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Techniques to Value Environmental Resources:
an Introductory Handbook

Published as a joint exercise by the
Commonwealth Department of the Environment, Sport and Territories,
the Commonwealth Department of Finance,
and the Resource Assessment Commission
Australian Government Publishing Service, 1995

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Chapter 3 - Market Value Approaches

The basic economic concepts and the role of economics were all introduced in Part One. The techniques to apply these principles and derive values for environmental effects are reviewed in Part Two.

Willingness to pay/accept is the economic concept of benefit and opportunity cost is the concept of cost. Net value, or net benefit, is therefore calculated as

Net value = benefit - cost

= willingness to pay/accept - opportunity cost

The techniques to estimate willingness to pay/accept and opportunity cost vary with the market situation. In competitive markets, prices are direct measures of benefit and cost and so can be observed and then used as values. Competitive markets rarely exist for environmental goods and services. In their absence, willingness to pay/accept and opportunity cost must be derived from other kinds of data. These other data provide the opportunities to apply the techniques of valuation. They guide the arrangement of the techniques chapters of Part Two, as the following table shows.

Table 2.1: A typology of valuation technique


Market situation               Data used     Kind of technique        Chapter


Observable market data for    Price cost of        Market value approaches    3
prices or                     cost environmental   (derive value from 
                              resource             comparisons of costs and
                                                   revenues)


                              Price or cost of     Surrogate market           4
                              surrogate goods      approaches (derive value
                              or services          from costs and revenues in
                                                   related markets)


No observable market          Responses to         Simulated market           5
data for price or cost        questions in a       approaches (derive value
                              survey which         from hypothetical questions)
                              simulates a market

The validity of the techniques and the values they provide can be assessed on two criteria:

Theoretical validity-Is the technique consistent with economic theory, providing values consistent with the above equations?

Market validity-Would the technique provide values consistent with values from a market, if a market existed for the unpriced goods and services?

The usefulness of the techniques is assessed on this basis at the end of each chapter. The examples to illustrate each technique are taken from the wide range of Australian applications. It is important to note that the examples of issues for which the techniques may be useful is not intended as a definitive list of possible applications and is only a guide.

INTRODUCTION

A change in the environment may alter economic activities and so change the monetary revenues and costs of the activities. The change in these revenues and costs can sometimes be used to value the change in the environment. The range of techniques which apply this general approach is reviewed in the present chapter

The techniques value a benefit as an increase in revenue or as a decrease in monetary outlay. Similarly, they value a cost as an increase in monetary outlay or as a reduction in revenue. This chapter describes each technique in terms of the problems it can help resolve, the values it can estimate, its underlying concept, practical applications, and its strengths and weaknesses.

Table 3.1: The range of market value approaches

Effect of change                                      Valuation technique


Change in availability, quality or quantity of an    Change in productivity
output


Change in availability, quality or quantity of an    Change in income
input


Individuals, groups or society replace an entire     Replacement cost
asset, part of an asset, or quality of an asset


Individuals, groups or society spend money to        Preventative expenditure
defend their environment


Individuals, groups or society relocate an           Relocation cost
activity

The change-in-productivity technique

The concept

Market prices can often be used to value the output from a productive process and environmental conditions often affect such processes. In these circumstances, values for a change in the environment can be derived from the associated change in productivity. An increase in output due to the change is a measure of an increase in benefit, and a decrease in output is a measure of an increase in cost.

When to use it

To resolve the latter question, the monetary values would need to be estimated for the benefits of land conservation, shelter belts on farms and the preservation of forests. The monetary values for the costs of land degradation would also be required.

One cost to society of preserving native forests is the loss in timber output following preservation. This loss can be measured as the decrease in income from logging, which Rogers (1992) assessed in the following two ways:

In their evaluation of cessation of logging in National Estate forests, Streeting and Hamilton (1991) expanded the concept of lost production to include the cost of unemployment. They also rounded out the analysis by including the benefits of ceasing logging, which included cost savings in the forest and mill.

Strengths and weaknesses

The strengths of the technique include:

The difficulties include:

The technique is widely used, especially in land conservation, forest management, watershed management, tourism and grazing.

