Estimating the Cost of Environmental Degradation

7
CONTINGENT VALUATION METHOD
In the market-place, individuals tend to have clear information on which to base their valuation and
choices. The product tends to be visible, its characteristics are generally well known, and it has a
market price. Economists can elicit the value that individuals place on a good or service by observing
purchasing behavior. Most valuation techniques are based on observing people’s behavior to “reveal”
the value they place on it. However, in some cases there are simply no market proxies to observe. In
such circumstances, it is possible to ask a sample of people what they would be willing-to-pay
(WTP). In this situation, economists rely on people to “state” their preferences. This method is known
as the contingent valuation method (CVM) and is the main approach for eliciting values of changes in
behavior using stated preferences as shown in Figure 7.1.

Figure 7.1 The contingent valuation method

Environmental
Degradation

Estimation Dose-Response
of impacts Effect

Change in Change in Change in Behavior

Production Health Revealed Stated

Value of changes Human capital Hedonic price Contingent

in productivity approach method valuation
method
Economic
valuation Opportunity cost Medical costs Averting and
approach approach preventive
behavior
Replacement cost
approach Travel cost
method

The Contingent Valuation Method

The CVM enables economic values to be estimated for a wide range of commodities not traded in
markets. This method uses survey techniques to establish the value of goods and services that are not
exchanged in markets and therefore have no prices associated with them. The CVM involves asking a
randomly chosen sample of people what they are WTP for a clearly defined change in the provision
of a good or service, or to prevent a change. It can also be used to elicit what people are willing-to-
accept (WTA) to forgo a change or tolerate a change. The most commonly applied approach in the
CVM is to interview people and ask them what they are WTP towards the preservation of that asset.
Analysts can then calculate the average WTP of respondents and multiply this by the total number of
people who enjoy the environmental site or asset in question to obtain an estimate of the total value
which people have for the asset.

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An interesting advantage of the CVM approach is that it can be used to elicit values of resources that
people will never personally utilize or visit. Take Antarctica as an example: a natural reserve
individuals are WTP to preserve, but would not in general like, or be able, to visit. In other words
CVM can be used to elicit non-use values.

Steps for Designing a Contingent Valuation Study

The main stages in the application of the contingent valuation method are summarized in Figure 7.2.
Each stage in discussed in more detail below.

1 - Setting up the hypothetical market

The first step is to set up a hypothetical market for the environmental service in question. The
following issues should be considered when setting up the hypothetical scenario. The valuation
scenario should be well defined, fully explaining the good in question and the nature of the change.
This may be done with the use of images such as photographs or illustrations.

The institution responsible for providing the good must also be identifiable and believed to be capable
of providing it. This helps the respondent visualize how the good will be provided in practice.

It should also be made clear how the payment will be made. Commonly used payment methods
include taxes, fees, price changes, or donations.

An example of a well-defined scenario is given below:

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

2 - Obtaining bids

Bids can be elicited using several survey techniques: face-to-face interviewing, telephone
interviewing, or mail. Telephone interviews are probably the least preferred method since conveying
information about the good may be difficult over the telephone, partly due to a limited attention time
span. Mail surveys are frequently used, but suffer from potential non-response bias and low response
rates. Face-to-face interviews with well-trained interviewers offer the greatest scope for detailed
questions and answers.

The purpose of the survey is to elicit an individuals maximum WTP in order to have the
environmental improvement go ahead (or their maximum WTP to prevent a deterioration in
environmental quality occurring). Alternatively, the scenario may be phrased so that a minimum
WTA to go without the improvement or to put up with the deterioration is appropriate.

Follow-up questions such as “Do you think the environmental service would improve the quality of
life in your community?”, should be administered in order to understand the motives behind each
respondent. This can help eliminate protest or invalid responses.

3 - The results of the analysis

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Once the data has been collected, the difficult work of making sense of it begins. The wealth of
information collected can be used in different ways and for a variety of purposes. The possible
outputs we can obtain from a CVM study are presented below.

