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Valuing Ground Water: Economic Concepts and Approaches (1997)

Chapter: 4: Economic Valuation of Ground Water

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Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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,

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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-

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×
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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

exposure to the contaminant, such as (a) boiling water for cooking and drinking or (b) reducing frequency or length of showers if a volatile organic chemical were present (Dickie and Gerking, 1988). Households, businesses, and other organizations may undertake averting actions to protect individuals from exposure to contaminants.

Several theoretical analyses (Courant and Porter, 1981; Bartik, 1988) of the averting behavior methods have concluded that under certain conditions such expenditures can provide a lower bound estimate of the true cost of increased pollution. Averting expenditures and true benefits of a pollution reduction differ because such expenditures do not measure all the costs related to pollution that affect household utility. While this approach measures household production costs, it fails to capture direct utility losses related to pollution (Musser et al., 1992). Courant and Porter (1981) found that when the level of ambient environmental quality conditions is valued directly by individuals, it is uncertain whether averting expenditures are not necessarily an accurate lower bound estimate of pollution reduction benefits. Bartik (1988) concluded that theoretically correct measures of WTP can be estimated using averting expenditures for both marginal and nonmarginal pollution changes. The ability of this valuation approach to provide a lower bound to WTP depends on the following assumptions: averting inputs should not serve in the production for only one output that is valued by the household (i.e., no jointness in household production); households should not obtain direct utility from the averting behavior; no income effects occur as a result of loss of work through illness; and the purchases of durable goods do not lower costs. In many ground water contamination situations, at least one of these assumptions is not likely to hold. Care must be taken in interpreting averting expenditures alone as a lower bound estimate of the value of a ground water function or service. In most cases information from averting cost studies will need to be coupled with and in some cases compared to results from studies using other valuation techniques to arrive at a complete measure of value of the ground water (Abdalla, 1994).

Hedonic Price Method

The hedonic pricing method (HPM) is based on the premise that people value a good because of the attributes of that good rather than the good itself. For example, the decision to purchase a particular house may be influenced by the attributes of that house (number of bedrooms, square footage, view, quality of the neighborhood, etc.). If one of those attributes is an environmental commodity, such as clean air, comparison of the price consumers pay for houses in areas of "clean air" (all other attributes of the house being equal) may provide information on the value of clean air.

Hedonic price models encompass both land (housing) price models and wage models that account for variations due to environmental attributes (e.g., air and

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

water quality, noise, aesthetics, and environmental hazards). Wage models can be used to infer values for environmental attributes by examining the relationship between wage rates and the quality of the environmental attributes across jobs and locations. Hedonic models can only measure use values. The measurement of use values is based on one fairly strong assumption (weak complementarity), which holds that the purchase of some market good is associated with consumption of an environmental good or service, and when consumption of the market good is zero, then demand for the environmental good or service is also zero (Adamowicz, 1991).

The hedonic technique, like other indirect nonmarket valuation methods, depends on observable data resulting from the actual behavior of individuals. An advantage of the HPM is that market data on property sales and associated characteristics are readily available from county or municipal sources (e.g., assessor's office) as well as from private real estate services. These data can usually be linked to other secondary sources of data for the same geographical area (e.g., data on water quality, air quality, or a range of physical attributes). These secondary sources of data can be used to construct indices of environmental quality for use in a statistical analysis.

Despite the advantage of readily available data, several problems limit the use of the HPM in many settings. One problem is that the effect of an environmental attribute or characteristic on price may be small and hard to detect statistically or to disentangle from the effects of all other variables. Another problem with the technique is that it is difficult to derive value measures from the estimated hedonic price function (the basic first-stage equation where the sale price of a house is regressed on the set of attributes of that house). Derivation of the value of an attribute requires a second-stage procedure to obtain a demand or WTP function built around market segmentation (to address an estimation problem known as identification). To date, few empirical studies have successfully completed the second stage. Thus most studies report only the results from the hedonic price function, which gives an estimate of the marginal effect of an environmental variable on price.