The Change-in-income technique

The concept

Income can be lost due to loss of work from ill health, premature illness or death. Each of these problems can be caused by environmental effects such as pollution. Income can be gained due to improvements in health, postponed illness and fewer deaths. If the changes in health are due to changes in the effect, the loss in health is an environmental cost and the gain is an environmental benefit. When the relationships between the environmental effect, health and income can be established, the effect can be valued as a change in income.

When to use it

The change-in-income method focuses on changes in labour inputs and on wages and income. The major applications have been to value changes in health-hence the alternate name is the human-capital approach. Nevertheless, the method has applications for many other areas.

To resolve the latter question, the monetary values would need to be estimated for the benefits of improvements in health, prevention of corrosion of buildings and materials as well as the costs of damage to health and the corrosion of buildings and materials.

The technique has not yet been widely applied in Australia. This method has been used to estimate the benefits to health from sulphur oxide control in Europe (OECD 1989a, 1989b). The effect on the sulphur oxide concentration of several strategies for pollution management was predicted and a linear relationship was assumed between reductions of sulphur oxide and increase in the number of working days. The increase in wages due to increased pollution control was calculated for each country from the predicted increase in working days. The benefits of pollution control were identified as the increase in wages.

The technique can be extended to use changes in expenditure on inputs to measure gains as cost savings and losses as cost increases. For example, the cost of corrosion of buildings due to pollution can be estimated from increase in labour costs to clean the buildings.

Strengths and weaknesses

The principal weakness of this technique is that the link between pollution and health (the dose-response relationship) and between health and income must be identified for each application.

Despite this drawback the technique:

For these reasons, it has been frequently applied overseas to value health benefits from pollution control.

The replacement cost technique

The concept

The technique identifies the expenditure necessary to replace an environmental resource or a human made good, service or asset. Expenditure actually incurred on replacement is a measure of the minimum willingness to pay to continue to receive a particular benefit. It gives only a minimum estimate because more may have been spent had it been seen to be necessary to do so.

When to use it

To resolve the latter question, the monetary values would need to be estimated for the benefits of environmental preservation and flood protection and the costs of land degradation, such as the cost of damaged roads.

Yapp (1989) examined the costs of replacement and repair of public assets such as roads, rivers, and water storages affected by land degradation damages. For example, the annual costs of restoring roads after silting in Jerramungup, Western Australia, were $40 000 in 1982. The annual cost of repairing erosion-related damage to public utilities in New South Wales in 1983 was $10.7 million. The annual cost of restoring damage due to surface water salinity in New South Wales towns was $2.8 million in 1987. These values were taken as a measure of the minimum willingness to pay for the use of those assets.

Box 3.2: Application of the replacement-cost technique

The costs of replacing access to houses lost by re-routing a highway were taken as a measure of the benefits of maintaining access in the assessment of the Noarlunga Freeway in Adelaide (Nairn1971).

The cost of replacing parkland lost in construction of the Sydney Harbour tunnel are a measure of the benefit from maintaining the flow of parkland amenities (Beder undated).

Expenditure to restore strip-mining sites to their original condition can be used to estimate the benefits of maintaining the land environment. This provides information for decisions on mining (Thampapillai 1988).

Strengths and weaknesses

Replacement costs can often be estimated relatively simply, so this technique has been widely applied. Further, replacement costs are a useful measure of benefit when they are required to meet some socially sanctioned constraint on use of the environment. The shadow-project technique applies the notion of replacement costs in this way. The cost of a project to restore an environment to meet socially determined standards is a minimum value of the benefits maintained (James 1991).

The weaknesses concern certain requirements that must be met for the replacement.

The preventative-expenditure technique

The concept

Households are sometimes willing to pay to prevent damage to their environment and so defend their existing level of enjoyment from it. They will only make such expenditures when they believe that the benefits from the damage that is avoided exceed the payments to prevent it. The willingness to incur these expenses indicates the benefit from protection. The technique applies wherever households spend money to prevent damage to their environment. Examples include spending to prevent floods, noise, fire and reductions in water quality.

