revealed preference methods market analogy method travel cost methods defensive expenditures method...

REVEALED PREFERENCE METHODS

MARKET ANALOGY METHOD

TRAVEL COST METHODS

DEFENSIVE EXPENDITURES METHOD

INTERMEDIATE GOOD METHOD

ASSET VALUATION METHOD

THE HEDONIC PRICE METHOD

Table 1: QUALY CostsTable 1: QUALY Costs

ProgramChildhood immunizations <0

Prenatal care <0

Flu shots $1200

Water chlorination $8K

Pneumonia vaccination $24K

Breast cancer screening $34K

ProgramChildhood immunizations <0

Prenatal care <0

Flu shots $1200

Water chlorination $8K

Pneumonia vaccination $24K

Breast cancer screening $34K

Table 1: QUALY CostsTable 1: QUALY Costs

ProgramOSHA Construction safety rules $76K

EPA home radon standards $280K

EPA asbestos standards $3.8M

EPA radiation standards $54M

Source: (John D. Graham, et. al, 1994)

ProgramOSHA Construction safety rules $76K

EPA home radon standards $280K

EPA asbestos standards $3.8M

EPA radiation standards $54M

Source: (John D. Graham, et. al, 1994)

Regulatory Policies and Practices

Health and Safety

Environmental

Figure 1: TYPES OF REGULATIONFigure 1: TYPES OF REGULATION

Source: Thomas D. Hopkins (2006) AN ASSESSMENT OF CROSS-NATIONAL REGULATORY BURDEN COMPARISONS. Fordham Urban Law Journal (July: 9-48)

Figure 2: FEDERAL REGULATORY OUTLAYSFigure 2: FEDERAL REGULATORY OUTLAYS

Source: file:///Work/Courses/ABC-04/pubfin/REGBUD~1.HTM

Figure 3: Costs of Major Rules (1981-2007)Figure 3: Costs of Major Rules (1981-2007)

Source: http://www.whitehouse.gov/omb/inforeg/costs_benefits/2008_draft_cb_report.pdf

Figure 4: Benefits and Costs of Major Rules (1992-2007)Figure 4: Benefits and Costs of Major Rules (1992-2007)

Source: http://www.whitehouse.gov/omb/inforeg/costs_benefits/2008_draft_cb_report.pdf

Costs and Benefits Requiring ValuationCosts and Benefits Requiring Valuation

MARKET ANALOGY

METHOD

MARKET ANALOGY METHODMARKET ANALOGY METHOD

Using Price of Analogous Good- The market price of a comparable good in the private

sector- Problematic when beneficiaries don’t pay market

prices

Using Price and Quantity of an Analogous Private-Sector Good to Estimate the Demand Curve for a Publicly Provided Good- Use private-sector data to map the demand curve for

a publicly-provide good if the goods and their markets are similar.

- Using expenditures alone ignores consumer surplus.

Using Price of Analogous Good- The market price of a comparable good in the private

sector- Problematic when beneficiaries don’t pay market

prices

Using Price and Quantity of an Analogous Private-Sector Good to Estimate the Demand Curve for a Publicly Provided Good- Use private-sector data to map the demand curve for

a publicly-provide good if the goods and their markets are similar.

- Using expenditures alone ignores consumer surplus.

Example: Using Price of Analogous good Example: Using Price of Analogous good

Note: distinction betweenComparable and substitutes

MARKET ANALOGY METHODMARKET ANALOGY METHOD

Using the Market Analogy Method to Value Time Saved

- The obvious analogous market for time saved is the labor market.But…

1) Wages ignore taxes and fringe benefits. 2) People could be working while traveling or waiting

and, therefore, time saved would be worth less than the wage rate (plus benefits).

3) People value different types of time differently. Importantly, many people enjoy traveling.

4) Method assumes working hours are flexible – (ignores structural rigidities and failures).

5) Firms may not pay employees their marginal social product.

