formally, we represent this as
If U = f(Q) where Q is environmental quality
du d 2u
UQ   0, U QQ  0
dQ dQ 2
Now the U function is
 U= U(X, Q0) where Q0=the original level of environmental quality and
X= (X1.X2,…, XN) all other marketable goods and services. Then UXI
2
 dU  0 & U xixi d u <0, for all Xi (i.e., the law of diminishing marginal utility).
dX i dxi2

Dear learner! The individual’s problem is to maximize his utility subject to (S.T) his income (M)
constraint. Then the optimization problem is written as

Max U=U(X, Q0)

S.T M  PX ; Q0 is pre-assigned. M  PX means the expenditure (PX) can not exceed the income of
the consumer which implies the individual spends less or all of his income on X.
Now let us define the economic value of an increase in the level of the environmental good to Q1 from Q0.
Commodity =X

D
ES
__ A B
X
CS U1
0 Q= environmental quality
Q0 Q1

__
Dear learner! Point A represents U0 given the fixed level of Q0 and x . If we increase environmental
__
service from Q0 to Q1 keeping X fixed ( X ), utility level increases from U0 to U1, more of Q gives the
individual more utility. The maximum WTP of the individual to secure this change from Q 0 to Q1 is the
quantity of X the individual would give up until he reached his original utility level, i.e., the move to
point C from point B. The consumer would not give up more because he would be worse off and he
wouldn’t give up less that would not be the maximum.

The maximum WTP is just the amount that would return the consumer to his original level of utility-no
more, no less. This is maximum WTP is called the Hicksian compensating surplus (CS). In the other
round, the minimum WTA (the minimum compensation the individual is willing to accept) to forgo the
increase in the environmental good is that the individual would require increase in X such that he
achieves the new level of utility, U1, that would have been reached if the environmental good had
increased to Q1 from Qo. This is represented by the difference between points A and D. If he asked less he
wouldn’t reach U1 and if he asked more-this wouldn’t be the minimum WTA. This minimum WTA is
called the Hicksian equivalent surplus (ES). Note that for a decrease in environmental services the
maximum WTP is a Hicksian equivalent surplus, while the minimum WTA is a Hicksian compensating
surplus measure of value. The CS and ES show measure of welfare change due to the change of
environmental quality rather than changes in price

In this analysis, we can say that the non-marketed goods and services are evaluated in terms of marketed
goods and services. Since X has a market price, the gain or forgone of a certain amount of good X can be
changed into money (because the WTP and WTA are measured in terms of the quantity gain /forgone of
X).
8.1.2. Dimensions (Components) of Value

Dear learner! Total value is the idea that consumers have both use and non-use values for environmental
resources. Use value is–straight forward–the economic value of current use. Under use values these are
direct and indirect use values, option value, and bequest value. Under non use value there are bequest
value and existence value.

Value

Use value Non-use value

Direct Indirect Option Bequest Bequest Existence

Use value use value value value value value

Dear learner! Can you mention some of the benefits we can derive from any natural or environmental
resource? Please take Lake Tana as one of the examples.
Have you tried? Very good now let us consider the Semen National Park to describe the various kinds of
values.

Direct use values are recreational use value, biodiversity (the park promotes the maintenance of
biodiversity which in turn helps to maintain ecological equilibrium), economic security for the
surrounding community (e.g., source of money through providing tour services, collect fuel wood, the
country earns from tourism…) and the charming landscape (amenity).

Indirect use values include biodiversity, watershed/ecosystem functions (protect soil erosion and land
degradation), climatic equilibrium such as absorbing carbon dioxide. Option value is the value to preserve
the resource for potential future use, such as biodiversity, recreation, commodity integrity, landscape.
That means the country has the option to use this resource for the future. Bequest value: the current
generation can bequest the resource for the coming generation, for purposes mentioned above.

