Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.
Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.
OCR for page 68
Valuing Ground Water: Economic Concepts and Approaches 4— Economic Valuation of Ground Water Chapter 3 presented an integrative framework for valuing ground water resources. This chapter examines the key economic principles and methods used to value various ground water services identified in the previous chapter. It is divided into five major sections. The first offers a brief history of the science and art of economic valuation of natural/environmental resources, including the role of these methods in public policy development. This is followed by a review of the methods for estimating the value of environmental amenities. The approaches are discussed in terms of their relevance for the categories of service flows generated from the integrative framework in Chapter 3. The fourth section reviews selected ground water valuation studies with the aim of drawing conclusions about the state of current knowledge of the value of ground water resources. Finally, recommendations are made for using elements of the integrative framework from Chapter 3 and the economic concepts and methods presented here to estimate the value of ground water in specific contexts. The application of these methods to a range of ground water services is explored in a series of case studies in Chapter 6. HISTORY OF ECONOMIC VALUATION OF NATURAL/ENVIRONMENTAL RESOURCES Since the 1960s economists have developed a variety of techniques for assessing the value of nonmarket goods and services, not priced and traded in markets. While most applications are to natural resources and environmental assets, the concepts and methods of nonmarket valuation extend to a range of
OCR for page 69
Valuing Ground Water: Economic Concepts and Approaches goods not usually traded in markets. The ability to assign values to such goods and services has improved the accuracy of benefit-cost analysis. Inclusion of economic values for some important (and previously ignored) classes of environmental services enables benefit-cost assessments to reflect more fully the consequences of natural resource policies and regulations. Some of the earliest attempts to value a nonmarketed natural resource involved the value of water to agriculture in the western United States. Since water has traditionally been allocated to farmers and other users according to the prior appropriation doctrine ("first in time, first in use"), information was not available on the user's willingness to pay for water. To estimate (impute) a value for irrigation water, economists used models and techniques borrowed from studies of the behavior of firms, such as profit-maximizing models of farm behavior cast as linear or other programming models. Specifically, economists had to infer value by examining changes in returns to the farm associated with changes in the amount of water applied. In this way they could estimate the value of both surface and ground water. These early water resource valuations used conceptual models and estimation techniques that had been developed and used primarily for analyzing market-related issues. These techniques worked well in assigning an economic value to water use in agriculture, given that water is simply an input into the farm's production process and that abundant cost data (on other inputs) and revenue information for farm operations existed. The first application of techniques developed specifically for valuing nonmarketed commodities involved the travel cost method (TCM), Hotelling proposed in 1946 as a means of valuing visits to national parks. The travel cost method, in its numerous variants, has been used extensively to assess the value of a commodity used directly by the consumer, namely outdoor recreation. Refinements of the travel cost method and the development of new techniques, such as the contingent valuation method (CVM) and hedonic price method (HPM), enhanced the ability of economists to value a wider range of use values for environmental commodities, including improvements in air and water quality. Within the past decade, attention has shifted to estimating nonuse values, such as what individuals are willing to pay to ensure the existence of species or unique natural settings. The values elicited with these techniques for specific environmental goods and services are being used in an increasing array of settings; however, their use is not without controversy, as discussed later in this chapter. The development of nonmarket valuation techniques enabled economists to place values on individual environmental commodities. However, policy and regulatory attention is now increasingly focused on the management of ecosystems. Valuing complex hydrologic or ecological functions and the associated range of service flows is relatively uncharted territory and raises a number of conceptual and practical issues. For instance, natural scientists cannot unambiguously define and measure ecosystem performance and endpoints. Other
OCR for page 70
Valuing Ground Water: Economic Concepts and Approaches problems arise from the inability of economic science to measure adequately the consequences of long-term and complex phenomena. A related problem is the difference in disciplinary perspectives between economists and scientists from other fields who provide knowledge about physical relationships required for bioeconomic assessments, such as how a change in aquifer flow will alter surface stream flow and how a change in stream flow will, in turn, affect items people value, such as recreational fish catch. These issues and challenges affect the ability of economists to assess the full range of service flows from ground water; these challenges are discussed in the case studies in Chapter 6. THE ECONOMIC APPROACH TO VALUATION Economic values are only one type of assigned values (Brown, 1984). They indicate human preferences for a good or service and are not inherent in the good or service itself. Further, economic values are exchange values; they reflect the terms of trade, dollars for services. Decision criteria which are based on economic values, such as efficiency and benefit-cost analysis, demonstrate a utilitarian philosophical perspective. Recognizing and using economic values does not deny the existence or validity of alternative perspectives of value; however, the foundations of economic analysis offer the only unifying approach in making some types of private and public choices. The Role of Time in Economic Valuation Ground water services, like the services arising from many natural resources, frequently occur over multiple time periods. The rate of conversion of value between time periods is called a rate of time preference. The rate of time preference is defined at the individual level, and is a feature of people's desires. If an individual's rate of time preference is positive (greater than 0 percent), then the individual prefers a dollar today to a dollar a year from today because the dollar (or the consumption that dollar could purchase) in one year is worth less to the individual than the value of a dollar (and its level of consumption) today. To account for this, some economists like to discount the future values of assets in order to compare them accurately to present assets. Discounting converts future values to present ones. The present value (V) is related to a future value (FV) received t years hence by the rule (1) in which r is the role of time preference. Discounting thus reduces the future value of an asset by a percentage equal to the rate of time preference. Note that the two concepts of a rate of time preference and a bank rate of interest are distinct. They are, of course, related to one another in a market system. (Indeed,
OCR for page 71