Average WTP or WTA

Once bids (WTP or WTA) have been gathered, an average bid can be calculated. Average WTP or
WTA can be used to have a quick assessment of the value a resources has for a particular population.

“Protest” bids are usually omitted from the calculation. Protest bids are zero bids given for reasons
other than a zero value being placed on the resource in question. For example, a respondent may
refuse any amount of compensation for loss of a unique environmental resource such as the Grand
Canyon, as they believe it is the government’s responsibility to protect it, or simply that they do not
wish to take part in the survey. A decision must also be taken over how to identify and treat outliers.
The follow-up questions can help with this.

Average bids are easily calculated if an open-ended value approach has been used. If a closed-ended
referendum approach has been used, i.e. Yes/No answers, then econometric techniques can be used to
calculate the probability of “yes” answers to each suggested amount.

Bid curves

A bid curve can be estimated using econometric regressions. WTP/WTA amounts are used as the
dependent variable and information on variables such as income, age and education, which has been
collected during the survey, is used as explanatory variables.

A typical regression will look like the following:

WTPi = f (Ii, Ei, Ai)

Where ‘i’ indexes respondents.

Bid curves open the possibility of predicting WTP amounts given changes in the independent
variables. For example, “What would be the effect of higher wages on the WTP for the provision of
water services?”

Aggregated data
Aggregation refers to the process whereby the average bid is converted to a population level value
figure. Decisions over aggregation revolve around three issues:
• First is the choice of the relevant population. The aim is to identify either (a) all those whose
utility will be significantly affected by the action, or (b) all those within a relevant political
boundary who will be affected by the action. This group might be the local population, the
regional population, or the population of the country.
• Second is the issue of moving from the sample mean to a mean for the total population.
Several alternatives have been proposed. If the sample mean is truly representative of the
total population then the sample mean could be multiplied by the number of households in the
population.
• Third is the choice of the time period over which benefits should be aggregated. This will
depend on the setting within which the CVM exercise is being performed. If the present value
of environmental benefits flows over time is of interest, then benefits are normally
discounted.

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4 - Evaluating the CVM exercise

This entails an appraisal of how successful the application of CVM has been. Did the survey result in
a high proportion of protest bids? Is there evidence that respondents understood the hypothetical
market? How much experience did respondents have of the good in question? If asking respondents
living in a calm rich residential area about their willingness to tolerate a new quarry in their
neighborhood resulted in high number of protest bids, then the CVM application would not be
considered successful. Similarly, suppose that respondents state their WTP preserve the panda bear in
China. This may lack credibility if these respondents are not familiar with this animal.

The quality of a CVM study heavily depends on the quality of its underlying process, i.e. the
preparation and administration of the survey. In 1993, based on the existing experiences, a panel of
experts published a set of guidelines that would allow the use of CVM in court cases for damage
compensation. The guidelines (known as the NOAA guidelines) still constitute a milestone in the
CVM short history and are described in Box 7.1.

Box 7.1 Recommendations from the NOAA Panel

Due to the large number of issues and considerations regarding the contingent valuation technique,
there is an ongoing debate surrounding its credibility. In the late 1980s questions began to arise about
its usability in the legal system to estimate damages. Following the Exxon Valdez soil spill in 1989, the
Oil Pollution Act of 1990 was implemented. Under that new law the Department of Commerce of the
USA, acting through the National Oceanic and Atmospheric Administration (NOAA), was asked about
its opinion on whether CVM is capable of providing estimates of non-use or existence values that are
reliable enough to be used in natural resource damage assessments. The panel established a set of
guidelines to which it felt future applications of CV should follow. These guidelines were numerous,
but the seven most important are summarized below.
1. Applications of the CVM should rely on personal interviews rather than telephone surveys where
possible, and on telephone surveys in preference to mail surveys.
2. Application of CVM should elicit WTP rather than WTA when possible. The reason is that WTA
questions may cause a strategic behavior in the respondent, who may have an incentive to overstate
its true value.
3. Applications of the CVM should utilize the referendum format; that is, the respondents should be
asked how they would vote if faced with a program that would produce some kind of
environmental benefit in exchange for higher taxes or product prices. The panel reasoned that
because individuals are often asked to make such choices in the real world, their answers would be
more likely to reflect actual valuations than if confronted with, say, open-ended questions eliciting
maximum WTP for the program.
4. Applications of CVM must begin with a scenario that accurately and understandably describes the
expected effects of the program.
5. Applications of CVM must contain reminders to respondents that a WTP for the program or policy
in question would reduce the amount they would have available to spend on other things.
6. Applications of the CVM method must include reminders to respondents of the substitutes for the
“commodity” in question. For example, if respondents are being asked how they would vote on a
measure to protect the wilderness area, they should be reminded of the other areas that already
exist or are being created independent of the one in question.
7. Applications of the CVM should include one or more follow up questions to ensure that
respondents understood the choice they were being asked to make and to discover the reasons for
their answer.
The NOAA guidelines were criticized as they were believed to make carrying out a CVM too
expensive. This was especially thought to be the case with in-person interviews. The guidelines were
created within the context of large legal lawsuit settlements, so it was felt that high quality CVMs were
necessary. There is no standard approach to CVM, but the NOAA guidelines provide a framework for
good practice.