Non-use value is that value for the current time period no one can be benefited from its use value. The
benefit from non use value is derived from the bequest and existence values. Existence value is the value
of the mere existence of a resource given that the individual has no plans ever to use it .The bequest and
existence values comprise of the value of biodiversity, ecosystem, and landscape.

8.1.3. Valuation Methods

Dear learner! The previous section (discussion) was concerned with an analysis of the theory behind the
valuation of environmental resources. This section, in contrast, is concerned with an analysis of methods
for obtaining empirical estimates of environmental values, such as the benefits of improved river water
quality, or the costs of losing an area for recreational development, etc.

Valuation methods are usually divided into two approaches: direct methods and indirect methods. Direct
methods seek to infer individuals’ preferences for environmental quality directly, by asking them to state
their preferences for the environment. Indirect methods seek to recover estimates of individuals’ WTP for
environmental quality by observing their behavior in related markets.
8.1.3.1 Direct methods of valuation

A) The contingent valuation method (CVM)

It consists of asking people for either maximum WTP for an increase in environmental quality, or their
minimum WTA to forgo such an increase. Respondents might instead be asked about their minimum
WTA to accept this reduction. Because the level of environmental quality is usually chosen by a third
party (such as government) and not by the individual being questioned, these measures correspond to
either Hicksian equivalent or compensating surplus (CS) (rather than equivalent or compensating
variation, where quality/quantity is chosen by the individual).

CVM uses survey questions to elicit (draw out) from a sample of consumers their WTP and/or WTA for a
change in the level of environmental goods or services in a carefully structured hypothetical market. Any
CVM exercise can have four main steps (stages):
1. Designing and administrating the CVM survey;
2. Empirical analysis of responses;
3. Estimating & aggregating WTP and / or WTA; and
4. Evaluating the CVM exercise.

1) Designing and administrating the CVM survey

A. Set up a hypothetical market for the environmental service flow in question. For example, take a
policy to restore or to develop a new recreational site in a city center Respondents may be told that
the local government could engage in such restoration activities, describe what these would
consist of and their effects, and explain that the operation could only go ahead if extra funds are
generated. This sets up a reason for payment for services, where no direct payment is currently
exacted.
B. Designing the questionnaire (decide how much and what kind of information is needed).
C. Elicit the respondents’ WTP/ WTA for the good being valued. A commonly used hypothetical
question simply asks people what value they place on a specified change in an environmental
quality or the maximum WTP to have it occur. Another major type of hypothetical question asks
for a ‘yes’ or ‘no’ answer to the question. Would you be willing to pay $X? Each individual’s
response reveals only an upper bound (for a no) or a lower bound (for a yes) on the relevant
welfare measure. Questions of this sort are often referred to as referendum questions because of
the analogy with voting. This is called iterative bidding game.Dear learner! Consider the
following example to determine WTP (Birr/month) for an improved water system in a certain
locality.

20?

Yes No

25? 15?

Yes No Yes No

25 and over 20-24.99 15-19.99 0-14.99

A person may be asked to pay, say Birr 20 for the service indicated above. Then he may answer by saying
‘Yes’ or ‘No’. If he said ‘Yes’ then we increase the amount of Birr he will be willing to pay. Thus we ask
him do you want to pay 25. If his response is ‘No’ then his final willingness to pay will be in between 20
and 24.99. Standard bidding game continues until a yes answer changes into a no or a no answer changes
into a yes.

D. Questions about respondents’ characteristics (e.g., age, income, education …) their preferences to
the good(s) being valued, and their use of the good.
E. Administering the survey (obtaining bids). Once the survey instrument (questionnaire) is set up,
the survey is administered. This can be done either by face-to face interviewing, telephone
interviewing or mail. Of course each method of communication has its own advantages and
disadvantages. Pre-testing questionnaires, training interviewers, etc contribute a lot to the proper
administration and accuracy of results, and data comparability. Recognize also the importance of
culture, ethics, and tradition.