Valuing Ground Water: Economic Concepts and Approaches bank interest is an implicit recognition that people value a dollar more today than the same dollar tomorrow.) The role of changes in productivity, as discussed in the following section, is also important in determining the appropriate discount rate. The following two examples demonstrate how the concepts of rate of time preference, discounting, and present value are used in measuring economic values over time. The examples include calculation of the value of an asset and the optimal rate of extraction of a resource over time. Both examples are relevant to the valuation of ground water services. The Value of an Asset An asset, such as a piece of machinery or a ground water aquifer, is valuable because of its contribution to producing a product of value (e.g., agricultural crops or clean drinking water). The relationship between the value of the product produced and the value of the machine or an aquifer is important. Suppose that a machine or an aquifer lasts forever and that it contributes an increment to production each year that the firm values at $R. Suppose further that the bank rate of interest is i percent. Then value (V) of the asset is (2) (3) The value of the asset today is thus equal to the sum of the annual incremental contributions the asset will make to production during its life, less an appropriately discounted percentage for each year. This is the value (V) of the machine or aquifer to the firm; and the firm would be willing to pay up to this amount (but no more) today for the asset. In short, the value of any productive asset is the present value of the increment to the owner's objectives that it will generate. The relationship in (3) holds exactly only for infinitely lived assets that do not depreciate, but the same idea holds in general. In this special case, we can see that the machine's value is such that the yearly increment to the value of production, R, (called the rental value of the machine, for that is what the company would be willing to pay to use the asset for one year) is the interest rate times the value of the asset. The Dynamic Price of Water The example above shows one way of placing a value on the services provided by a ground water aquifer that produces a finite stream of benefits. A somewhat more complex dynamic decision involves the optimal time rate of use (exploitation) of a natural resource. Optimizing involves balancing marginal gains
OCR for page 72
Valuing Ground Water: Economic Concepts and Approaches against marginal costs. Suppose a single private firm owns an aquifer. For now, suppose further that the aquifer is confined, with no recharge. Thus it is a finite exhaustible resource, like a mineral deposit. The stock of water contained in the aquifer is known to be S (for stock) gallons initially. After t years of extraction, there are S(t) units of water left in the aquifer. The firm extracts an amount E (an action corresponding to extraction) of water; in year t, this amount is E(t). Suppose this extracted water can be sold for a price of $P per unit. The dollar cost of pumping and distribution depends on both the amount extracted and the size of the stock. A larger stock means lower pumping costs. To capture this idea, let C(S) be the unit cost of pumping and distributing water when the stock size S gallons; total cost is E(t)C(S(t)). The objective of a private water supply company is to maximize the present value of extraction. To do so, the firm will balance the benefits of an additional (marginal) unit of extraction against the (rising) costs of removal; that benefit will be P, the price the unit sells for. The marginal costs of extraction will be of three kinds. First there is the marginal pumping and distribution cost C(S). Second, there is the opportunity cost of current extraction: that is, the loss of the option to extract that unit of water later. Third, pumping water today increases the cost of pumping at all future times. Thus there is a ''dynamic" cost of pumping water that includes not just the usual cost of extraction and distribution but opportunity costs and the "cost" of driving up future pumping costs. The dynamic cost of water increases as the ground water is depleted. Let R(t) be the dynamic cost at year t. Balancing price and marginal extraction cost will involve accounting for both the unit cost of pumping (C(S)) and the dynamic cost (R(t)) as in (4) As extraction continues, C(S) rises while S declines. In the market, the price of water will rise. The dynamic term R(t) also increases over time to reflect increasing scarcity of water. If there is recharge, the details of the model change, but not its fundamental lessons. There still is a dynamic price of water, R(t), but its behavior over time is modified to reflect recharge. At some point the aquifer may enter a steady state, in which the amount of extraction and the amount of recharge are equal and no net change in the stock takes place. Then, assuming energy and other costs remain stable, the price of water becomes a constant as well, equal to the stable extraction and dynamic costs C(S) + R. It should be noted that in circumstances where aquifers discharge naturally to a stream, assuming that extraction does not affect future uses or users, and the level of the water table is unaffected—then ground water is not scarce and R(t) equals zero. The term R(t), the dynamic cost of the additional water, is also the rental value of the ground water stock. It is the amount the firm would pay for another unit of ground water stock. As such, it measures the value in the market of having
OCR for page 73
Valuing Ground Water: Economic Concepts and Approaches another unit of ground water in terms of the extra value the ground water will produce either as a consumption good or as an input to the production of other goods. This is the value the marketplace places on additional ground water resources. This may or may not correspond to the best thing for society, depending on society's objectives. The dynamic price of water, R(t), gives the value of having another unit of stock. It is also a price for balancing the (dynamic) supply of water against the demands for water, present and future. Obviously, its magnitude depends on several things. First, R(t) depends on the stock of water. If all else is equal, as the stock goes up, R(t) goes down and vice versa. In instances where ground water is not scarce, it commands no rental value and R(t) is zero. What is relevant to proper water pricing in a market is the size of the stock relative to demand for it. Anything that increases the demand for the ground water stocks (e.g., population growth or increased allocation of water to produce environmental services) increases R(t). And conversely, decreases in demand (by water conservation or development of substitute sources) will reduce the efficient water price. Contamination events also will drive up the dynamic water price, R(t) by reducing usable supply. This allows a method for determining the social cost of contamination. If contamination makes ground water useless for some purpose (e.g., drinking) but it leaves it acceptable for another (e.g., irrigation), the stock relative to the second demand will increase. This will automatically be built into changes in the dynamic price. METHODS FOR ESTIMATING THE ECONOMIC VALUE OF NATURAL/ENVIRONMENTAL RESOURCES The preceding section provided a brief introduction to economic concepts and constructs central to the measurement of benefits and costs. Applied economic analysis uses these theoretical concepts and constructs in combination with models and quantitative techniques, to answer questions involving private and public choice. Specifically, theories of firm and consumer behavior are used to develop testable hypotheses and as a guide to model specification. Quantitative methods, such as econometric and operations research techniques, provide a means of testing the hypotheses and models against real-world data. This combination of models and techniques has been successfully used for decades to address a wide range of economic issues, including the estimation of values for nonmarketed commodities. The place to start any valuation effort is to look for situations where prices for natural/environmental resources are already revealed as a result of competitive market or simulated exchange arrangements (Freeman, 1993). Many natural resources are sold in markets and therefore the prices that result offer opportunities for valuing natural resources. These markets must be well-functioning and competitive in order for the prices to reveal reliable information. It should be
OCR for page 74