Using the Market Analogy Method to Value Time Saved

- The obvious analogous market for time saved is the labor market.But…

1) Wages ignore taxes and fringe benefits. 2) People could be working while traveling or waiting

and, therefore, time saved would be worth less than the wage rate (plus benefits).

3) People value different types of time differently. Importantly, many people enjoy traveling.

4) Method assumes working hours are flexible – (ignores structural rigidities and failures).

5) Firms may not pay employees their marginal social product.

Using the Market Analogy Method to Value a Life SavedUsing the Market Analogy Method to Value a Life Saved

Forgone earnings method. Value of a life saved = discounted future earnings. Higher values for young, high-income males than old, low-income females. - ignores consumer surplus- WTP for a small reduction in risk of death

Consumer purchase studies. How much people pay for life-saving devices, such as safety belts.

Forgone earnings method. Value of a life saved = discounted future earnings. Higher values for young, high-income males than old, low-income females. - ignores consumer surplus- WTP for a small reduction in risk of death

Consumer purchase studies. How much people pay for life-saving devices, such as safety belts.

Consumer Purchase MethodConsumer Purchase Method

If people are willing to pay an extra $220 to reduce the probability that they will die by 1/10,000, then they value life at $2.2 million.

Using the Market Analogy Method to Value a Life SavedUsing the Market Analogy Method to Value a Life Saved

Labor market studies. If a person is willing to forgo an extra $2,000/yr to increase the probability that he will not have a fatal on-the-job accident by 1/1,000, then he values his life at $2 million (or more).

This method assumes labor markets are efficient and no self selection bias (some people may

like to take risks which would lead to a relatively small gap in the salary between risky

and less-risky jobs).

Labor market studies. If a person is willing to forgo an extra $2,000/yr to increase the probability that he will not have a fatal on-the-job accident by 1/1,000, then he values his life at $2 million (or more).

This method assumes labor markets are efficient and no self selection bias (some people may

like to take risks which would lead to a relatively small gap in the salary between risky

and less-risky jobs).

Miller Value of Life EstimatesMiller Value of Life Estimates

29 studies considered (originally estimated in 1985 dollars). They estimate value of life in four ways:

Wage premia for risky jobs. Consumers’ WTP for a variety of safety features, such as safer cars,

smoke detectors and life insurance. Observation of individual behavior on such decisions as the use of

pedestrian tunnels, seatbelts or speed choice. Contingent Valuation (CV) methods to survey people about their

willingness to invest in ways to increase safety and health.

The mean value of life = $3.02M (1999 U.S.$). with a standard deviation of 0.77.

The evidence also suggested that individuals value life similarly whether the risk is voluntary or involuntary or whether the death is painful and slow or quick.

29 studies considered (originally estimated in 1985 dollars). They estimate value of life in four ways:

Wage premia for risky jobs. Consumers’ WTP for a variety of safety features, such as safer cars,

smoke detectors and life insurance. Observation of individual behavior on such decisions as the use of

pedestrian tunnels, seatbelts or speed choice. Contingent Valuation (CV) methods to survey people about their

willingness to invest in ways to increase safety and health.

The mean value of life = $3.02M (1999 U.S.$). with a standard deviation of 0.77.

The evidence also suggested that individuals value life similarly whether the risk is voluntary or involuntary or whether the death is painful and slow or quick.

Fisher, Chestnut, and Violette Survey of Value of Life EstimatesFisher, Chestnut, and Violette Survey of Value of Life Estimates

21 studies (originally estimated in 1986 dollars). 1)Early low-range wage-risk estimates.

Early high-range wage-risk estimates. New wage-risk estimates. New contingent valuation studies. Consumer market studies.

They conclude that the most defensible estimates suggest the reasonable range for the value per-statistical-life is $2.43M to $12.92M (1999 U.S.$), but they place more confidence in the lower end of the range.

21 studies (originally estimated in 1986 dollars). 1)Early low-range wage-risk estimates.

Early high-range wage-risk estimates. New wage-risk estimates. New contingent valuation studies. Consumer market studies.

They conclude that the most defensible estimates suggest the reasonable range for the value per-statistical-life is $2.43M to $12.92M (1999 U.S.$), but they place more confidence in the lower end of the range.