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Figure 7.2 Flow chart of designing a contingent valuation study.

Define:
• the good and nature of
Set up hypothetical
change/s
market
• institution responsible
• payment vehicle

Interview techniques:
Obtain Bids • face-to-face
• telephone
• mail
Follow up questions

Results
Omit protest bids.
Check for outliers.
Calculate average
WTP/WTA

WTPi = f(xi)
where X – set of independent variables
Estimate bid curves
i – index of respondent

Aggregate data Convert average bid to population level figure.

Issues:
• Choice of relevant population?
• Use sample mean or total population mean?
• Choice of time periods to aggregate
benefits?

Evaluate the CVM Understand the motives behind the answers.

exercise • Are there many protest bids?
• Did the respondents understand the hypothetical market?
• How familiar are the respondents with the good in
question?

Case Study: the Environmental and Financial Sustainability of the Machu

Picchu Sanctuary

Established in 1981, and declared a “world heritage” site by UNESCO in 1983, the historic sanctuary
of Machu Picchu covers an area of 32 thousands hectares in the Department of Cusco, Peru. The
sanctuary includes the ‘ciudadela’, a 14th century Inca city located on the top of a mountain at 2,500
meters above sea level. Every year, nearly 300,000 tourists visit the ‘ciudadela’, making it one of the
greatest tourist attractions in South America. Despite the number of visits, the revenues derived from
the entrance fees have been low. This has been the effect of a tourism policy that aims to maximize
the number of tourists thus capturing revenues through lodging, transport and souvenirs. However, in
the future this policy option may not be sustainable as the carrying capacity of the site may be
exceeded.

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This case study uses contingent valuation to elicit visitors’ willingness to pay. This can be used to
analyze the feasibility of a price system that is capable of maximizing revenues for the site
administration while allowing demand to be controlled. The example is based on a paper by T. Hett et
al (2003) and EFTEC (1999).

The original study was requested by the Finnish Forests and Parks Service in the context of a
technical assistance program for Machu Picchu. A total of 1,014 visitors were interviewed in 15 sites
around Cusco, the gateway of tourists coming to and from Machu Picchu. Tourists were divided in
two groups: (1) those who only visited the ‘ciudadela’ and (2) those traveling to the ‘ciudadela’ via
the ‘Inca trail’, a walking route that leads to the city of Machu Picchu, following (at least partly) the
old Inca roadway. Here we will concentrate on the results of the first group of interviews.

1 - Setting up the hypothetical market

At the time of the survey, a US$10 entrance fee was being charged to tourists visiting the ‘ciudadela’.
Thus, the initial steps to the analysis were made easy by the fact that a market for the recreation
services of Machu Picchu already existed. Surveyed visitors needed not be induced to imagine a
situation in which a price was charged for accessing the site. The aim of the survey was however to
ask them to imagine a situation in which a higher price would be charged.