Valuing Ground Water: Economic Concepts and Approaches remembered that prices represent only a marginal value and steps must be taken to calculate the total value by estimating the demand for the good (see Chapter 3). Nonuse values cannot be captured through this approach. Recent developments in negotiated land transactions also offer an opportunity to gain some important information about the value of a natural resource. For example, some municipalities in the West bought up agricultural land in order to obtain water rights. These negotiated transactions over water rights provide evidence of the value of ground water in these areas. Nonmarket valuation techniques consist of two basic types. Indirect approaches rely on observed behavior to infer values. Direct approaches use survey-based techniques to directly elicit preferences for nonmarket goods and services. Both sets of techniques share a foundation in welfare economics, where measures of willingness to pay (WTP) and willingness to accept (WTA) compensation are taken as basic data for individual benefits and costs. Indirect Valuation Approaches Indirect approaches, sometimes referred to as revealed preferences approaches, rely on observed behavior to infer values. This section begins with an overview of two general classes of indirect methods: derived demand and production cost techniques, which impute the value of a nonmarketed environmental input, such as ground water, into a production process; and the opportunity cost approach, which quantifies the economic losses associated with the impacts environmental degradation has on human health. The discussion then turns to more detailed presentations of three techniques that are commonly labeled as indirect methods: the averting behavior method, the hedonic price method, and the travel cost method. These methods depend upon the ability of individuals to discern changes in environmental quality and adjust their behavior in response to these changes. Recent summaries of indirect approaches can be found in Braden and Kolstad, 1991; Mendelsohn and Markstrom, 1988; Peterson et al., 1992; Smith, 1989, 1993; and Freeman, 1993. A summary of the advantages and disadvantages of the indirect as well as direct methods is given in Table 4.1. Derived Demand/Production Cost Estimation Techniques Where water is an important component of a production process and a firm's cost structure is known, the water's implicit value can be calculated by measuring water's contribution to the firm's profit. If water supply is unrestricted, a firm will continue to use units of water up to the point where the contribution to profit of the last unit is just equal to its cost to the firm. Even if water is "free," there will be costs to the firm associated with water use (including pumping and delivery costs). If water supply is restricted (for example, by quotas or water rights), the firm may cease use of water before the equality is met.
OCR for page 75
Valuing Ground Water: Economic Concepts and Approaches TABLE 4.1 Advantages and Disadvantages of Selected Methods Method Advantages Disadvantages Derived demand/production cost estimation techniques Based on observable data from firms using water as an input or from household consumption.; Firmly grounded in microeconomic theory.; Relatively inexpensive. Not possible to measure in situ or nonuse values.; Understates WTP. Cost-of-illness method Relatively inexpensive. Omits the disutility associated with illness.; Understates WTP because it overlooks averting costs.; Limited to assessment of the current situation. Travel cost method (TCM) Based on observable data from actual behavior and choices.; Relatively inexpensive. Need for easily observable behavior.; Limited to resource use situations including travel.; Ex post analysis; limited to assessment of the current situation.; Does not measure nonuse values.; Possible sample selection problems and other complications relate to estimate consumer surplus. Averting behavior method Based on observable data from actual behavior and choices.; Relatively inexpensive.; Provides a lower bound WTP if certain assumptions are met. Estimates do not capture full losses from environmental degradation.; Several key assumptions must be met to obtain reliable estimates.; Need for easily observable behavior on averting behaviors or expenditures.; Ex post analysis; limited to assessment of current situation.; Does not estimate nonuse values. Hedonic pricing method (HPM) Based on observable and readily available data from actual behavior and choices. Difficulty in detecting small, or insignificant, effects of environmental-quality factors on housing prices.
OCR for page 76
Valuing Ground Water: Economic Concepts and Approaches Method Advantages Disadvantages Hedonic pricing method (HPM) Connection between implicit prices and value measures is technically complex and sometimes empirically unobtainable. Market prices or negotiated transactions Based on observable data from actual choices in markets or other negotiated exchanges. Does not provide total values (including nonuse values) ex post in nature, limited to assessment of current situation. Potential for market distortions to bias values. Contingent valuation method (CVM) Ex ante technique: it can be used to measure the value of anything without need for observable behavior (data).; Only method to measure existence or bequest values.; Technique is not generally difficult to understand. Since hypothetical, not actual, market transactions or decisions are the focus of CVM, various sources of errors (i.e., incentives to misrepresent values, implied value cues, and scenario misrepresentation) may be introduced. Expensive due to the need for thorough survey development and pretesting. Concerns about reliability for calculating nonuse values (particularly for such calculations to support natural resource damage assessments for use in litigation). Controversial, especially for nonuse value applications. The level of water use at varying costs to the firm defines a "derived" demand relationship, given that the demand for the input (water) is derived from the demand for the output (e.g., agricultural commodities). Simple budgeting or more complex linear programming and other optimization methods have been applied to calculate use value and derived demand for ground water in agricul-
OCR for page 77
Valuing Ground Water: Economic Concepts and Approaches tural production to gauge efficiency of water allocation or to manage ground water extraction rates (Snyder, 1954; Ciriacy-Wantrup, 1956; Burt, 1964, 1966; Bain et al., 1966; Kelso et al., 1973). Production/cost techniques have also been applied to municipal water delivery and use (Teeples and Glyer, 1987). A related and important category of research on water values focuses on the demand for municipal water. Such studies do not use indirect techniques or processes to impute water value; rather, they combine concepts from the theory of consumer behavior with econometric (statistical) procedures to estimate the demand for water. This line of inquiry has documented consumers' willingness to pay for water under a range of prices and delivery systems (e.g., Wong, 1972; Berry and Bonen, 1974; Foster and Beattie, 1979; Cochrane and Cotton, 1985). These types of studies have also been helpful in understanding the "price-responsiveness" or price elasticity of water demand (Martin and Wilder, 1992; Renzetti, 1992). Application of these techniques to measure demand for (and value of) water requires sufficient variation in water prices across time and/or space to elicit statistically robust results. This condition is often lacking in municipal water pricing, where consumers or households often face a fixed price, regardless of quantity consumed. Some of these input-oriented valuation techniques are conceptually similar to the averting behavior approach discussed in the next section, in that a lower bound on the value of water is indicated by what a firm spends to acquire water of acceptable quality. For agriculture, this expenditure may be for energy to pump ground water or for delivery systems to transport water to the site of use. This general class of techniques can also be used to assess buffer value and other dynamic functions of an aquifer, such as the value of a ground water supply to supplement surface water during times of drought. Tsur and Graham-Tomasi (1991) used dynamic programming methods to estimate the buffer value of ground water to wheat growers in southern Israel's Negev region. Using certain assumptions, they found that buffer values were positive and in some scenarios were a significant component (up to 84 percent) of the total value of ground water. This application also highlighted the potential for uncertainty in surface water availability, acting through the buffer role of ground water, in influencing ground water extraction over time. This influence is a function of size of the aquifer stock, its extraction cost, and uncertainty. Moreover, differences in the magnitude of the buffer value of ground water have important implications for the dynamic behavior of ground water extraction (Tsur and Graham-Tomasi, 1991). Using this class of static and dynamic optimization techniques requires detailed production and cost data. Such data are most likely to be associated with the production of marketed goods, such as agricultural production. Since the majority of potential ground water services do not fall into this use class (of inputs used in the production of marketed goods), the use of these techniques is restricted to some of the potentially less important ground water services.