Viscusi Survey of Value of Life EstimatesViscusi Survey of Value of Life Estimates

3 sets of studies (originally reported in 1990 dollars:

21 wage premia for risky jobs studies. The majority of these studies find value of life estimates in the $3.82M to $8.92M range (in 1999 U.S.$).

7 other revealed preference approach studies. These studies provide widely varying estimates between $0.09M and $5.10M (in 1999 U.S.$).

6 contingent valuation surveys. These also provide a wide range of estimates – from $0.13M to $19.1M (in 1999 U.S.$).

A plausible range for the value of a statistical life is between $2.5M and $4.0M in 1999 U.S.$.

3 sets of studies (originally reported in 1990 dollars:

21 wage premia for risky jobs studies. The majority of these studies find value of life estimates in the $3.82M to $8.92M range (in 1999 U.S.$).

7 other revealed preference approach studies. These studies provide widely varying estimates between $0.09M and $5.10M (in 1999 U.S.$).

6 contingent valuation surveys. These also provide a wide range of estimates – from $0.13M to $19.1M (in 1999 U.S.$).

A plausible range for the value of a statistical life is between $2.5M and $4.0M in 1999 U.S.$.

TRAVELCOST METHODS

Value of TimeValue of Time

Time spent on any activity that individuals would pay to avoid is a cost. In CBA the most important time cost is travel time. This travel time cost is called the “Value of Travel Time Savings” (VTTS). VTTS is usually expressed as a percentage of the after-tax wage-rate.

Time spent on any activity that individuals would pay to avoid is a cost. In CBA the most important time cost is travel time. This travel time cost is called the “Value of Travel Time Savings” (VTTS). VTTS is usually expressed as a percentage of the after-tax wage-rate.

Value of Travel Time SavingsValue of Travel Time Savings

TRAVEL COST METHODSTRAVEL COST METHODS

The clever insight of the TCM is that, although admission fees are usually the same for all persons (indeed, they are often zero), the total cost faced by each person varies because of differences in the travel cost component.

Consequently, usage also varies, thereby allowing researchers to make inferences about the demand curve for the site.

The clever insight of the TCM is that, although admission fees are usually the same for all persons (indeed, they are often zero), the total cost faced by each person varies because of differences in the travel cost component.

Consequently, usage also varies, thereby allowing researchers to make inferences about the demand curve for the site.


The full price paid by persons for a visit to a site is more than just the admission fee.

It also includes the costs of traveling to and from the site. Among these travel costs are the opportunity cost of time spent traveling, the operating cost of vehicles used to travel, the cost of accommodations for overnight stays while traveling or visiting, and parking fees at the site.

The sum of all of these costs gives the total cost of a visit to the site.

The full price paid by persons for a visit to a site is more than just the admission fee.

It also includes the costs of traveling to and from the site. Among these travel costs are the opportunity cost of time spent traveling, the operating cost of vehicles used to travel, the cost of accommodations for overnight stays while traveling or visiting, and parking fees at the site.

The sum of all of these costs gives the total cost of a visit to the site.


To estimate demand for access to a particular site, we expect that the quantity of visits demanded by an individual, q, depends on its total cost, p; the cost of substitutes, ps; the person’s income, Y; and variables that reflect the person’s tastes, Z:

q = f(p,ps,Y,Z)

To estimate demand for access to a particular site, we expect that the quantity of visits demanded by an individual, q, depends on its total cost, p; the cost of substitutes, ps; the person’s income, Y; and variables that reflect the person’s tastes, Z:

q = f(p,ps,Y,Z)

Zonal Travel Cost MethodZonal Travel Cost Method

• This method allows one to estimate the market demand curve for access to a non-unique site, which is shown in the next slide.

• The consumer surplus may be obtained from the market demand curve in the usual way.

• This method allows one to estimate the market demand curve for access to a non-unique site, which is shown in the next slide.

• The consumer surplus may be obtained from the market demand curve in the usual way.

