- The document discusses methods for conducting cost-benefit analyses of the environment, including both direct and indirect methods. - Direct methods like contingent valuation try to assign monetary values to environmental benefits, while indirect methods estimate costs of environmental degradation. - However, all of these methods underestimate environmental costs since they are spread over long periods and spaces, do not include costs to non-human species, and cannot fully capture costs to non-living systems or future costs.

1. COST BENEFIT ANALYSIS OF
THE ENVIRONMENT
Prof Prabha Panth,
Osmania University,
Hyderabad
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2. • Social and environmental costs and benefits are
not included in Market Analysis.
• Only private costs and benefits are included, as
they have monetary value.
• Environmental assets also have value, and
degradation of the environment leads to various
dis-benefits.
• Economic activity creates environmental costs.
• Preserving the environment creates benefits.
• These have to be measured to ascertain the
environmental CB of economic activity.
Social, Private and Environmental
Costs/ Benefits (CB)
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3. Environmental Values
Total
Economic
Value of
Environment
1. User Value
i) Actual Use
Value
ii) Option Value
a) Vicarious Value b) Bequeath Value
2. Intrinsic
Value
Passive, Non-
User or
Existence
Value
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4. 1. User or Use Value
• User Value is the benefit that the individual
derives from use of the environment.
• It is made up of two categories:
– A) Actual Use value: Value of environmental
resources used directly from the environment,
– e.g. value of fish caught by fishermen from a lake,
or value of wood cut down in forests.
– These can be measured in money terms
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5. • B) Option Value: People may not actually use the
environment now, but may do so sometime, if it is
still available.
• Option value consists of two categories:
1) Vicarious Value: the value of preserving the environment
for themselves and others to use. E.g. people want the Taj
Mahal to be protected, hoping to visit it one day.
2) Bequeath Value: Preserving the environmental for their
children or future generations to use.
It can be seen that these values cannot be measured,
least of all in money terms, as they are subjective
in nature.
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1. User or Use Value

