Revealed Preference Methods

New Bedford

• New Bedford Harbor is a major commercial fishing port and industrial center in southeastern Massachusetts on Buzzards Bay. From the 1940s to the 1970s, electrical parts manufacturers discharged wastes containing PCBs and toxic metals into New Bedford Harbor, resulting in high levels of contamination throughout the waters, sediments and biota of the Harbor and parts of Buzzards Bay. Hundreds of acres of marine sediment were highly contaminated. One location contained the highest concentrations of PCBs ever documented in a marine environment.

CERCLA

• Comprehensive Environmental Response, Compensation, and Liability Act

• Aka Superfund• Allows EPA to name “potentially

responsible parties” – Anyone who owned the property while the

toxin leaked to the environment.– Very wide net

Cercla

• Either the “parties” clean it up or EPA does and sends them the bill

• Spawned huge litigation over who was responsible.

• Required remediation • Allowed Natural Resource Damages

– E.g. lost fishing, beach recreation etc.

How Much

• The 5 companies that were found to be responsible for the damages to New Bedford Harbor paid $110 million. Of that total, the amount attributed to damages to beach recreation and to fishing was $20.2 million

• This is real money.

Types of Value

• Use value. – Fishing– Beach visiting– Can estimate use value based upon observations

about usage

• Passive or non use values– I like wolves in yellowstone but I don’t go there.– Can’t measure value based on observations of usage

Value of Non Market Goods

• Revealed Preference– Observe actions and deduce value

• Travel Cost• Hedonic • Averting behavior

• Stated Preference– Ask

Marketed or Non Marketed

• Marketed– Electricity– Can measure use value by looking at electric

meter• Non Marketed

– Outdoor recreation– Challenge is to measure non marketed use

values.

Revealed Preference

• Both bundle A and bundle B are affordable (on or under the budget constraint)

• If bundle A is chosen we say it is revealed preferred to bundle B.

• We infer preferences from choices/actions.• Today we do revealed preference

methods, starting with transportation cost method.

Data on Beach Visits

Table 6.1: Hypothetical data on the price and quantity of beach visits.

Person Price Quantity

1 0.9 28

2 1.95 17

3 3 14

4 3.95 12

5 5 5

Objective: Explain quantity as a function of price

• Quantity is the dependent variable• Price is an independent variable

Regression

• Statistical method to fit line to data points.– For our purposes only need to know that we

can recover a formula for a line from the data points

– Next slide plots our points and shows the line closest to those points in the sense that the squares of the vertical distances between point and line are minimized. (called least squares)

Plot of Data

Demand for Beach (Idealized)

-5

0

5

10

15

20

25

30

0 1 2 3 4 5 6

Cost of Trip

Nu

mb

er o

f T

rip

s

Triangles are actual data; line is predicted; squares are residuals—actual - predicted

• Q = 30 – 5 * P – Is the formula for the line. – We could find the area under the line and that

would be total willingness to pay.

TWTP and CS

Demand for Beach (Idealized)

-5

0

5

10

15

20

25

30

0 1 2 3 4 5 6

Cost of Trip

Nu

mb

er o

f T

rip

s

Find them for q= 10Watch the axis reversal

Hotelling

• Show Hotelling’s letter and read it.

Fort Point Beach

• Is in New Bedford Harbor.– It is visited.– Get data on visits to find value of beach.– Ted McConnel did this and it was the first of

the natural resource damage cases.

Number of trips to Fort Point

Travel Cost to Fort Point

Travel Cost to Nearest Other Beach

Travel Cost to Second Nearest Other Beach

12 2.061 2.30 3.336

15 2.949 3.45 5.276

15 1.526 4.659 4.677

16 1.073 2.730 2.632

20 1.596 3.774 5.535

Travel costs are in 1986 dollars. They include the cost of time

Five observations on costs of travel to Fort Point and other beaches .

Sample Price Calculation

• five miles from the beach• automobile of 42 cents. . • Fifteen minutes travel

– wage rate (after taxes) were $8 per hour – Cost of commute time would be $2.

• Her total cost of traveling to Fort Point would then be $2.42.

Demand Curve

• Number of trips = 12.43 -5.48* travel cost to Fort Point + 2.03 * travel cost to nearest other beach + 2.03 * travel cost to 2nd nearest other beach

Demand Shift

• The first time he ask people how many trips they would make given that they knew there were PCBs in the harbor. The second time he asked how many trips they would make if there were no PCBs in the harbor

Damage Estimate

• two demand curves that were calculated from 495 randomly selected people in the area.

• area under the demand curves is twtp. • the difference between the areas under these two curves

gives the estimate of the lost consumer surplus in beach recreation from PCB contamination for the 495 people.

• he divided his estimate by 495 to get consumer surplus per person, and he multiplied that value by the number of people in New Bedford (adjusted for those that did not go to the beach.). This gave him an estimate of the losses in beach recreation for a single year.

TCM questions

• On a vacation is the travel part of the fun or part of the cost?

• I go to Beijing and see the Great Wall and the Purple Forbidden City. What is my travel cost to the Wall?

• How many visits did Gloria, my brother and I make to Rocky Mountain NP. We stayed a week. We were 11 people. 77? (recreation visitor days.)

Kerry’s creek

• Kerry Smith was asked to find value of lost recreation from mine leakage.

• Leakage ruined creek below confluence and not above.

• So he too difference in recreation value in the two zones.

• He didn’t have to ask, “how many times would you go fishing without the arsenic..”

Walt Disney and Mineral King

Travel Cost: Method

• (Krutilla and Fisher. Economics of Natural Environments. Johns Hopkins University Press. Baltimore. 1975. pp:189-218.

• miles to measure price • income by county of origin • number of skiers by ski area • D(y, pThisArea, pOtherAreas, snow conditions?)

Cost Benefit Analysis

• A project is not bad if the benefits (to whomever they may accrue) are greater than the costs.– Take $20 from a homeless person and

(magically) give $21 to Bill Gates– Take $100 from Bill Gates and give $20 to a

homeless person.

Should Mineral King be a Ski Area

• Would a new area make sense • Cost of new area (25 million dollars,

present value at 9%) • Cost of road (25 million dollars) • Willingness to pay for new area (8.2 to

26.7 million dollars present value)• Do we need to know what it is worth as

Wilderness?

Why did Disney want it?

• Who paid and who benefited?• Beers, restaurants and lodging

– long, steep, slippery road– monopoly profits to Disney– how does that change Disney’s analysis– how does that change the public choice

problem

Hedonic Pricing

• First known example:– Price of cucumbers explained by length, width and

color.

• General idea:– Explain price of something based upon its

characteristics.

• Frequent use:– House prices depend on sq ft, lot size, number of

bathrooms, view and so on.

• Method: regress price on characteristics

Example

• Show the Ligget and Bockstael example.• Note the coliform bacteria.

Table 6.4: Hedonic Price Equation for Housing near Chesapeake Bay (Leggett & Bockstael). Dependent Variable: Market Price Minus Value of Structure (in $1000s).

Variable Parameter

Intercept 4445.8358

Lot Size (acres) 131.0783

Lot Size Squared -8.4342

Distance to Baltimore (miles) -9.0215

Distance to Annapolis (miles) -17.0269

Distance to Baltimore x Distance to Annapolis (miles squared) 0.5333

Distance to Baltimore x % of residents who commute out of county -13.2027

% of nearby land densely developed 325.6553

% of nearby land of low density 59.7778

% of nearby area that's water or wetlands 275.9341

% of nearby area open space 20.5546

Served by public sewer? -0.8928

Inverse of distance to source with water discharge permit (1/miles) -149.4962

Inverse of distance to marina (1/miles) 0.1445

Inverse of distance to sewage treatment plant (1/miles) 5.9401

Fecal coliform concentration (counts per 100 mL) -0.0656

Notice in Table 6.4 that the parameter for fecal coliform concentration is a negative number; an

increase in coliform concentration of 100 (an increase with potentially serious health effects) leads

to a decrease of about $6,500 in property value (100*-0.0656 gives the change in property value in

thousands of dollars). In fact, if all properties in the study area met the water quality standard for

Better experimental design

• Would prefer—• Two communities have same water

quality.• One gets a sewer outfall• We find property values before and after in

the two communities

Value of Statistical Life

• The value of a statistical life is the willingness to pay to avoid a risk that would result in one more death in the population

VSL to work in a bad neighborhood

• job in a safe neighborhood has a risk of death, of 10-4) each year.

• job in the unsafe neighborhood had three times the risk (3*10-4) of death each year.

• The company can get people to work in the unsafe neighborhood only by paying an extra $1000/year.

• I$1000 per year was necessary to accept a risk of 2*10-4; • the VSL in this case is $1000/(2*10-4) = $5 million.

Wages and risk

• Look at how wages increase with risk of death.

• Hedonic: wages are dependent variable• Risk of death: independent variable• Get VSL

Averting behavior

• Water is contaminated.• Decide to drink bottled water• Cost of bottled water is the estimate of the

damage from the contamination.• Do you believe this? Would you let me

poison your household water if I supplied you with bottled water?

• In 1987, residents of Perkasie, Pennsylvania, faced contamination of their drinking water and exposure to vapor in their homes from trichloroethylene (TCE), a toxic chemical. The TCE was left by Stainless, Inc. and was part of its former industrial activities. In response, many of those residents bought bottled water or water filters, boiled their water, or hauled water from elsewhere. Economists Abdalla, Roach, and Epp found that the costs associated with these activities were estimated to average between $22 and $48 per household during the 21-month contamination period.

Final comment

• In this type of analysis, only the lack of direct use leads to damages. So coliform in the bay or pcb’s in the harbor only affect those who live nearby or use the resource.