2 - Obtaining bids

Two different procedures were used to obtain the bids. The first group of respondents were asked
about their willingness to pay through a referendum type of question. They were asked to imagine
that while they were planning their trip they were informed that the price had been increased from the
current price of US$10 to US$20. They were asked whether they would still be willing to visit the site
at the new price. A second group of respondents were asked to mark their maximum willingness to
pay on a ‘payment card’, like the one depicted in Figure 7.3. Both methods allow average willingness
to pay and bid curves to be estimated. Using a variety of split-sample experiments allows us to better
understand how respondents may be reacting to the CV scenario and the elicitation procedure
(Whittington, 2002). We will focus here on the results from the second type of elicitation method: the
payment card.

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Figure 7.3 Payment card for assessing the maximum willingness to pay to visit the city of
Machu Picchu
The maximum amount that you are prepared to pay to
access the city of Machu Picchu (in US$)
10
15
20
25
30
35
40
45
50
55
60
65
70 Please do not state that you are willing to
75 pay an amount if you think you that:
80 • You cannot pay
85 • Your money could be better
90 spent on other things
95 • If you are uncertain
100
110
120
130
140
150
160
170
180
190
200
225
250
300
Any other amount: ……………..

3 - The results of the analysis

Using the results from the payment cards, it is possible to obtain a value for the maximum willingness
to pay of tourists by calculating the average of the responses. Table 7.1 shows the results. The
respondents have been grouped into Peruvians and foreigners. One of the objectives of the study was
in fact to analyze the proposal for a differentiated entrance fee that would allow maximizing
revenues. Notice that the value of average WTP is US$26 for the Peruvians, US$47 for the foreigners
and US$40 for the whole group. These results seem to be biased upwards by the existence of some
respondents with very high willingness to pay (more than US$100)xv. A way to control for this
problem is to show the median WTP. As Table 7.1 shows, overall median WTP is US$30, ten units
less than the average.

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Table 7.1 Maximum willingness to pay for visiting the city of Machu Picchu
Average WTP Median WTP % of respondents WTP more
(US$) (US$) than the current fee (US$10)
All respondents 40 30 82
Peruvian tourists 26 20 66
Foreign tourists 47 30 91

The questionnaire also elicited information on the socioeconomic characteristics of respondents, the
purpose of their visit, their attitude towards the management of the site, and their perception of
proposed changes. This information can be used to observe the relationship between individual
characteristics and maximum WTP.

logWTPi = α 0 + α1Sexi + α 2 Agei + α 3 Educationi + α 4 Incomei + α 5 Nationalityi + ... + errori (1)

To do so, a regression was performed using the Ordinary Least Squares method. This method allows
estimating the coefficients (α0, …, α5,…) that provide the best fit between the data and the assumed
theoretical model represented by equation (1). The coefficients obtained from the estimation are key
as they provide information on how much a change in each explanatory variable affects the maximum
WTP. Table 7.2 shows the regression results. A measure of the overall fit of the theoretical model (1)
to the survey data is provided by the R2 value. A low R2 value is typical of contingent valuation
studiesxvi. For example, the survey results highlight the fact that, all else constant, visitors with a post-
graduate degree are WTP more than those without. Being Peruvian on the other hand, implies a lower
willingness to pay compared to being a foreign visitor – the coefficient is negative.

Table 7.2 Bid function for the visits to the city of Machu Picchu – Regression results
Variable Coefficient
Logarithm of WTP Dependent variable
Constant 3.15
Male 0.07
Education 0.25
Income 0.00
Peruvian -0.67
…
R2=0.25
N=531

4 - Estimating demand and maximizing revenues from the site’s entrance fee

These results could have strong policy implications. If we assume that the sample is representative of
the almost 300,000 tourists that visit the ‘ciudadela’ annually, it is possible to estimate demand curves
for foreigners and Peruvians. These are represented in Figure 7.4. The lower curve represents the
demand for visits by Peruvian tourists and the higher curve is for foreigners. The different positions
reflect the influence of different socio-economic characteristics, attitudes and perceptions by the two
different groups.