6. 2. Intrinsic Value
• Also called Non-User, or Passive Value.
• It includes all values placed on conservation of
environmental quality.
• For e.g. people want to preserve certain species
such as the Giant Panda, or the Gir Lion,
• Even though they may never see these creatures.
• Based on “altruism”, also called Existence Values.
• People are happy that the species, and other
environmental assets are conserved.
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7. Methods of Environmental CB
analysis
• Two methods to measure environmental costs
and benefits.
• They are:
1) Direct Methods: Such as the CVM or Contingent
Valuation Method, and
2) Indirect Methods:
a) Hedonic Pricing method,
b) Travel cost method,
c) Avoided Cost method, and
d) Dose response method
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8. 1. The Contingent Valuation Method
We first look at the CVM method:-
• Assume that the government is going to
conserve a lake or heritage building.
• It has to raise revenue through additional
taxes. This is a Social Cost.
• Are people willing to pay the extra taxes to
conserve that lake or building?
• They will pay if they perceive some benefit
from the conservation programme.
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9. 1. The Contingent Valuation Method
• The amount that they are Willing To Pay for the
conservation, can be taken as the environmental
benefit they get from the lake or building.
• The amount they are WTP (Be) is compared with
the tax levied by the government (Cm).
– So if Be > Cm, i.e.
– If Environmental Benefit Be is greater than the money
costs (i.e. taxes) Cm,
– It is worthwhile to undertake the conservation project.
– Otherwise it should be rejected.
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10. CVM
• The CVM exercise creates a Surrogate Market for
environmental goods and services.
• This is a purely hypothetical exercise,
• to find out how much value an average person
places on an environmental good/ service.
– If the environmental good is available, how much are
people willing to pay (WTP) to conserve it,
– Or if it is destroyed, then how much compensation are
they willing to accept for the loss (WTA).
– For example if a lake is filled up for ‘development’
purposes, then how much compensation are the
affected fishermen willing to accept for their loss.
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11. 6 stages of the CVM exercise
1) Hypothetical Market:
• The hypothetical market is constructed through a Survey.
• It identifies the respondents, and stakeholders,
• Prepares the questionnaires,
• Elicits responses to arrive at WTA or WTP.
Respondents do not actually pay, but only express how
much they are willing to pay.
2) Obtaining Bids:
interviewing the public or those affected by the
activity.
Various methods of bidding can be used, to find
out maximum WTP or minimum WTA of the public
concerned.
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12. • Bids can be obtained in any one or more of
the following ways:
– Bidding game: Higher and higher amounts are
suggested, and the bidder chooses one.
– Simple Yes or No, to a predetermined sum.
– Payment card: different values are written on the
cards, and one is chosen by the respondent.
– Open ended question: they can give their own bid
– Protest bids are also important, and should be
included.
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13. 3) Calculating average WTP/WTA:
• After collecting the data, the average WTP or
WTA has to be estimated.
• Either Mean or Median is taken as an estimate.
– But Mean > Median,
– Mean is affected by outriders
– Median may underestimate the average.
– Problems of Free Riders, who want the change, but
are not willing to pay for it.
4) Estimating bid curves:
• To estimate how accurate and valid the bids are,
some statistical analysis has to be done.
• To ascertain the impact of different factors on WTP
or WTA.
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14. • Taking WTP or WTA as the dependent variable,
regress against a number of independent variables
collected from the questionnaires.
• For example:
WTPi or WTAi = f(Yi, Ei, Ai, Qi,....)
Where i = respondent’s index, Yi = Income of respondent, Ai
= Age, Ei = education, Qi = environmental quality
• To ascertain which of these has a higher impact on
WTP or WTA.
• Bid curves useful to predict the valuation of changes
in environmental quality, other than those suggested
in the survey.
• Can be used to test sensitivity of WTP to variations in
Qi.
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15. 5) Aggregating Data:
• To convert mean bids to population values,
since the above is taken from a sample.
• Relevant population has to be determined,
how many are affected by the action (e.g.
filling up a lake, or restoring a building)
• Sample mean  Population mean, but bias
may remain.
• Choice of time period is important, since
benefits are felt over a period of time.
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16. Net Present Value (NVP) =xt __1__
(1+r)t
NPV or xt = ΣBt __1__ − ΣCt __1__
(1+r)t (1+r)t
Where Bt is flow of Benefits over time, and Ct is flow of
Costs over time.
If NVP > 0, the project is accepted
If NVP < 0, it is rejected
6) Evaluation:
Finally, the CVM exercise has to be evaluated to
find out how successful it was.
Policy suggestions could be given, based on the
findings of this exercise.
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17. • Limitations:
– Design of the survey, questionnaires, and bias
– Studies have shown that WTA > WTP (4 to 5 times
more). Private benefit > social benefit
– Respondents should have some knowledge about
environmental quality and impacts,
– Income distribution impacts responses,
– Social factors – education, types of respondents, age,
etc. also affects the response.
– Choice of future generations is not considered, only
present generation.
– Finally, difficult to monetise environmental benefits –
these can be underestimated.
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18. II. Indirect Methods
Are made up of a) “user” values on environmental assets,
based on Consumer Behaviour, and b) Production
function Approaches.
1a.1) User Values: The Hedonic Pricing Method (HP):
• Based on Lancaster and Rosen’s theory of consumer
behaviour,
• Value or Benefit of a commodity depends not only on
its price, but also on other characteristics,
• E.g. value of a property or house depends on the
surroundings also.
• Such as clean air, peaceful and quiet, greenery, etc.
• Better environmental quality – higher the price of the
property.
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19. Property value or House Price HP equals:
HP = f(PV, NV, AV, EV)
PV = property variables – area, number of rooms, type of
construction.
NV = types of neighbours, and neighbourhood,
AV = Accessibility variables, i.e. Bus stops, stations, schools,
hospitals, banks, shops, etc
EV = Environmental variables i.e. clean air, water, trees, peace and
quiet, etc.
Other things remaining constant, HP is higher with
better environmental quality.
If EV, HP (direct relationship).
Willing to pay more for better environmental quality.
This gives an indirect measure of the benefits or utility
that people give to a clean environment.
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20. • Limitations:
– Does not cover all types of environmental services –
only housing. Non residential areas, such as
ecosystems are ignored,
– Multi-collinearity – Variables are not independent of
each other. E.g. increase in greenery, less dust, closer
to airport or station, more noise.
– Inequalities – poor live in degraded environments, but
cannot opt for better surroundings.
– Other values such as Existence values are ignored.
– Future generations requirements not addressed.
– Does not cover depletion of natural resources, loss of
species, ecosystems, etc.
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21. 1a.2) User Values: The Travel Cost Method (TCM):
• TCM used as a proxy for the value of outdoor
recreational sites.
• Public values an environmental site (lakes,
mountains, wildlife sanctuaries, etc)
• Are willing to pay to travel and see those sites Cost
of travel = WTP
• A statistical relationship between observed visits
and cost of visiting, is drawn to derive a surrogate
Demand curve of environmental quality.
– Depends on a) distance to be travelled, b) Income of
respondent, c) Alternative sites available, d) Personal
interest, e) recreational facilities available, and f) Cost
of travel
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22. V =f(C, S)
P
Visits per capita is a function of C = travel costs, S = social
variables,
C = Ti + Ei + FY
Ti = cost of travelling to the site, Ei = Entry fee, FY =
income of visitor, S = social status of visitor.
Survey and questionnaires to visitors to environmental
sites.
Data should be aggregated across similar respondents
(same Y, same distance travelled),
More the visits, more distance travelled , more
costs incurred in travelling.
The more they are willing to pay to see the site,
the higher the value of that environmental asset.
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23. 22/03/2015 Prabha Panth 23
Demand
Number of visits
Costofvisits
0 V
B
C
Ent
benefits
F
CFB is the consumer surplus of
travelling to an environmental site