A brief hypothetical example illustrates the use of an indirect approach to measuring nonmarket value. The HPM can be applied to housing prices to estimate the value of environmental attributes, such as well (drinking) water or proximity to wetlands, which vary across a region. It is assumed that variations in housing prices can be linked to real or perceived variations in these environmental attributes (controlling for a variety of other statistical determinants). In practice the approach involves collection of cross-sectional data on house sales (or possibly assessed values) and information on a menu of potential determinants of value (lot size, number of bedrooms, etc.). These factors would include one or more indices of environmental attributes or services. Through multivariate statistical techniques, analysts can infer the marginal value of either positive or negative environmental externalities. For example, a researcher might find

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

that the average homeowner in a particular county would pay $X to be Y yards closer to an open-water wetland and would require a reduction in price of $Z to purchase a house in an area of contaminated ground water.

There have been few hedonic price studies on ground water contamination problems and the results have not been conclusive. While they have found statistical differences for industrial sites (due to cleanup costs and liability concerns), researchers have been less successful in isolating the effect of contaminated ground water upon residential property values (Malone and Barrows, 1990; Page and Rabinowitz, 1993).

Travel Cost Method

Travel cost methods (TCM) encompass a variety of models, ranging from the simple single-site travel cost model to regional and generalized models that incorporate quality indices and account for substitution across sites. The basic premise behind all versions of the travel cost model is that the travel costs incurred in traveling to a site can be regarded as the price of access to the site. Changes in the travel cost to a site can then be viewed as having the same effect on visits to the site as would a change in an access fee or a price. Under a set of assumptions involving opportunity cost of travel time, purpose of the trip, availability of substitute site, and time spent at the site, it is possible to derive the individuals' demand for visits to a site as a function of the price of admission using the simple or basic travel cost model.

In many situations the analyst is interested in understanding the effect of substitute sites on demand for a given site or the effect of changes in quality of certain site attributes on visits to the site. These types of concerns can be addressed using more complex versions of the travel cost model. For example, the role of substitute sites on visitation can be addressed with multiple-site travel cost models or with discrete-choice travel cost models. Changes in site quality, such as improvements in water quality, fish catch, and so forth, can be estimated using the generalized travel cost model, the hedonic travel cost model, or similar specifications. Because of the flexibility of travel cost methods and the relative ease of collecting data necessary for estimation, researchers have relied extensively on these methods in deriving use values for a wide range of recreational activities.

Since most extractive uses of ground water do not involve travel, TCM has limited applications to valuing these uses. However, ground water can provide in situ services, such as recharging surface water and wetlands and dilution of contaminants that may support recreational services. Since many ground water aquifers are a source of recharge into surface water and wetlands, ground water may support a number of recreational services. The TCM could conceivably be employed to value such services, although its use may be limited because of the difficulty of determining the share of recreational value attributable to ground water.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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Direct Valuation Approaches

Direct approaches to nonmarket valuation use survey-based techniques to directly elicit preferences. The hypothetical nature of these experiments requires that markets be ''constructed" to convey a set of changes to be valued. While there are a number of variants on these constructed markets, the most common is the contingent valuation method (CVM). CVM is a survey-based procedure designed to elicit a respondent's WTP or WTA for an environmental change (see Appendix B).

A method related to CVM is conjoint analysis, which includes contingent ranking of behavior. Conjoint analysis refers to a general approach marketing researchers employ to predict behavior based on studies of consumers, using contingent comparisons of product attributes, including price. Federal decision-makers concerned with valuation issues as well as environmental economists are giving greater attention to conjoint analysis. For example, a recent statement by the National Oceanic and Atmospheric Administration (NOAA) recommends the use of conjoint analysis, indicating that attributes may be valued in terms of price and if replacement costs were used would provide decision-makers the ability to compare alternative service flows (NOAA, 1995). Environmental economists are exploring several variants of this approach, including contingent ranking and contingent behavior, as a way to improve upon the CVM. These survey-based techniques derive information about an individual's preferences between alternatives with varying levels of environmental attributes. The contingent ranking method goes beyond the simple yes/no of a referendum format and asks individuals to reveal more information about their preferences by asking them to rank the hypothetical alternatives. If one attribute of the good is measured in monetary terms, subsequent statistical analysis allows the calculation of the WTP for changes in the attribute. A disadvantage of contingent ranking is that it is time-consuming and potentially difficult for a respondent to rank several goods and multiple attributes.

