6.3 Environmental valuation  (Page 2/23)

Willingness to pay/accept

Economists use measures of value that are anthropocentric, or human centered. A rigorous body of theory about consumer choice lies beneath those measures. Mathematical complexity can make that theory seem like unreliable trickery, but in truth, consumer theory rests on only a very small number of fundamental assumptions:

• People have preferences over things.
• People are able to rank any two bundles of goods to identify which one they prefer.
• People are rational in that they will choose the bundle they prefer (over bundles they do not prefer) if they can afford it.

Those uncontroversial axioms are actually enough to derive all the results economists use when working with valuation methodology. However, the derivations are easier and sometimes more intuitive with a little more structure added to our hypothetical consumer choice problem:

• People face budget constraints (total expenditures can’t exceed their income).
• People make choices to make themselves as well off as possible (“maximize their utility”) within the rationing forced by their budget constraints.

This framework yields two ways to think about the values of changes to the quality or quantity of environmental goods. Consider first a situation where we are trying to determine the value of a project that yields an environmental improvement—say, for example, water in the Chicago River will be cleaner. The social benefit of that project turns out to be what people are willing to pay for it. The second measure of value is appropriate if we want to measure the value of environmental goods that will be lost or degraded by a deleterious change—say, for example, climate change leading to the extinction of polar bears. In that context, the value of the change is given by the amount of money you would have to pay people in order to make them willing to accept it.

“ Willingness to pay ” (WTP) is a budget-constrained measure of a change in welfare; a person cannot be willing to pay more money for a change than they have income. In contrast, “ willingness to accept    ” (WTA) is not a budget constrained measure of value—you might have to increase a person’s income many times over in order to fully compensate them for the loss of an environmental amenity they hold dear—and can theoretically approach infinity. Empirical studies tend to find that WTA value estimates are larger than equivalent estimates of WTP.

Analysts usually choose whether to use WTA or WTP approaches as a function of the context of the analysis. The “right” measure to use may depend on whether you want value estimates to inform a policy that would improve conditions relative to the current legal status quo, or to understand the consequences of a change that would cause deterioration of some environmental good citizens currently enjoy. Another factor in choosing a valuation method is that WTP is budget constrained while WTA is not. WTP estimates of value tend to be lower in places where people have lower incomes. That variation captures a realistic pattern in the size of willingness to pay for environmental improvements. However, equity problems clearly plague a study that concludes, for example, that improvements in air quality are more valuable to society if they happen in rich areas rather than poor.