2) - Empirical analysis of responses

Three ways to analyze the information obtained from a CVM survey are

a) Examining the frequency distribution of responses to the WTP questions.

b) Looking at cross-tabulations between WTP /WTA responses and socio-economic characteristics of
the respondents and descriptive statistics. It is very important to detect data errors like outliers.
c) Using multivariate statistical analysis (techniques) to analyze the determinants of WTP/WTA
responses. It is an econometric analysis using bid function (estimating bid curves). For example, run
the regression of econometric model of WTPi = f(Yi, Ei, Ai, Qi ) ; i=1, …n and Y= income,
2
E=education, A= age, Q= environmental quality. Then analyze the R , the sign and magnitudes of the
coefficients of the model.

3) - Estimating and aggregating benefits (WTP/WTA)

If open-ended, bidding game or payment card approaches have been used, then the calculation of sample
mean and/or median WTP or WTA is straight forward. That means the analyst should estimate total WTP
(or total revenue) by aggregating each responses.

4) - Evaluating the CVM exercise

Since the major questions regarding all hypothetical methods concern the validity & reliability of the data.
Whether the method leads to some kind of bias, by ‘bias’ we mean a systematic over-or under- statement
of true WTP /WTA. Biases are many types: sampling, personal strategic, etc. Check also the reliability &
validity of the result.

B) Stated Preference methods

While it is true the CVM is a stated preference method, it is only one example of this more general
approach. Stated preference (SP) can be considerably generalized to encompass situations where
individuals are asked either to rank a list of environmental options (contingent ranking) or else to choose
between pairs of choices. These choices typically include attributes of the environmental good, and the
cost of provision/access.
In SP analysis, all possible attributes of the good in question are first identified, and ways found of
measuring these attributes. Then, from the set of all attributes & all possible values these attributes could
take, a much smaller sub-set is chosen using statistical design techniques.

8.1.3.2. Indirect methods of valuation

It is to infer the value that individuals place on the environment from their behavior in related markets.
For example, the value an individual places on a recreational site may be revealed by what that individual
spends to get to the area. There are several such indirect or revealed preference approaches to
environmental valuation. Such as the travel cost method (TCM), hedonic pricing method (HPM), dose-
response approaches, and averting expenditure/avoided cost approach.

i) The travel cost method (TCM)

Dear learner! The method involves using travel costs as a proxy for the price of visiting outdoor
recreational sites. A statistical relationship between observed visits and the cost of visiting is derived and
used as a surrogate demand curve from which consumer’s surplus per visit-day can be measured (by
integrating under this curve). TCM allows the welfare effects of changing the characteristics of a site to
be analyzed. TCM assumes weak coplementarity between the environmental asset and consumption
expenditure. This implies that, when consumption expenditure is zero, the marginal utility of the public
good is also zero. So if traveling to a forest becomes so expensive that no one goes any more, the
marginal social cost of a decrease in the quality of that forest is also zero. The TCM cannot therefore
estimate non-user values.

The simplest version of the TCM involves collecting data on visits to a site (V) from different parts of the
surrounding country (zones, i) and explaining the visit rate per capita ( Vi ) as a function of travel costs,
Pi
Ci. These costs are assumed to be some function of both distance and time spent traveling and of
socioeconomic variables Si Vi  f (Ci, Si)
Pi
The TCM is a survey technique. A questionnaire is prepared and administered to a sample of visitors at a
site in order to ascertain their place of residence: necessary demographic and attitudinal information;
frequency of visit to this and other sites; associated costs (includes opportunity cost of time), etc.