OCR for page 78
Valuing Ground Water: Economic Concepts and Approaches Using Opportunity Costs to Value Health Losses (Cost-of-Illness Method) Human health effects are a prime concern in ground water contamination incidents. Exposure to unsafe levels of substances in water through ingestion in drinking water or other routes (e.g., skin absorption) can lead to increased morbidity or mortality. In most cases contaminant levels are not high enough to produce acute health effects. Rather, consumption of relatively low levels of harmful substances in water may lead to long-term or chronic illnesses, such as cancer, and possibly to premature death. In addition to mortality losses, contamination of ground water creates losses due to increased morbidity, such as the costs of medical treatment and care, loss of leisure-time activities, and pain and suffering associated with illnesses (Spofford et al., 1989). The theory underlying WTP approaches to valuing mortality is summarized in Freeman (1993). The two main approaches economists have used to value morbidity are based on either individual preferences (WTP or required compensation) or the resource or opportunity cost approach (Freeman, 1993). In the latter, known as the cost-of-illness (COI) approach, the analyst attempts to measure benefits of pollution reduction by estimating the possible savings in direct out-of-pocket expenses resulting from the illness (e.g., medicine, and doctor and hospital bills) and opportunity costs (e.g., lost earnings associated with the sickness). For example, the costs per illness or losses in wages per day associated with cancer caused by drinking water containing a volatile organic chemical would be multiplied by the number of days of illness in the population to arrive at an aggregate benefit figure. The cost-of-illness approach has several important limitations. First, it does not consider the actual disutility of those afflicted with illnesses. Second, it overlooks that individuals faced with pollution undertake defensive or averting expenditures to protect themselves. Harrington and Portney (1987) demonstrated theoretically under a set of plausible assumptions that without the inclusion of expenditures on averting behaviors, the COI benefit estimation method will underestimate true willingness to pay for a reduction in pollution. Averting Behavior Method Actions taken to avoid or reduce damages from exposure to ground water contaminants are another category of economic losses. Theoretical explanations of averting expenditures are based on the household production function theory of consumer behavior. In the context of averting behavior models, the household produces consumption goods using various inputs, some of which are subject to degradation by pollution. The household may respond to increased degradation of these inputs in various ways that are generally referred to as averting or defensive behaviors. The adverse impacts of ground water contaminants can be avoided in at least three ways: (1) buying durable goods (e.g., point-of-use treatment system); (2) buying nondurables (e.g., bottled water); and (3) changing daily routines to avoid
OCR for page 94
Valuing Ground Water: Economic Concepts and Approaches reference condition changes for each respondent; grouping respondents into a range of safety categories does not solve the problem since the difference between ''somewhat safe" and "safe" is not the same for each respondent. Hence a change in condition from the initial to an improved environmental state cannot be compared nor aggregated for respondents. There is some disagreement on what information should be presented in the hypothetical market (Boyle, 1994; Lazo et al., 1992). Specifically, what types of information, the quantity of information, and an appropriate presentation of technical information must be determined so that respondents provide valid and reliable valuation responses. Boyle (1994) recommends a hybrid of expert and respondent's subjective perceptions. The problem with this approach is that it is still not certain whether one or the other should be the starting point, which creates a lack of clarity regarding the effects of the different approaches on estimated values. The baseline ground water condition is the foundation for determining values. Since many of the studies focus on option price (McClelland et al., 1992; Caudill, 1992; Edwards, 1988; Jordan and Elnagheeb, 1993; Poe, 1993; Poe and Bishop, 1992; Powell, 1991; Shultz, 1989; Sun, 1990; Sun et al., 1992), it is imperative that the baseline condition is well defined so that researchers can determine the welfare change from the initial condition to the proposed change. If the initial condition is not well defined, then it is questionable whether researchers are measuring what they intend to measure, and the validity of the results are called into question. There are two general schools of thought regarding the presumed knowledge of respondents. The first (McClelland et al., 1992; Poe and Bishop, 1992) maintains that experts should be used to provide background information for survey design. This approach generates more consistent estimates, but suffers from testing bias and often results in informing respondents as to what they should answer. This information bias decreases the validity of results by making it difficult to generalize results from the informed sample to the general population. A second approach (Caudill, 1992; Edwards, 1988; Powell, 1991; Shultz, 1989) rests on the belief that consumers make decisions based on the information they have on hand, that is, their subjective perceptions of ground water characteristics (specifically safety). This approach may be more appealing from the standpoint that the validity of responses may increase but the random nature of responses about goods with which consumers have very little experience increases. Clemons et al. (1995) show that information on nitrates does not significantly alter value estimates, a finding contrary to those of Bergstrom and Dorfman (1994) and Poe and Bishop (1992). Boyle (1994) recommends testing experts' opinions in focus groups with sample respondents to filter out highly technical information. Poe (1993) took steps to this end with a two-tiered study that provided respondents with water testing kits in the first stage so as to nail down the baseline condition. This
OCR for page 95