Currently, a US$10 fee is charged to both Peruvian and foreign tourists. If the price was raised, the
number of visits would decline, as indicated by the downward slope of the demand curve. However,
the total revenues obtained (price times the number of visits) would initially increase and then decline
above beyond a certain fee level. From the point of view of the government it would be useful to
know what level the fees should be set at in order to maximize revenues. The study calculates these
levels and the results are summarized in Table 7.3.

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Figure 7.4 Demand curve for visits to the city of Machu Picchu
Price ($) (Peruvians and foreign tourists)

100

80

60

40

20

10

100,000 200,000 Visitors

Table 7.3 Policy implications of the survey

Type of policy Visitors (thousands) Price (US$) Total revenues
(US$ millions)
Peruvians Foreigners Peruvians Foreigners
Current price 94 174 10 10 0.81

Maximize revenues without 17 98 37 37 2.21

price differentiation
Maximize revenues with 44 93 23 44 2.68
price differentiation

Under the current pricing scheme, a total of 268,000 paying tourists visit Machu Picchu and the total
revenues are estimated in US$810,000. If the entrance fee were raised to US$37, the total revenues
would go up to US$2,210,000 – more than twice the current revenues. This would of course result in
a drop in the number of tourists, especially Peruvians, whose lower income and perception of the site
as a public good imply a lower WTP. Differentiating prices (US$23 for Peruvians and US$44 for
foreigners) would generate the highest revenues and would result in a higher number of Peruvians
visiting the site than that under the undifferentiated price option.

It is in the end the government who decides on which price policy to adopt. The objective of the
government may not necessarily be to maximize the revenues and may be influenced by other
considerations such as equity. However, the results from the CVM provide a powerful information
tool for decision makers and scientists.

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Annex 7.1 Advantages and Disadvantages of Different Questionnaire’s

Formats

Open-ended Advantages Disadvantages

What is the maximum amount you are Straightforward. It leads to large non-response rates, protest
WTP as an addition to your water bill to Does not provide respondents with cues answers, zero’s and outliers. This is
implement the previously described clean- about what the value of the change might because it may be difficult for respondents
up program in the river Nile? be. to come up with WTP “out of the blue”.
Informative as maximum WTP can be
identified for each respondent.
Requires relatively straightforward
statistical techniques.
Bidding Game Advantages Disadvantages
Are you WTP an additional $10 on your May facilitate respondents thought Anchoring bias may exist, that is the
water bill to implement the previously processes and encourage them to consider respondent is influenced by the starting
described clean-up program in the river their responses carefully. point.
Nile? Leads to a large number of outliers due to
positive but insincere responses.
If yes, interviewer keeps increasing the bid Cannot be used in mailing surveys and
until the respondent says no. other self-completed questionnaires.

If no, interviewer keeps decreasing the bid

until the respondent says yes.
Single-bound referendum Advantages Disadvantages
Are you WTP an additional $10 (price is Simplifies thought process as similar to a Empirical studies reveal it elicits larger
varied randomly across the sample) on real life situation where a product has a WTP values than open-ended questions.
your water bill to implement the single price. Some degree of positive, yet insincere,
previously described clean-up program in Minimizes non-responses and outliers. responses.
the river Nile? Endorsed by the NOAA panel. Provides less information.
Starting point bias.
Double-bounded referendum Advantages Disadvantages
Are you WTP an additional $10 (price is Receives more information than the single Limitations of single-bound apply.
varied randomly across the sample) on bound as know WTP is between certain
your water bill to implement the number.
previously described clean-up program in
the river Nile?

If no, would you pay $5?

If yes, would you pay $10?
Payment card elicitation Advantages Disadvantages
Which of the amounts listed below are Provides a context to the bids, while Vulnerable to biases relating to the range
you WTP as an additional to your water avoiding starting point bias. on numbers on the card.
bill to implement the previously described Number of outliers is reduced. Cannot be used in telephone interviews
clean-up program in the river Nile?
0
0.5
1
2
5
7.5
10
12.5
15
20
40
50
75
100
150
200, or >200
Reproduced from DTLR (2002) Economic Valuation with Stated Preference Techniques:Summary Guide

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