Vhj
The trip-generating function is  f ( Pvh , S h ) where
Nj
Vhj = visits from zone h to site j; Nh= population of zone h
Pvh = visit costs from zone h; Sh=socio-economic variables (like income, education, profession, sex,
etc)

Steps involved in travel cost (TCM) study are as follows:

 Identify a site to be studied (valued) and group residents into zones around the site.
 Estimate average travel cost and visitation rate to the site from each zone;
 Derive an aggregate demand curve for the sites and
 Calculate benefits from the site.

ii) Hedonic Pricing (HP)

The hedonic pricing approach seeks to explain the value of a commodity as a bundle of valuable
characteristics. One or more of these characteristics may be environmental. For example, the value of a
particular house may depend on the number of rooms, how close it is to the road, hospital, transport,…,
but also on the other environmental variables include pleasant views, distance from toxic waste dumps, or
offensive smells from factories or farms. HP measures only use values.

The steps to calculate HP

a) A HP function is estimated;
b) Implicit prices are calculated for the environmental variable of interest;
c) A demand curve for this variable may be estimated.

iii) Dose response, averting expenditure and avoided cost methods

The dose-response method involves finding a link between environmental change and production
conditions for so marketed good. Depending on the behavioral assumptions made and the statistical
techniques employed, welfare estimates are then calculated using changes in, for example, profit from
production of the marketed good. This increment in profit may be associated with the rise in
(improvement) environmental quality. For instance, protecting the water from pollution will increase the
fish production and there by increases profit. Air pollution damages farm crops and will result in fall in
profits.

The averting expenditure/avoided cost approach (like the TCM) employs the notion of a household
production. Households can be viewed as ‘producing’ certain service flows or goods, such as drinking
water, by combining various inputs, one of which is environmental quality. Thus a rural household might
combine water taken from its well with purification equipment to produce water fit to drink. If water
quality in the well declines then the household must increase its expenditure on other inputs to maintain
constant the quality of its drinking water. This averting expenditure measures the welfare loss to the
household of the decline in environmental quality.
8.2. Environmental Analysis/Assessment
Dear learner! Whenever we prepare the project feasibility study (i.e., cost-benefit analysis), we should
take into account the impact of the project on the environment. This is done by making use of the
Environmental analysis (EA) so that the cost-benefit analysis of any project does not incorporate only the
financial costs and benefits but also the environmental costs and benefits. Environmental analysis (EA)
sometimes referred to as environmental impact assessment (EIA) is, therefore, the information gathering
and analytical process that helps to ensure environmentally sound development. This section of the
course deals with EIA as presented below.

Dear learner! Have you ever tried to prepare a feasibility study of a project or do you know someone who
has done such a study? If so, how the costs of environmental damages were treated? Let you try to answer
about it below.

Dear learner! Environmental Analysis (EA) sometimes referred to as Environmental Impact Assessment
(EIA) is the information gathering and analytical process that helps to ensure environmentally sound
development. The EA process attempts to identify potential problems so that economic feasibility (and
environmental impact) of alternative approaches can be assessed while there is still time to make changes.
As such, EA complements the conventional package of engineering, socioeconomic, and financial and
economic analyses and provides practical advice to planners.

EIA and the project cycle: The project cycle is the process in which a project passes through its
inception (idea) to implementation. There are numerous places within the project cycle where
environmental and resource concerns may be injected. The project designers must work in
multidisciplinary team to design projects that consider a variety of goods and services-economic, social,
environmental at the same time. EA identifies potential problems and opportunities and is thus an
essential part of the project cycle. By itself, however, it is insufficient for decision making.

The contents of an impact assessment should cover the following topics:

a) Description of the project, focusing on possible sources of environment impacts;
b) Description of the environment situation before the implementation of the project;
c) Analysis and prediction of environment impacts resulting from the project;
d) Comparison / evaluation of environmental conditions with or without the project (eventual project
alternatives); and
e) Out coming of mitigation measures needed to minimize adverse impacts.
The following figure shows environmental assessment and the project cycle

PREPARTION

IDENTIFICATION Starting point

DETAILED DESIGN

COMPLETION
APPRAISAL

SUPERVISION
NEGOTIATION

LOAN
IMPLEMENTATION APPROVAL

The EIA procedure used at present is more or less standardized and consists of the basic steps of
screening, initial environmental examination (IEE), scoping, impact statement preparation, review and
final decision, monitoring and auditing. Most developing countries in Asia review projects based on their
potential environmental impact. The definitions used are however often somewhat general. Typical
formulations are ‘major industrial projects’ or ‘large reservoirs’. On the basis of the reviews carried out
for various Asian countries, it can be said that mitigation measures and their implementation,
environmental monitoring and compliance control need to be strengthened. Most countries do not have
specific regulations to monitor and control the extent of implementation of the proposed remedial
measures. A problem still unresolved is proper co-ordination with other concerned ministries.