Valuing Ground Water: Economic Concepts and Approaches approach allows a more reliable and valid measurement of the change in ground water condition from the initial condition to the new condition resulting from a ground water protection program because the initial condition is defined precisely through self-administered tests of well water quality. Dealing with Uncertainty The two preceding themes suggest that uncertainty is a common feature of existing CVM studies of ground water protection benefits. In measuring economic welfare under conditions of uncertainty, several factors must be considered when evaluating benefits estimates: future prices, future income, opportunity costs, uncertainty about future human health responses to prevent exposures, future use, and future availability. Uncertainty about future states is compounded by any inability to measure present states. The studies reviewed here attempted to derive the option price or the maximum amount an individual would be willing to pay to maintain the option to consume the good. The conceptual model underlying the treatment of uncertainty uses the measurement of option prices for risk changes. Caudill (1992), Poe (1993), and Sun (1990) measured respondents' subjective perceptions of uncertainty of future supply, while Edwards (1988) found option prices for a range of probabilities and Powell (1991) asked respondents about their subjective perceptions of safety. Few studies have attempted to capture quasi-option value or the measurement of option price when there is a possibility of having better information in the future. What We Know about Ground Water Values Based on Existing CVM Studies The major issues of agreement and disagreement found in our review of these diverse CVM studies are presented in the next section. The framework established by Boyle and Bergstrom (1994) is a helpful guide to this discussion. Useful discussions of the strengths and weaknesses of CVM studies completed to date can be found in Boyle and Bergstrom (1994) and in Crutchfield et al. (1995). Areas of Agreement (Strengths) The CVM's ability to measure use values is generally accepted in the economics profession. Its ability to capture nonuse values remains controversial, even though the NOAA panel defined conditions under which CVM may generate reliable estimates of such values (e.g., adequate survey design and commodity definition). Efforts towards a consensus of survey design incorporating the use of verbal protocol and focus groups have led to the acceptance of CVM estimates
OCR for page 96
Valuing Ground Water: Economic Concepts and Approaches in some policy settings (but not necessarily in litigation or judicial settings). There is also significant agreement that local context factors are important (e.g., Poe, 1993; Powell, 1991; Sun et al., 1992). For example, site-specific information is important to respondents when faced with a contingent decision. Areas of Disagreement (Weaknesses and Areas for Future Research) There is still some disagreement over payment vehicles, although most studies have focused on referendum type questions. Mitchell and Carson (1989) maintain that the chosen payment vehicle must be both realistic and neutral. Most studies have focused on either a referendum format (to pay for a bond for some type of protection or remediation program) or an increase in water or tax bills. Use of the latter presents difficulties because in instances where the respondent does not own property the vehicle is not realistic. Similarly, neutrality is problematic because a tax increase may invite scenario rejection. A referendum valuation question asks whether respondents would vote for the referendum given a specified cost for the referendum. The dichotomous choice valuation question format has received considerable support (see Table 4.4). Valuation questions using dichotomous choice appear to elicit more consistent responses than open-ended questions or bidding games. Bishop and Heberlein's Wisconsin Sandhill study (1990) suggests that there is no significant difference between valuations collected from a hypothetical market using binary choice vs. actual cash transactions. At the same time, dichotomous choice questions lead to consistently higher estimates than open ended questions. Further research is necessary to determine the source of this error. The literature indicates a controversy surrounding CVM survey respondents' estimates of health risks and their comparability with expert opinion (Boyle et al., 1995; Boyle, 1994; Lazo et al., 1992). This controversy arises not only in the design of survey instruments but also in the use of results. It is generally acknowledged that individuals need a full information set that includes both general and specific information to identify their own best interests with respect to ground water protection programs (Poe and Bishop, 1993). Overly general information in the survey instrument appears to lead to biased estimates of willingness to pay. An illustrative example of the problems arising from differences between expert opinion and CVM estimates is sketched in Portney's 1992 study, where experts believed a chemical in ground water to be harmless, whereas citizens held the chemical responsible for above-average incidence of cancer and were willing to pay $1,000 for what experts say will be a costly and unnecessary treatment. Very little empirical research has been devoted to establishing a minimum standard of information adequacy for CVM studies (Poe and Bishop, 1993; Powell, 1991; Boyle, 1994). The question remains as to what type of information should be presented to respondents and how that information affects estimated
OCR for page 97
Valuing Ground Water: Economic Concepts and Approaches TABLE 4.4 Summary of CVM Studies—Survey Characteristics Author(s) Dates Response Rates Usable Responses (Percent) Payment Vehicle Valuation Question McClelland et al. (1992) 60; 44 water bill payment care Caudill (1992); Caudill and Hoehn (1992) 67; 60 higher taxes dichotomous choice Doyle (1991) NA bond payment card Edwards (1988) 78; 58 bond dichotomous choice, open ended Jordan and Elnagheeb (1993) 35; 34 water bill; water purification equipment payment card Poe (1993); Poe and Bishop (1992) 76-91 increased taxes, lower profits, higher prices dichotomous choice Powell (1991); Powell and Allee (undated) 50 water bill; higher taxes payment card Clemons, Collins, and Green (1995) 64 bond dichotomous choice SOURCE: Reprinted with permission from Boyle (1994). values of the benefits of protecting ground water (Boyle, 1994). Lazo et al. (1992) provide guidelines for reducing information biases using verbal protocols. The increasing costs of conducting benefit studies and decreasing support for research efforts have led to renewed efforts to minimize costs by establishing some method for transferring benefits from study sites to policy sites. Preliminary evidence (VandenBerg et al., 1995) indicates the challenges inherent in benefits transferability with ground water resources. While complete transferability of benefits estimates is an impossible goal given the site-specific nature of most ground water valuations, the debate itself is leading to collaborative interdisciplinary efforts which may create benefits in and of themselves. A final area, though not specifically an area of disagreement, is the dearth of
OCR for page 98
