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Valuation of Non-Market Goods

Lecture 5
Outline

1. Project Evaluation
2. The Need for Values of Non-Market Goods
• Cost benefit analysis
• Concepts of economic value
3. Valuation Technique: Contingent Valuation
• Survey evidence
4. Valuation Technique: Inference from Market Behaviour
• Travel Costs method
• Avertive behavior
• Hedonic Pricing
Valuation of a Private Project

Step 1: Evaluate Monetary Costs and Benefits

Year Benefits Costs Net Revenue


0 B0 C0 R0 = B0 - C0
1 B1 C1 R1 = B1 - C1
2 B2 C2 R2 = B2 - C2
Step 2: Add them up!

R0 + R1 + R2 + R3 + ?????????????????????
Step 2: Add them up!
You have to remember that money tomorrow is worth less
than money today.
If I invest £100 today I get back £100 x (1.02) = £102 next
year if the interest rate is 2%.
Thus £102 in a year’s time is worth £102/1.02 = £100 today

Similarly, £ R1 in a year’s time is worth


£ R1 / (1+interest rate) today.
Present Discounted Value

PDV = R0 + R1 + R2 + R3 +
(1+r)1 (1+r)2 (1+r)3
Decision Rule

Undertake the project if

PDV >0

Or NPV>0
Basically need to do the same thing for
Public Projects but…

1. Many more costs and benefits – need to find them all not
just how they affect a company.

2. Its hard to evaluated costs and benefits. Often cannot


use prices.

Need to find ways of valuing these things.

Decision rule is again undertake project if PDV >0!!


Example

Building a Road
Costs:
Materials 100m in first year.
Labour 15m in first year.
Maintenance 10m per year.

At a 5% social discount rate 10m per year is


(1.05/.05)*10m = 210m

Total Discounted costs = 325m = 210+100+15


Building a Road

Benefits
Driving time saved: 500,000 hours per year.
Lives Saved: 5 lives per year.

Suppose we assess this as being worth y per year. Then the


road should go ahead if

y*(1.05)/.05>325m!
Cost Benefit Analysis
This is the name for evaluation techniques for public
projects.

Examples of non-market price problems:


1. Improved public health?
Costs are well know
Benefits (longer lives & better health)
2. Improved Environmental Quality.
Costs ?
Benefits?

Cannot just ignore things you cannot measure.


Where do the Costs and Benefits come
from?

Personal Use Values


1. Direct Use (Consumption of outputs)
2. Indirect Use ( Functional benefits) Flood control, climate
etc.
3. Option values (Future direct and indirect use)

Non-Use Values
1. Bequest Values: Value of passing assets on
2. Existence Value: Knowledge of continued existence.
Contingent Valuation
Direct survey evidence on individual’s stated valuations.

How much an individual would be willing to give up to


have the specified improvement?

Notes:
1. Similar tools used for market research, but market
research can be checked against future behaviour.
2. Evidence of use and non-use values.
3. Controversial in US as it was used in Exxon Valdez suit.
4. NOAA panel has issued guidelines on its use.
Contingent Valuation Formats

Willingness to pay vs. Willingness to Accept.

WTP – What is the most you are willing to pay for 5 days
without air pollution?
WTA – How much would compensate you for ….?

In theory they should be close to equal if they were small


amounts.
WTA>>>>WTP in practice.
WTP seen as more reliable, less prone to protest.
Contingent Valuation Formats
Open Ended vs. Closed Ended Questions .

Open ended: What is the most you would be willing to pay


for…?

Popular early on and can be easily analysed.

Closed ended: If it cost $20 would you be willing to pay


this?
Respondents find these q’s easier to answer.
But requires more complex analysis.
Problems in CV studies
1. Treatment of Outliers – a source of bias
• Strategic responses
• Protest answers (refusal to answer)
Problems in CV studies
1. Treatment of Outliers – a source of bias
• Strategic responses
• Protest answers (refusal to answer)
2. Embedding Problem
• Tendency for WTP answers to be similar across
different surveys.
• Part-whole bias – some people claim this invalidates
the whole process
Problems in CV studies
1. Treatment of Outliers – a source of bias
• Strategic responses
• Protest answers (refusal to answer)
2. Embedding Problem
• Tendency for WTP answers to be similar across different
surveys.
• Part/whole bias – some people claim this invalidates the whole
process
3. Starting Point Bias
• Structure of survey influences all responses and the order of
magnitudes in responses.
• Yes/No Q’s in ascending vs. descending order influences
answers given.
Problems in CV studies
1. Treatment of Outliers – a source of bias
• Strategic responses
• Protest answers (refusal to answer)
2. Embedding Problem
• Tendency for WTP answers to be similar across different
surveys.
• Part whole bias – some people claim this invalidates the whole
process
3. Starting Point Bias
• Structure of survey influences all responses and the order of
magnitudes in responses.
• Yes/No Q’s in ascending vs descending order influences
answers given.
4. Instrument Bias
• Proposed financing affects peoples’ answers.
NOAA Panel on CV
Recommendations:
1. Sample: Statistician recommend size and type to ensure
significance of results.
2. Non-responses High rate makes results unreliable.
3. Interviews Face to face are best, must test effect of interviewer.
4. Reporting Data and procedure used must be available to all.
5. Questionnaire design: Piloted + pre-tested
6. Cross-tabulations: Cross checks to assess interpretation of data
7. Elicitation procedure: WTP better than WTA, Yes/No Q’s
8. Accurate Description of issue
9. Expenditure implications
Inference From Market Behaviour
1. Travel Costs:
How much does it cost to travel to Alaska – how many
people do it.
This gives a lower bound
Inference From Market Behaviour
1. Travel Costs:
How much does it cost to travel to Alaska – how many
people do it.
This gives a lower bound.
2. Avertive Behaviour:
What costs to people incur to avoid certain risks.
This gives an upper bound.
Inference From Market Behaviour
1. Travel Costs:
How much does it cost to travel to Alaska – how many
people do it.
This gives a lower bound
2. Avertive Behaviour:
What costs to people incur to avoid certain risks.
This gives an upper bound.
3. Hedonic Pricing:
Use differences in market prices to impute a value for a
hidden variable. (Shadow Pricing)
Parking near a ball ground.
House prices
Values for Life and Time
Time:
Opportunity Cost – if you gave up work then it is your
wage.
If you gave up leisure – how much would you pay to
travel quicker?
Life & Mortality:
Implicitly this values health too.
QALY = Quality-Adjusted Life Years
This is a standard accepted measure.
You can use CV evidence to assess this – life
insurance contracts etc.
Examples of Implicit Values of Life
Legislation imposes costs and achieves a reduction in lives
lost. You can deduce a value of life from these costs:
Legislation Implied 2005($) value of Life
Childproof Lighters 0.1m
Food labeling 0.4m
Reflective devices for Lorries 1m
Rear seatbelts 4.8m
Asbestos 6m
Gov Value 7.6m
Cattle feed reg’s 185m
Time and Risk

How should we assess future costs and benefits?


• This really has a huge affect on very long-lived projects.
• Could look at market rates or how individuals make
these trade offs, but generally they vary with the
population’s characteristics.
• Maybe we should explicitly include future generations
welfare in the benefits side?
• How rich should we assume they are going to be?
• Should we give them equal weight or less weight?
Risk?

Most common route is to discount at a higher rate,???

Risk premium?

Worst Case Scenario?


Distributional issues