TCM Demand ScheduleTCM Demand Schedule


Estimating the demand schedule for a non unique site is quite straightforward.

1. select a random sample of households within the market area of the site.

2. survey these households to determine their numbers of visits to the site over some period of time, all of their costs involved in visiting the site, their costs of visiting substitute sites, their incomes, and other characteristics that may affect their demand.

3. specify a functional form for the demand schedule and estimate it using the survey data.

Estimating the demand schedule for a non unique site is quite straightforward.

1. select a random sample of households within the market area of the site.

2. survey these households to determine their numbers of visits to the site over some period of time, all of their costs involved in visiting the site, their costs of visiting substitute sites, their incomes, and other characteristics that may affect their demand.

3. specify a functional form for the demand schedule and estimate it using the survey data.

Zonal Travel Cost MethodZonal Travel Cost Method

One can also use TCM to estimate demand for a unique site. To us this method

1. survey actual visitors rather than potential ones2. allocate visitors to a particular zone, depending on

their “travel costs” (usually distance). 3. For each zone, compute the average number of

visits per year and the average total travel cost. 4. Estimate the relationship between cost/trip and the

number of trips per person.

The consumer surplus for a visitor from a particular zone is given by the area below this curve and above the cost of a visit from that zone

One can also use TCM to estimate demand for a unique site. To us this method

1. survey actual visitors rather than potential ones2. allocate visitors to a particular zone, depending on

their “travel costs” (usually distance). 3. For each zone, compute the average number of

visits per year and the average total travel cost. 4. Estimate the relationship between cost/trip and the

number of trips per person.

The consumer surplus for a visitor from a particular zone is given by the area below this curve and above the cost of a visit from that zone

Estimating Consumer SurplusEstimating Consumer Surplus

By repeating this calculation for each zone, it is possible to calculate the total consumer surplus.

Estimating Consumer Surplus: Benefits of a recreation areaEstimating Consumer Surplus: Benefits of a recreation area

5,000 Visitors

5,000 Visitors

3,000 Visitors

100,000 Pop

10,000 Pop

20,000 Pop

Wilderness Area100 300 500

Miles

ZONE A

ZONE B

ZONE C

Estimating Consumer Surplus: Benefits of a recreation areaEstimating Consumer Surplus: Benefits of a recreation area

ZONE POPULATIONDISTANCE

FROM AREAVISITS AS % OF POP

COST PER VISIT

A 10,000 100 Miles 50 10B 20,000 300 Miles 15 80C 100,000 500 Miles 5 100

ZONE A: .5 (10K) * (60-10) or .5 (10K) * [(110-10)/2] =$250K

ZONE B: .15 (20K) * (95-80) or .15 (20K) * [(110-80)/2] =$45K

ZONE C: .05 (100K) * (105-100) or .05 (100K) * [(110-100)/2] =$25K

SUM = $320K

ZONE A: .5 (10K) * (60-10) or .5 (10K) * [(110-10)/2] =$250K

ZONE B: .15 (20K) * (95-80) or .15 (20K) * [(110-80)/2] =$45K

ZONE C: .05 (100K) * (105-100) or .05 (100K) * [(110-100)/2] =$25K

SUM = $320K

Limitations of the TCM Limitations of the TCM

1. It is restricted to sites where people (in the zones) have different travel costs. Without variation in total cost, it’s hard to estimate a demand curve

2. There may be analytical problems in measuring the price of a visit. How does one measure opportunity cost of travel time? Does one include the marginal cost of capital goods used at the site? Should multiple purpose trips be included in the data (desirable if costs can be accurately apportioned to the site)? Also, the journey may have value (and hence the trip has multiple purposes).

1. It is restricted to sites where people (in the zones) have different travel costs. Without variation in total cost, it’s hard to estimate a demand curve

2. There may be analytical problems in measuring the price of a visit. How does one measure opportunity cost of travel time? Does one include the marginal cost of capital goods used at the site? Should multiple purpose trips be included in the data (desirable if costs can be accurately apportioned to the site)? Also, the journey may have value (and hence the trip has multiple purposes).