Valuing Ground Water: Economic Concepts and Approaches TABLE 4.5 A General Matrix of Ground Water Functions/Services and Applicable Valuation Methods Water Function/Service Flow Applicable Valuation Method A. Extractive values Cost of illness 1. Municipal use (drinking water) a) Human health - morbidity Averting behavior; Contingent valuation; Contingent ranking/behavior b) Human health - mortality Averting behavior; Contingent valuation; Contingent ranking/behavior 2. Agricultural water use Derived demand/production cost 3. Industrial water use Derived demand/production cost B. In situ values 1. Ecological values Production cost techniques; Contingent valuation; Contingent ranking/behavior 2. Buffer value Dynamic optimization; Contingent valuation; Contingent ranking/behavior 3. Subsidence avoidance Production cost; Hedonic pricing model; Contingent valuation; Contingent ranking/behavior 4. Recreation Travel cost method; Contingent valuation; Contingent ranking/behavior 5. Existence value Contingent valuation; Contingent ranking/behavior 6. Bequest value Contingent valuation; Contingent ranking/behavior SOURCE: Adapted from Freeman, 1993. (Reprinted with permission from Resources for the Future, 1993. Copyright by Resources for the Future.) information on nonuse values of ground water. For example, only one study (McClelland et al., 1992) has attempted to address existence value of ground water, and the approaches used in the study have been criticized. The estimates for existence and bequest values found in this study were smaller than use values found from other studies using indirect or direct methods. Additional research is needed to further document the existence and size of nonuse values for ground water resources. Table 4.5 illustrates the applicable valuation methods for address-
OCR for page 99
Valuing Ground Water: Economic Concepts and Approaches ing various potential ground water values. It is not an exhaustive list. Following Table 1.3, it is organized according to extractive and in situ services of ground water. Nonuse values are treated as a subcategory of in situ values in this scheme. Such values can only be measured using direct methods, such as CVM or a variant. Two cautions should be kept in mind when examining Table 4.5. In some cases, several different methods can be used to measure the same ground water function. This permits the potential for checking the consistency of estimates of the same function or service. However, it also raises the potential that some decision-makers will double-count value estimates of the same service when attempting to arrive at a total value estimate of a particular ground water resource. Use of a comprehensive list of ground water functions and services can serve as a guide to keep correct calculations of total values from individual studies. Finally, the reader should recall the advantages and disadvantages of each of the techniques (summarized in Table 4.1) when considering their use in decision-making. CONCLUSIONS AND RECOMMENDATIONS For valid and reliable results to be obtained, the valuation method must be matched to the context and the ground water function or service of interest. It is hard to make generalizations about the validity and reliability of specific valuation approaches in the abstract. The validity of the approach depends on the valuation context and the type of ground water services in question. Different approaches are needed to value different services; care must be taken not to double count values resulting from different services. Previous ground water valuation studies have focused primarily on a small part of the known ground water functions and services (identified in Chapter 3). Thus current empirical knowledge of the values of ground water is quite limited and concentrated in a few areas, such as extractive values related to drinking water use. If data are available and critical assumptions are met, indirect valuation methods (e.g., TCM, HPM averting behavior) can produce reliable estimates of the use values of ground water. The contingent valuation method (CVM), when used correctly, has the potential for producing reliable estimates of ground water use values in certain contexts. However, few, if any, studies to date meet the stringent conditions, as established by a NOAA panel of Nobel-Laureate economists, that are required to produce defensible estimates of nonuse values. More research is needed to compare use values from CVM with those of other methods to determine whether CVM will consistently yield reliable estimates. CVM does have the advantage of allowing researchers to be precise in focusing on the total resource attribute to be valued, compared to the
OCR for page 100
Valuing Ground Water: Economic Concepts and Approaches results from other indirect approaches that generally fail to capture total economic value. The EPA, and other federal agencies as appropriate, should develop and test valuation methods for addressing the use and nonuse values of ground water, especially considering the ecological services provided by ground water. Given the problems in using CVM to measure ground water values, EPA and other appropriate government agencies should encourage ways of enhancing the utility of CVM. For example, contingent ranking or behavior methods may be useful in improving the robustness of CVM estimates and may expand the potential for benefits transfer. Technical, economic, and institutional uncertainties should be considered and their potential influence delineated in ground water valuation studies. Research is needed to articulate such uncertainties and their potential influence on valuation study results. Ground water values obtained from both indirect and direct methods are dependent on the specific ground water management context. Attempts to generalize about or transfer values from one context to another should be pursued with caution. Traditional valuation methods such as cost of illness, demand/analysis, and production cost can be used for many ground water management decisions that involve use values. Such methods offer defensible estimates of what are likely to be the major benefits of ground water services. The pervasiveness and magnitude of nonuse values is uncertain. Few and limited studies have been conducted, and little reliable evidence exists with which to draw conclusions about the importance of nonuse values for ground water. Additional research is needed to document the occurrence and size of nonuse values for ground water systems. What is most relevant for decision-making regarding ground water policies or management is knowledge of how the TEV of ground water will be affected by a decision. Pending documentation of large and pervasive nonuse values for ground water, it is likely that in many, but not all, circumstances, measurement of use values or extractive values alone will provide a substantial portion of the change in TEV relevant for decision-making. In some circumstances the TEV is likely to be largely composed of nonuse values. At the current time, pending documentation of large and pervasive nonuse values for ground water systems, this appears to be most likely when ground water has a strong connection to surface water and a decision will substantially alter these service flows. In these situations, focusing on use values alone could seriously mismeasure changes in TEV and will ill serve decision-making. Decision-makers should approach valuation with a careful regard for measurement of TEV using direct techniques that can incorporate nonuse values.