The contingent behavior (or activity) method involves the use of hypothetical questions about activities related to environmental goods or services. The main use of contingent behavior surveys has been to support other valuation analysis. For example, it can be used to support a TCM study of benefits by assessing how participation in recreational activity changes as environmental quality changes. Such contingent choice information can then be used to estimate a shift in the demand curve for recreational visits (Freeman, 1993).

An Introduction to the Contingent Valuation Method

The contingent valuation method (CVM) can be viewed as a highly structured conversation (Smith, 1993) that provides respondents with background information concerning the available choices of specific increments or decre-

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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ments in environmental goods. Values are elicited directly in the form of statements of maximum WTP or minimum WTA compensation for hypothetical changes in environmental goods. Typically, multivariate statistical techniques are used to model a WTP function. Such models allow the analyst to control for variation in the personal characteristics of the respondents, check for consistency of results with economic theory, and possibly estimate an entire WTP response across varying levels of environmental goods.

The contingent valuation method is applied when calculating for both use and nonuse values. The flexibility it provides in constructing hypothetical markets accounts for much of the technique's popularity. There are numerous methodological issues associated with application of CVM including how the hypothetical environmental change is to be specified, how valuation questions are formulated, the appropriate welfare measure to be elicited (i.e., WTP or WTA), and various types of response biases. Randall (1991) argues that because of the importance of nonuse values, CVM is likely to be the primary tool for measuring the environmental benefits of biodiversity. The CVM is also capable of measuring the disutility associated with some types of environmental degradation that indirect methods are unable to capture. Recent summaries of CVM can be found in Mitchell and Carson, 1989; Carson, 1991; Portney, 1994; Hanemann, 1994; and Diamond and Hausman, 1994.

CVM for Estimating Use and Nonuse Values

The contingent valuation method is a direct valuation technique: researchers ask people about their willingness to make certain trades and use the answers to estimate willingness to pay. Its appeal is that it is the only method that (in principle) can be used to estimate nonuse values for goods that do not yet exist or quality changes for goods that are outside the bounds of experience. It can also help estimate use values for goods traded on markets (in which it is called marketing research) or nonmarket goods such as ground water quality or recreation sites.

Three important classes of errors can bias the results of CVM studies (Freeman, 1993). First, participants may have an incentive to misrepresent their value for the hypothetical environmental good or service. For example, some respondents may state low values in order to reduce their obligation to pay for the goods or service even if they value it (i.e., free-rider behavior). Others may overstate the actual value if they believe the bid will affect the level of provision and the good is desired. A second category is implied value cues. This bias is particularly troublesome for unfamiliar goods or ones for which the respondent has not yet developed clear preferences. In such cases, the respondent may look for clues regarding a "correct" choice or value from the information provided by the researcher. When such "value cues" are present, they are likely to systematically bias the values elicited. One type of this problem is known as "starting point"

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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bias. However, this bias can be overcome by using a referendum or voting approach to the bid question. Another form of bias, called "yea saying," may even exist in the voting format (Mitchell and Carson, 1989). A third category of possible error in CVM studies comes from mispecification of the scenario. This causes the respondent to have a different definition of the environmental good or service than the researcher intended.

Researchers have employed many versions of the CVM, but CVM practitioners now agree on certain best practices. The basic idea is to have an individual vote yes or no on a public program which provides a change in the provision of some good, such as air quality, and that will cost households like their $X. The amount X is then varied across the sample. If a person votes yes, then WTP>X, while if they vote no, then WTP8X. Statistical techniques are then used to uncover willingness to pay. Sometimes, a follow-up question is asked: "If you vote yes at X, how would you vote at X+c, or if you vote no at X, how would you vote at X-c?" These "double-bounded" estimators provide more information on WTP.