3. Travel cost may be endogenous not exogenous. People who plan to travel to the site frequently may choose to live near the site (hence number of visits and travel costs are determined simultaneously). OLS estimators could be biased.

4. There may be other econometric problems, such as truncation (drawing sample from only visitors rather than the population at large – resulting in biased results). Also, there may be omitted variables (if tastes or substitutes vary across zones).

3. Travel cost may be endogenous not exogenous. People who plan to travel to the site frequently may choose to live near the site (hence number of visits and travel costs are determined simultaneously). OLS estimators could be biased.

4. There may be other econometric problems, such as truncation (drawing sample from only visitors rather than the population at large – resulting in biased results). Also, there may be omitted variables (if tastes or substitutes vary across zones).


5. The method estimates the WTP for the entire site rather than features of the site. It’s possible to value features if people in zones can choose among alternative sites with different attributes – by using the “hedonic travel cost method,” which treats total cost as a function of both distance from zone to the site and the various attributes of the site.

5. The method estimates the WTP for the entire site rather than features of the site. It’s possible to value features if people in zones can choose among alternative sites with different attributes – by using the “hedonic travel cost method,” which treats total cost as a function of both distance from zone to the site and the various attributes of the site.

DEFENSIVE EXPENDITURES

METHOD

DEFENSIVE EXPENDITURES METHODDEFENSIVE EXPENDITURES METHOD

A defensive expenditure is an expenditure in response to something undesirable, such as pollution.

If smog improves (worsens) you may spend less (more) on having your windows cleaned. The change in expenditures can be used as a measure of the change in pollution.

A defensive expenditure is an expenditure in response to something undesirable, such as pollution.

If smog improves (worsens) you may spend less (more) on having your windows cleaned. The change in expenditures can be used as a measure of the change in pollution.

DEFENSIVE EXPENDITURES METHODDEFENSIVE EXPENDITURES METHOD

Problems with this MethodProblems with this Method

1. Reduced spending on a defensive expenditure underestimates the benefits of cleaner air.

2. It assumes people adjust quickly to the new equilibrium, such as new smog levels.

3. Defensive expenditure may not remedy entire the damage.

4. Defensive expenditures may have benefits other than remedying damage, which should be included.

5. Not all defensive expenditures are purchased in markets, for example, some people clean their own windows; changes in these “expenditures” should also be included.

1. Reduced spending on a defensive expenditure underestimates the benefits of cleaner air.

2. It assumes people adjust quickly to the new equilibrium, such as new smog levels.

3. Defensive expenditure may not remedy entire the damage.

4. Defensive expenditures may have benefits other than remedying damage, which should be included.

5. Not all defensive expenditures are purchased in markets, for example, some people clean their own windows; changes in these “expenditures” should also be included.

INTERMEDIATE GOOD METHOD

INTERMEDIATE GOOD METHODINTERMEDIATE GOOD METHOD

If a project produces an intermediate good that is not sold in a well functioning market (e.g., improvements in human capital), then its value can be imputed by determining the value added to the “downstream activity”:

Annual Benefit = NI(with project) – NI(w/o project)

where, NI = net income of downstream business. The total benefit of a project can be computed by discounting these

annual benefits over the project’s life.

If a project produces an intermediate good that is not sold in a well functioning market (e.g., improvements in human capital), then its value can be imputed by determining the value added to the “downstream activity”:

Annual Benefit = NI(with project) – NI(w/o project)

where, NI = net income of downstream business. The total benefit of a project can be computed by discounting these

annual benefits over the project’s life.

Asset Valuation Method

ASSET VALUATION METHODASSET VALUATION METHOD

The impacts of a project or policy can be imputed from changes in the price for certain capital goods.

For example, the “value” of noise can be inferred from comparing the price of a house in a noisy neighborhood to

the price of a similar house in a quiet neighborhood. An advantage of using prices is that information is

quite quickly and efficiently capitalized into prices so that price changes or price differences provide a good estimate of the value of the policy change.