OCR for page 101
Valuing Ground Water: Economic Concepts and Approaches REFERENCES Abdalla, C. W. 1990. Measuring economic losses from ground water contamination: An investigation of household avoidance costs. Water Resources Bulletin 26(3):451-463. Abdalla, C. W. 1994. Groundwater values from avoidance cost studies: Implications for policy and future research. American Journal of Agricultural Economics 76(5):1062-1067. Abdalla, C. W., B. A. Roach, and D. J. Epp. 1992. Valuing environmental quality changes using averting expenditures: An application to ground water contamination. Land Economics 68(2):163-169. Adamowicz, W. L. 1991. Valuation of environmental amenities. Canadian Journal of Agricultural Economics 39:609-618. Arrow, K., R. Solow, E. Leamer, P. Portney, R. Randner, and H. Schuman. 1993. Report of the NOAA panel on contingent valuation. Federal Register 58(10):4602-4614. Bain, J. S., R. E. Caves, and J. Margolis. 1966. Northern California's Water Industry. Baltimore: Johns Hopkins University Press. Bartik, T. J. 1988. Evaluating the benefits of non-marginal reductions in pollution using information on defensive expenditures. Journal of Environmental Economics and Management 15:111-127. Bergstrom, J. C., and J. H. Dorfman. 1994. Commodity Definition and Willingness-to-pay for Ground Water Quality Protection. Review of Agricultural Economics 16:413-425. Berry, D. W., and G. W. Bonen. 1974. Predicting the municipal demand for water. Water Resources Research 10:1239-1242. Bishop, R. C., and T. A. Heberlein. 1990. The contingent valuation method. In Economic Valuation of Natural Resources: Issues, Theory, and Applications. Rebecca L. Johnson and Gary V. Johnson, eds. Boulder: Westview Press. Bishop, R. C., and M. P. Welsh. 1992. Existence values in benefit-cost analysis and damage assessment. Land Economics 68(4):405-417. Boyle, K. J. 1994. A Comparison of Contingent-Valuation Studies of Ground Water Protection. Department of Resource Economics and Policy, Staff Paper 456, Maine Agricultural Experiment Station. Orono: University of Maine. Boyle, K. J., and J. C. Bergstrom. 1994. A Framework for Measuring the Economic Benefits of Ground Water, Rep. 459. Maine Agricultural Experiment Station. Orono: University of Maine. Boyle, K. J., M. P. Welsh, R. C. Bishop, and R. M. Baumgartner. 1995. Validating contingent valuation with surveys of experts. Agricultural and Resource Economics Review. 24(2):247-254. Braden, J. B., and C. D. Kolstad. 1991. Measuring the Demand for Environmental Quality. Amsterdam: Elsevier Science. Brown, T. C. 1984. The concept of value in resource allocation. Land Economics 60(3):231-246. Burt, O. R. 1964. Optimal resource use over time with an application to groundwater. Management Science 11:80-93. Burt, O. R. 1966. Economic Control of Groundwater Reserves. Journal of Farm Economics 48:632-647. Carson, R. T. 1991. Constructed Markets in Measuring the Demand for Environmental Quality. J. B. Braden and C. S. Kolstad, eds. North Holland. Caudill, J. D. 1992. The Valuation of Ground Water Pollution Policies: The Differential Impacts of Prevention and Remediation, Ph.D. dissertation. Department of Agricultural Economics, Michigan State University. Caudill, J. D., and J. P. Hoehn. 1992. The Economic Valuation of Groundwater Pollution Policies: The Role of Subjective Risk Perceptions. Staff Paper No. 92-11. Department of Agricultural Economics, Michigan: Michigan State University. Ciriacy-Wantrup, S. V. 1956. Concepts used as economic criteria for a system of water rights. Land Economics 32:295-312.
OCR for page 102
Valuing Ground Water: Economic Concepts and Approaches Clemons, R., A. R. Collins, and K. Green. 1995. Contingent Valuation of Protecting Groundwater Quality by a Wellhead Protection Program. Paper presented at the American Agricultural Economics Association Annual Meeting, Indianapolis, Indiana. Cochrane, R., and A. W. Cotton. 1985. Municipal water demand study: Oklahoma City and Tulsa, Oklahoma. Water Resources Research 21:941-943. Collins, A. R., and S. Steinback. 1993. Rural household response to water contamination in West Virginia. Water Resources Bulletin 29(2):199-209. Courant, P. N., and R. C. Porter. 1981. Averting expenditures and the costs of pollution. Journal of Environmental Economics and Management 8(4):321-329. Crutchfield, S. R., P.M. Feather, and D. R. Hellerstein. 1995. The benefits of protecting rural water quality: An empirical analysis. Agricultural Economic Report No. 701. Washington, D.C.: Economic Research Service, U.S. Department of Agriculture. Diamond, P. A., and J. A. Hausman. 1994. Contingent valuation: Is some number better than no number? Journal of Environmental Perspectives 8(4):45-64. Dickie, M., and S. Gerking. 1988. Benefits of Reduced Soiling from Air Pollution Control: A Survey. In Migration and Labor Market Efficiency. H. Folmer, ed. Amsterdam: Martin Nijhoff. Doyle, J. K. 1991. Valuing the Benefits of Ground Water Cleanup. Interim report, Office of Policy, Planning and Evaluating U.S. EPA, Cooperative Agreement No. CR-815183. Edwards, S. F. 1988. Option prices for groundwater protection. Journal of Environmental Economics and Management 15:475-487. Fleming, R. A., R. M. Adams, and C. S. Kim. 1995. Regulating groundwater pollution: Effects of geophysical response assumptions on economic efficiency. Water Resources Research 31:1069-1076. Foster, H. S., and B. R. Beattie. 1979. Urban residential demand for water in the U.S. Land Economics 55:43-58. Freeman, A. M., III. 1993. The Measurement of Environmental and Resource Values: Theory and Methods. Washington, D.C.: Resources for the Future Press. Hanemann, W. M. 1994. Valuing the environment through contingent valuation. Journal of Economic Perspectives 8(4):19-43. Harrington, W., and P. R. Portney. 1987. Valuing the benefits of health and safety regulation. Journal of Urban Economics 22:101-112. Hausman, J. 1993. Contingent Valuation: A Critical Assessment. Amsterdam: Elsevier Science. Jordan, J. L., and A. H. Elnagheeb. 1993. Willingness to pay for improvements in drinking water quality. Water Resources Research 29:237-245. Kelso, M. M., W. E. Martin, and L. E. Mack. 1973. Water Supplies and Economic Growth in an Arid Environment: An Arizona Case Study. Tucson: University of Arizona Press. Kim, C. S., J. Hostetler, and G. Amacher. 1993. The regulation of groundwater quality with delayed responses: A multistage approach. Water Resources Research 29:1369-1377. Kopp, R. J. 1992. Why existence values should be used in cost-benefit analysis. Journal of Policy Analysis and Management 11(1):123-130. Lazo, J. K., W. D. Schulze, G. H. McClelland, and J. K. Doyle. 1992. Can contingent valuation measure non-use values? American Journal of Agricultural Economics (December):1126-1132. Malone, P., and R. Barrows. 1990. Groundwater pollution's effects on residential property values, Portage County, Wisconsin. Journal of Soil and Water Conservation 45(2):346-348. Martin, R. C., and R. P. Wilder. 1992. Residential demand for water and the pricing of municipal water services. Public Finance Quarterly 20:93-102. McClelland, G. H., W. D. Schulze, J. K. Lazo, D. M. Waldman, J. K. Doyle, S. R. Elliott, and J. R. Irwin. 1992. Methods for Measuring Non-Use Values: A Contingent Valuation Study of Groundwater Cleanup . Boulder: University of Colorado. McFadden, D. 1994. Contingent valuation and social choice. American Journal of Agricultural Economics 76:689-708.