When to use it

To resolve the latter question, the monetary values would need to be estimated for the benefits of peace and quiet and the costs of the noise from airports.

If their water became more saline, households in Kerang in Victoria would need to spend money on more expensive detergents, on new water filters and on renewing water-using equipment more frequently. These expenditures to defend their existing environment would be avoided if woodland is retained in the catchment. The retention of tree cover maintains the transpiration and evaporation of water from the soil and so minimises salinisation of the water that ends up in the urban water supply. Greig and Devonshire (1981) modelled the relationship between tree cover and salinity and that between salinity and household expenditure in Kerang. They used the money the households would have to spend to defend their existing environment as a measure of the benefits of retaining tree cover to avoid the increase in salinity of the water.

Box 3.3: Applications of the preventative-expenditure technique

Example of studies undertaken using the defensive behaviour technique include:

A study of salinity and household expenditure in Kerang by Greig and Devonshire (1981)

A study of noise pollution at the proposed third runway in Sydney (FAC 1990)

Strengths and weaknesses

This technique is potentially important and provides theoretically correct measures of welfare. It has two main advantages:

The strengths of this technique make it suitable for wide application, particularly when the minimum nature of the benefit values can be accommodated in the analysis.

The relocation-cost technique

The concept

The relocation-cost method is similar to the preventative-expenditure technique in that activities to maintain a level of enjoyment or output are costed. The activities now concern relocation of individual activities or entire firms or households, rather than adjustments to defend an existing activity at an existing location.

When to use it

To resolve the latter question, the monetary values would need to be estimated for the costs of loss of a trout stream.

The benefits of maintaining a trout habitat have been estimated from the costs to anglers to relocate. Anglers on the Ovens River in Victoria spent an average of $43 per trip in 1990 and caught between one and five trout per visit. If the trout habitat were lost through river breakouts, engineering works or vegetation growth, the anglers would need to spend $151 per trip to go to a good substitute trout river to replace the environmental service of fishing (Sinden 1990). The net cost of replacement of $108 (151 - 43) is a measure of the individual benefit of retaining the trout habitat.

Sometimes a physical facility can no longer operate effectively at its existing location due to changed environmental conditions. The cost of relocation is an estimate of the benefit from avoiding the damage. For example, downstream inlet pipes may have to be relocated due to the activity of an upstream polluter. If activities were relocated, the cost is an estimate of the damage expected in the present locality and of the minimum benefit in avoiding the damage.

Strengths and weaknesses

This method provides a direct way to incorporate damage costs into the valuation of proposals. If the development of an environmental resource would cause some other activity or facility to relocate, the relocation costs are a legitimate charge against the project.

If there are a number of possible sites for relocation, the cost of the cheapest one is taken as the benchmark. In any case, the new arrangement should leave the facility operating as closely as possible to the previous one.

DISCUSSION

There are theoretical and market tests of the validity of these techniques

Theoretical validity

Apart from the preventative-expenditure and change-in-productivity techniques, the methods pay only lip service to the principles which underlie the economic concept of value, namely willingness to pay/accept. As already discussed, the change-in-income, replacement-cost and relocation-cost techniques may all underestimate the value of benefits. This is because higher costs might have been incurred had it been necessary to do so. So these three techniques do not fully meet the theoretical test of validity but the values can still be used as minimums if carefully applied.

Consider the change-in-income technique and its use to value benefits of improved health. The basic economic value of improved health to an individual is the maximum the individual is willing to pay for it. There is no necessary relationship between the change in income and the amount that the individual is willing to pay. The technique therefore assumes that what one earns is a measure of one's benefit to society and that society should be prepared to pay this amount as a minimum to improve health or save a life.

Market validity

The techniques of this chapter all apply observable revenues and costs and all interpret observable behaviour and so the test of market validity is met. This advantage is sometimes gained only at the expense of statistical requirements to establish causal relationships. For example, the change-in-income technique requires a relationship to be established between the change in environmental characteristics and change in health, and between the change in health and change in production. Statistical estimation requires special skills, much data and the ability to separate the effects of multiple characteristics and random factors from the cause itself.

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