The impacts of a project or policy can be imputed from changes in the price for certain capital goods.

For example, the “value” of noise can be inferred from comparing the price of a house in a noisy neighborhood to

the price of a similar house in a quiet neighborhood. An advantage of using prices is that information is

quite quickly and efficiently capitalized into prices so that price changes or price differences provide a good estimate of the value of the policy change.

THE HEDONIC PRICE METHOD

THE HEDONIC PRICE METHODTHE HEDONIC PRICE METHOD

The hedonic price method can be used to value an attribute, or a change in an attribute, whenever its value is capitalized into the price of an asset, such as houses or salaries.

It consists of two steps.

The hedonic price method can be used to value an attribute, or a change in an attribute, whenever its value is capitalized into the price of an asset, such as houses or salaries.

It consists of two steps.

Estimating the value of a scenic view Estimating the value of a scenic view

The first step estimates the effect of a marginally better scenic view on the value (price) of lots (a slope parameter in a regression model), while controlling for other variables that affect lot prices. For example, we may postulate the following multiplicative model:

The first step estimates the effect of a marginally better scenic view on the value (price) of lots (a slope parameter in a regression model), while controlling for other variables that affect lot prices. For example, we may postulate the following multiplicative model:

This equation is called a hedonic price function or implicit price function. The change in the price of a lot that results from a unit change in a particular attribute (i.e., the slope) is called the hedonic price, implicit price, or rent differential of the attribute. €

P = 0β 1βCBD 2βSIZE 3βVIEW 4βNBHD εe

Estimating the value of a scenic viewEstimating the value of a scenic view

For example, the hedonic price of scenic views, which we denote as rv, measures the additional cost of buying a lot with a slightly better (higher-level) scenic view.

For the above multiplicative model:

For example, the hedonic price of scenic views, which we denote as rv, measures the additional cost of buying a lot with a slightly better (higher-level) scenic view.

For the above multiplicative model:

€

vr = 3βP

VIEW > 0

THE HEDONIC PRICE METHODTHE HEDONIC PRICE METHOD

The second step estimates the WTP for scenic views, after controlling for “tastes,” which are proxied by income and other socioeconomic factors.

To account for different incomes and tastes, analysts should estimate the following WTP function (inverse demand curve) for scenic views:

The second step estimates the WTP for scenic views, after controlling for “tastes,” which are proxied by income and other socioeconomic factors.

To account for different incomes and tastes, analysts should estimate the following WTP function (inverse demand curve) for scenic views:

rv = (VIEW, Y, Z), where rv is from step 1, Y is household income, and Z is a vector of household characteristics that reflects tastes (e.g., socioeconomic background, race, age, and family size).


It is straightforward to use the equation in the previous slide to calculate the change in consumer surplus to a household due to a change in the level of scenic view.

These changes in individual household consumer surplus can be aggregated across all households to obtain the total change in consumer surplus.

It is straightforward to use the equation in the previous slide to calculate the change in consumer surplus to a household due to a change in the level of scenic view.

These changes in individual household consumer surplus can be aggregated across all households to obtain the total change in consumer surplus.

AdjustingPlug Values

Adjusting Plug-in ValuesAdjusting Plug-in Values

• Time (nominal price adjustment)

• Income and Socioeconomic Factors

• Physical Characteristics

• Project Differences

• Technology, population changes, etc.

• Time (nominal price adjustment)

• Income and Socioeconomic Factors

• Physical Characteristics

• Project Differences

• Technology, population changes, etc.

Converting Earlier Figures to Current DollarsConverting Earlier Figures to Current Dollars

• In order to make comparisons across time periods, we must use current dollars.

• This can be done by “inflating” the earlier data for the increase in the price level.

• The formula for converting the figures for the earlier year into current dollars is:

Figurecurrent $ = Figureearlier $ * price indexcurrent year

price indexearlier year

• If prices have risen, this will “inflate” the data for earlier years and bring it into line with the current purchasing power of the dollar.

revealed preference methods market analogy method travel cost methods defensive expenditures method...

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