24. • Limitations:
– More visits to the site, more overcrowding. Leads to
loss of environmental benefits. E.g. in a national park,
or sanctuary.
– Sample not representative. Only high income groups.
Low income groups do not go site seeing, their
responses are not included.
– Protected areas where no human access is allowed,
no travel costs, but have high environmental values of
conservation.
– Local inhabitants visit, low costs!
– Pilgrimage centres – over crowded, dirty, people still
do visit.
– Many other environmental issues not addressed by
the TC method, such as costs of climate change, GM
crops, and so on.
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25. 2) Production Function Approaches:
Changes in environmental quality affects both
producers and households.
Both have to take measures to protect themselves
against environmental impacts.
2b.1) The Avoided Cost Method (ACM) of the Averted
Expenditure Method (AEM):
E.g. if there is a factory near a housing colony, creating
dust and smoke, the households have to spend
money to protect themselves against the pollution.
When pollution is high, households spend more money
on glass windows, netting, water filters, etc.
This is the Cost of environmental quality degradation.
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26. • In the figure, as
pollution levels
increase, costs
to avoid the
impacts, also
increase.
• This amount
could be taken
as a proxy for
the cost of
environmental
deterioration.
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Avoided
Cost
Pollution

27. • Limitations:
1) Only households’ averted costs are included, not
others affected by pollution.
2) Other types of environmental damages not
considered, e.g. deforestation.
3) Pollution may affect areas without human
habitation. Causes environmental damages, but
not estimated.
4) One type of protection creates another, e.g.
houses may put up glass windows, but more air
conditioners are needed, affecting ozone layer.
5) Environmental impacts > avoided costs. Hence
leads to underestimation of the environment.
6) Avoided costs not taken up by poor income
groups, but most affected by pollution.
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28. 2b.2) Dose Response Method:
Changes in environmental quality affects
production of certain marketable goods.
• E.g. effluents affect fishing, or agricultural
production.
• Twin effects: Leads to reduction in output,
and increase in costs.
• Victim loses his income, or spends money to
protect his assets.
• Loses his output and his profits are affected.
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29. To measure:
1) single estimate of
change in costs and
change in output in money
terms due to the pollution.
2) Linear programming,
optimising models – Q
maximised subject to
economic and
environmental constraints.
3) Econometric models:
time series or spatial data
to correlate pollution and
loss to producers.
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Output
Pollution
In the figure, as pollution
increases, output falls.
The value of this decrease
in output is the cost of
environmental pollution.

30. • Limitations:
1) All environmental damages cannot be
included, e.g. acid rains affects crops and can
be measured. But also affects forests,
grassland, water bodies, etc....immeasurable.
2) Pollution affects second and third levels also –
e.g. pesticides enter food chain, affect
consumers, passed on to next generation.
3) Long term effects of pollution cannot be
measured.
4) Natural resources depletion is not included.
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31. • It should be noticed that while the direct
method measures the expected “benefits”
of conservation, the indirect methods
measure the “costs” of environmental
degradation.
• So a combination of the above methods
should be used, when they are compatible
with each other.
• However,
– All these methods underestimate environmental
costs, since these are spread over time and
space,
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32. – Costs to non-human species not included. What
is the cost of an extinct animal such as the
cheetah in India? What is the benefit of
conserving the tiger?
– Costs to non living systems, such as climate,
hydrogen cycle, etc. cannot be measured in
money terms.
– Some costs are felt in the future, such as global
warming, or radio activity.
– Actual benefits and welfare of environment >
cost of averting, or WTP. For e.g. the ecological
benefits of forests > cost of planting trees.
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