EIA techniques: Various guidelines, models and methods have been developed to make the EIA process
more effective. The main focus was directed at the development of methods for impact identification and
evaluation. Formalized outlines, questionnaires, checklists and matrices have been developed and put into
use for screening. IEE and scoping. Manuals, handbooks and sectoral guidelines assist the preparation of
impact statements.

Some problems and overlooked issues: Most developing countries now recognize the need to promote
and strengthen EIA processes. The following are some problems and overlooked issues:
1) Is EIA a means or an end? It should be considered as a means; the analysis should be followed up.
2) Is EIA a planning tool or decision-making instrument? Make sure it can be implemented. The
analysis should cover all sides of benefits and costs.
3) Lack of integration into the project cycle: experience indicates that impact assessment processes are
initiated only after project preparation is near completion. The coordination of the EIA procedure and
the project cycle is still weak. Integration of EIA into project planning should maximize its
effectiveness and also minimize delays in project implementation.
4) Lack of resources and information.

The assessment should cover: Length of time and geographic area over which the effect will be felt
(number of people affected, how much of particular resource depleted (degraded), what action taken for
conservation). Urgency is another criterion, how quickly the resource depleted and how it takes to
stabilize. Asses also the degree of irreversibility damage on people and animal.

Dear learner! Conventionally, there are many criteria that are frequently used to evaluate the feasibility of
a project. The two common criteria are the benefit-cost ratio and the net present value (NPV) criteria. The
decision rule for the former criterion implies that an activity should be undertaken if the ratio of the
present value (PV) of benefits to PV of costs exceeds one, that is, PVB  1, i.e, PVB  PVC. The
PVC
decision rule for the second criterion implies that an activity should be undertaken whenever the present
values of net benefits (NPV) is greater than zero.
T
Bt  C t
That is NPV=  (1  r )
t 0
t
 0 . The project to be feasible NPV  0 .

When we consider this standard cost-benefit analysis, environmental impacts are not included when we
calculate benefits (Bt) and costs (Ct). That means positive and negative externalities are missed. For
instance, project analysis for big dams, factories, roads, etc misses their positive and negative externalities
or environmental benefits and damages. Of course the course development planning and project analysis
tries to incorporate linkage effects-backward and forward and externalities.

So one way of incorporating the impacts of projects on the environment is; to modify the objective
function with sustainable constraint, by considering net environmental damage (Eit) as a cost in the NPV
calculation. That is: Maximize NPV subject to sustainability. The environmentally adjusted or the
sustainable cost-benefit analysis would be as follows.

NPV=  dt (B - C -E )  0, for a project. Where d = discount factor at time t, B =benefit of project i at

t it it it t it

time t, Cit=financial cost of project i at time t, and Eit= environmental damages or environmental costs,
and for a program NPV= t dt   
i Bit  Cit  Eit   0. A program is a collection of projects.

But sometimes, even if, NPV can be greater or equal to zero, we may have (in the case of the program)
 E  0. to overcome this problem the sustainability criteria are introduced. Weak sustainability is
i it

when PV (i Ei)  0. It has the problem of uncertainty or irreversibility. Therefore, the strong
sustainability is i Ei  0, at each point in time for each project. It shows the actual not the present value
(PV).