OCR for page 103
Valuing Ground Water: Economic Concepts and Approaches Mendelsohn, R., and D. C. Markstrom. 1988. The Use of Travel Cost and Hedonic Methods in Assessing Environmental Benefits. In Amenity Resource Valuation: Integrating Economics with Other Disciplines. G. L. Peterson, B. L. Driver, and R. Gregory, eds. State College, Penn.: Venture Publishing. Mitchell, R. C., and R. T. Carson. 1989. Using Surveys to Value Public Goods: The Contingent Valuation Method. Washington, D.C.: Resources for the Future Press. Musser, W. N., L. M. Musser, A. S. Laughland, and J. S. Shortle. 1992. Contingent Valuation and Averting Costs Estimates of Benefits from Public Water Decisions in a Small Community. Agricultural Economics and Rural Sociology Staff Paper No. 171. University Park: Pennsylvania State University. National Oceanic and Atmospheric Administration. 1995. Natural resource damage assessments. Federal Register 60(149):39804-39834. Page, G. W., and H. Rabinowitz. 1993. Groundwater contamination: Its effect on property values and cities. Journal of the American Planning Association 59(4):473-481. Peterson, G. L., C. Sorg, D. McCollum, and M. H. Thomas, eds. 1992. Valuing Wildlife Resources in Alaska. Boulder: Westview Press. Poe, G. L. 1993. Information, Risk Perceptions and Contingent Values: The Case of Nitrates in Groundwater. Ph.D. dissertation. Department of Agricultural Economics, University of Wisconsin. Poe, G. L., and R. C. Bishop. 1993. Prior information, general information, and specific information in the contingent valuation of environmental risks: The case of nitrates in groundwater. Cornell Agriculture Economics Staff Paper 93-11. Poe, G. L., and R. C. Bishop. 1992. Measuring the benefits of groundwater protection from agricultural contamination: Results from a two-stage contingent valuation study. Staff Paper No. 341. Madison: Department of Agricultural Economics, University of Wisconsin-Madison. Portney, P. R. 1994. The contingent valuation debate: Why economists should care. Journal of Economic Perspectives 8(4):3-17. Portney, P. R. 1992. Trouble in Happyville. Journal of Policy Analysis and Management 11(1):131-132. Powell, J. R. 1991. The Value of Ground Water Protection: Measurement of Willingness-to-Pay Information and Its Utilization by Local Government Decisionmakers. Ph.D. dissertation. Cornell University. Powell, J. R., and D. J. Allee. Undated. The Estimation of Groundwater Protection Benefits and Their Utilization by Local Government Decision Makers. Final Report of a project conducted September 1988-September 1990. United States Geological Survey, Department of the Interior. Award Number 14-08-0001-G1649. Randall, A. 1991. Total and Non-use Values in Measuring the Demand for Environmental Quality. J. B. Braden and C. D. Kolstad, eds. Amsterdam: Elsevier Science. Renzetti, S. 1992. Evaluating the welfare effects of reforming municipal water prices. Journal EEM 22:147-163. Rosenthal, D., and R. H. Nelson. 1992. Why existence values should not be used in cost-benefit analysis. Journal of Policy Analysis and Management 11(1):116-122. Shultz, S. D. 1989. Willingness to Pay for Ground Water Protection in Dover, NH: A Contingent Valuation Approach. M.S. thesis. University of New Hampshire. Shultz, S. D., and B. E. Lindsay. 1990. Willingness to pay for ground water protection. Water Resources Research 26(9):1869-1875. Shultz, S. D., and A. E. Luloff. 1990. The threat of nonresponse bias to survey research. Journal of the Community Development Society 21(2):104-115. Smith, V. K. 1989. Taking stock of progress with travel cost recreation demand methods: Theory and implementation. Marine Resource Economics 6:279-310.
OCR for page 104
Valuing Ground Water: Economic Concepts and Approaches Smith, V. K. 1993. Nonmarket valuation of environmental resources: An interpretive appraisal. Land Economics 69:1-26. Smith, V. K., and W. H. Desvouges. 1986. Averting behavior: Does it exist? Economics Letters 20:291-296. Snyder, J. H. 1954. On the economics of groundwater mining. Journal of Farm Economics 36:600-610. Spofford, W. O., A. J. Krupnick, and E. F. Wood. 1989. Uncertainties in estimates of the costs and benefits of groundwater remediation: Results of a cost-benefit analysis. Discussion Paper QE 89-15. Washington, D.C.: Resources for the Future Press. Stevens, T. H. 1991. Measuring the existence value of wildlife: What do CVM estimates really show? Land Economics 67:390-400. Sun, H. 1990. An Economic Analysis of Ground Water Pollution by Agricultural Chemicals. M.S. thesis. University of Georgia. Sun, H., J. C. Bergstrom, and J. H. Dorfman. 1992. Estimating the benefits of groundwater contamination control. Southern Journal of Agricultural Economics 24(2):63-71. Teeples, R. K., and D. Glyer. 1987. Production functions for water delivery systems: Analysis and estimation using dual cost function and implicit price specification. Water Resources Research 23:765-773. Tsur, Y., and T. Graham-Tomasi. 1991. The buffer value of groundwater with stochastic surface water supplies. Journal of Environmental Economics and Management 21:201-224. VandenBerg, T. P., G. L. Poe, and J. R. Powell. 1995. Assessing the accuracy of benefits transfers: Evidence from a multi-site contingent valuation study of groundwater quality. Working Paper 95-01, Department of Agricultural, Resource, and Managerial Economics, Cornell University. Wong, S. T. 1972. A model of municipal water demand: a case study on northeastern Illinois. Land Economics (48):34-44.
Representative terms from entire chapter: