Environmental Decisionmaking

Problem Set 6

1) (4 pts) Explain, in your own words, the difference between willingness to pay and willingness to accept compensation. Why is this distinction important for cost-benefit analysis? Think of an example where a cost-benefit analysis done based upon willingness to pay might create a clearly unreasonable outcome.

Willingness to pay is how much you are willing to pay to get something that you don't currently own. Willingness to accept compensation is how much you would accept to voluntarily give up something that you currently own. WTP is always lower than WTA because of the oddities of the human psyche and income constraints. Imagine a cost-benefit-analysis where a government was trying to determine whether or not to allow slave trading, and they asked destitute peasants how much they would be willing to pay to keep their children out of slavery. It is quite likely that this amount of money would be less than the amount that rich slave traders would be likely to make on the deal (because the peasants have very little money to spend), and so a government might determine that the benefits outweighed the costs. However, if asked how much the peasants would want to be paid to sell their children into slavery, it might turn out to be a much higher number. Since the peasants currently have possession of their children, WTA is a more reasonable number. This is obviously an extreme example, but the point is that in cases where you are talking about allowing somebody to pollute a resource or remove habitat, WTA is usually the proper number due to previous assumptions about ownership.

2) (2 pts) Explain, in your own words, how economists calculate the value of a human life. Is this number closer to a measure of "willingness to pay" or "willingness to accept compensation"?

Economists try to determine how much extra people require in order to take on risky jobs, as a proxy for how much you need to pay them to assume a statistical risk. The theory is that if they are willing to risk their lives for that amount of money (even if the risk is small) then that number can be used in regulatory cost-benefit-analysis where the risks are also often small. This is WTA, because people are being paid in order to do something voluntarily.

3) (4 pts) In the reading by Bishop and Welsh (in the reader as one of the "Better Environmental Decisions" readings), the authors discuss an example of Contingent Valuation used in policy development for the Glen Canyon Dam. The study indicated that the American public would be willing to pay almost $3.5 billion per year to ensure that the Dam was operated in the most environmentally sensitive way. That is about ten times the value of the electricity produced by the dam (assuming that it operates at peak capacity and replacement costs would be about 3 cents per kilowatt). How do you feel about the accuracy of this number? Assume for a minute that there was no way to operate the dam in a more environmentally sensitive manner. Since the recreational value of the reservoir is relatively small, this figure would indicate that people might rather have no dam at all then one operating in an economically efficient manner, and so we should tear the dam down. Discuss this, and whether you agree that it is a reasonable interpretation of the data.

Many people discussed the idea that people wouldn't want to tear down the dam because that would leave others without electricity, but according to the survey people are willing to pay a large amount to get the dam to operate in an environmentally friendly way. If the survey was done properly, then this would indicate that the respondents would support a tax to pay the people in the area to voluntarily do without the electricity that the dam provides. Because the electricity could easily be replaced with other methods of electricity generation, I do not think this is nearly as significant an issue as many of you seem to feel. In any event, I wanted you to discuss whether you thought that the $3.5 was a reasonable estimate or not, based upon your understanding of contingent valuation and the way the survey was undertaken. The rest of the discussion just had to be interesting and non-superficial.

4) (4 pts) The Pearce paper (Auditing the Earth) mentions "the 'demonstration-capture' paradigm formulated by economists," and states: "demonstration without capture is clearly insufficient." What do they mean here? This is, in fact, a very important statement. Can you think of examples where the absence of "capture" did not prove to be insufficient? Should we grant Pearce this claim?

Demonstration in this context means that you can demonstrate the value of something, capture means you can capture the benefits, generally by defining property rights and charging for the right to use the good. Capture means that the economic benefits demonstrated can be appropriated by the market.

You may discuss whether we should grant Pearce his claim in any way you like, but I wanted your discussion to include thoughts on when demonstration without capture might be insufficient, and also how the acceptance of this idea -- that property rights are important for efficient use of natural re sources or public goods -- might affect the way we think about these goods and whether that is generally positive or not.

5) (4 pts) Costanza et al. calculate that over half of the value of global ecosystem services comes in the form of nutrient cycling (i.e. breaking down dead things into their constituents so that growing things can gain nourishment from them). But there is nothing particularly interesting about nutrient cycling, and it is not difficult to imagine a simple chemical process which would do the same thing. If we accept the Costanza number, however, then it means that someone could invent a process that would cycle nutrients in a large, stinking vat, and suddenly the value of all the world's oceans, parks, wildlife, soils, grasslands, and forests would fall by half (assuming the process was cheap). And yet, it is not at all uncommon in valuation studies to see large values like this for things that we would not, perhaps, agree with at first (or even after reflection). Discuss this comment, and whether the 17 trillion for nutrient cycling calls into question Costanza's overall figure.

Here the things that I wanted you to talk about were what does the value of an ecosystem mean? Is it helpful to talk about the ecosystem value as being related to various functions it provides for humans? As humans find ways to substitute artificial processes for natural ones, do ecosystems become less valuable? This last question is, I believe, particularly interesting, because you are essentially asking whether ecosystems might at some point become obsolete. If you think so, is this a problem? If you think not, then what, exactly, is so special about ecosystems that means we can't make substitutes for them?

6) (2 pts) Discuss the politics of cost-benefit analysis. Knowing what you know about how ecological-economic values are determined, why do you think that most environmentalists oppose the use of CBA, and most industry groups favor it? Asked another way, how do you think cost-benefit analysis, or the absence of cost-benefit analysis, could be used politically to systematically further the agenda of a particular ideology? Is this a danger that outweighs the benefits of "rational policymaking"?