The treatment of risk

Dear learner! Do you remember the concepts ‘uncertainty’ and ‘risk’ in your Microeconomics course?
Thus, what measures or theories can we use to analyze the above concepts? Please try to write the answer
below.
For many environmental problems, it is not possible to state with certainly what consequences a particular
policy will have, because scientific estimates, themselves, often are imprecise. The treatment of risk in the
policy process involves two major dimensions: (1) identifying and quantifying the risks; and (2) deciding
how much risk is acceptable. The former is primarily scientific and descriptive, while the latter is more
evaluative or normative.

Benefit-cost analysis grapples with the evaluation of risk in several ways. Suppose, for example, that we
have a range of policy options A,B,C,D and a range of possible outcomes E,F,G,H for each of these
policies depending on how the economy involves over the future. These outcomes might depend on
whether the growth of the demand for a resource is low, medium, or high. Thus if we choose policy A, we
might end up with outcomes AE, AF, or AG. Each of the other policies has three possible outcomes as
well, yielding a total of 12 possible outcomes. We could conduct a separate benefit-cost analysis for each
of the 12 possible outcomes.

Further, suppose, for example, that we were able to assess the likelihood that each of the three possible
outcomes would occur. Thus we might expect outcome E to occur with probability 0.5, F with probability
0.3, and G with probability 0.2. Then we can get the expected PV of net benefits for a particular policy
which is defined as the sum over outcomes of the PV of net benefits for that policy where each outcome is
weighted by its probability of occurrence. In other words, the application of probability theory, especially
making use of the expected value of NPV, i.e., E(NPV) is very important to analyze the consequences of
environmental risk in project cost-benefit analysis.

Summary
The theory of rational choice enables individuals to value changes in environmental services despite they
are not transacted (bought and sold) in the market. If a change occurs such that the person believes he is
better off in some way, he may be willing to pay money to secure this improvement. This willingness to
pay (WTP) reflects his economic valuation of improved environmental services. Alternatively, if the
change makes him worse off, he might be willing to accept (WTP) compensation to allow this
deterioration. In other words, WTP and WTA are calculated on the basis of the premise that individuals’
welfare can be improved/deteriorated through a certain environmental change in any location. Therefore,
WTP and WTA represent the two general measures of economic value for environmental services. The
value of any environmental change may be measured using various methods. Among them the contingent
valuation method (CVM) is the most widely used method.

In project cost-benefit analysis we are making use of Environmental Impact Assessment (EIA) which is
the information gathering and analytical process that helps to ensure environmentally sound development.
Since the conventional project appraisal criteria do not take in to account the environmental costs, it needs
to calculate environmentally adjusted NPV and/IRR (internal rate of return) to ensure sustainability.

Questions
1- Mention the concepts willingness to pay (WTP) and willingness to accept (WTA) compensation
measures
2- State when or in which condition we use the WTP and WTA
3- Show using graph how the utility function (curve) is applied to measure consumer welfare changes and
Estimate the maximum WTP or the Hicksian compensating surplus (CS) and the minimum WTA or
Hicksian equivalent surplus (ES) for a certain change in environmental services (or quality)
4- Mention the components (dimensions) of value
5- Discuss about the contingent valuation method (CVM) of environmental services
6- Describe direct and indirect methods of environmental valuation
7- List the main steps to estimate the CVM exercise
8- Explain the indirect or revealed preference approaches to environmental valuation
9- State why many of the environmental assets do not have market prices
10- Out line the reasons for the existence of market failures
11- Describe what Environmental Analysis (EA) or Environmental Impact Assessment (EIA) does mean
12- State the various stages a project passes (project cycle) in any economic activity
13- List the contents of an impact assessment should cover
14- Mention the EIA techniques in project study/appraisal
15- Explain the overlooked issues in project preparation
16- Define what NPV means and state how we can use it as criterion in project analysis
17- Discuss the difference between the conventional measure of NPV and the environmentally adjusted
NPV
18- Mention the use of calculating expected value of NPV as against the simple value of NPV