This voting approach is called a dichotomous choice format. Most CVM studies use some form or adaptation of an open-ended question such as: "How much would you be willing to pay in increased fees, taxes, or prices, for q?" The voting approach has some desirable properties. First, it gives incentives to tell the truth. Second, people are familiar with voting on public programs, at least in many places: we do not purchase education; we vote on property tax increases. A disadvantage of this format is that it makes inefficient use of a sample and thus increases cost. However, this disadvantage can be at least partly overcome by asking respondents follow-up questions (Freeman, 1993).

A sound CVM study requires careful attention to development of the questionnaire (see Appendix B). Advances in psychology have enabled researchers to recognize circumstances in which individuals who say they intend to do something (e.g., vote yes on a public program) actually will do so. This intended-actual behavior link is what CVM attempts to establish: if respondents say they would pay $t for the program and were actually faced with the choice, they really would pay.

In addition, people must understand exactly the good on which they are voting and that they are voting only on that good. This can be difficult, since people are aware that we have only a limited understanding of how elements of the environment are interconnected. Thus statements that something does not now and never will do something else may not be plausible. Further, care must be taken that one program is not symbolic of a larger, implied program. Second, respondents must have some confidence that the program will actually supply the good. They should be considering the change in environmental quality, not whether there is some better means to provide that change than the proposed program. And third, respondents must search their preferences, taking the matter seriously and comparing a payment for this good to other things they can do with

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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their money: both other public programs (education, crime fighting, etc.) as well as their own consumption.

To ensure these things, researchers must conduct qualitative research via focus groups and one-on-one interviews. Researchers need to make sure that the language they used in the final survey conveys exactly what they intend, and this can be a formidable task. Therefore, investigators must spend time with people, talking through "What were you thinking when I asked why?" and uncovering the impact of alternative approaches.

When the survey deals with past events, such as ground water contamination, the researcher must decide what type of program to present. One possibility is a hypothetical prevention program that would have protected the ground water if it had been in place before the contamination; another is an accelerated recovery/restoration program. The former is more what the investigator would like to sell, since it captures the whole event, but the latter may be more believable and easier to describe.

Much more can be said about CVM studies of particular types of issues, but such a detailed review is beyond the scope of this chapter. A large amount of research has been done on CVM over the past 25 years, and our understanding of it has expanded dramatically. It is clear that many CVM studies have produced meaningless WTP estimates and that adding a CVM question to the end of a telephone or mail survey without benefit of qualitative research to test the question is bad practice. It also seems clear that careful CVM research can generate reliable results, at least for some types of goods and values (e.g., use values).

While most economists accept CVM for direct use values, its application to measure nonuse values has been very controversial. Exactly how far CVM reliability can be extended to encompass unfamiliar goods and nonuse values has become the key issue. The feasibility of using CVM to measure some types of ground water services therefore remains in question.

A Special Problem: Estimation of Nonuse Values

Nonuse values are the most difficult to measure of TEV components. The contingent valuation method is the only technique available for assessing these values. The topic of existence values for environmental assets is one of the most controversial in environmental economics (Bishop and Welsh, 1992; Edwards, 1988; Kopp, 1992; Rosenthal and Nelson, 1992; McFadden, 1994; Hausman, 1993).

Examples of some of the ambiguities in existence value estimation can be seen in a CVM study on bald eagles, wild turkeys, and Atlantic salmon in New England. While Stevens (1991) found substantial economic benefit from protection and restoration programs, the results also indicated that in a setting of potential irreversibility, existence values were difficult to quantify and sensitive to how the species were aggregated. Further, a majority of respondents viewed species

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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protection as important but were unwilling to pay for such programs. Follow-up questions indicated that many respondents were uncertain of their values or protected the WTP question for ethical reasons.

Much of the recent controversy over CVM and its use in eliciting nonuse values has been stimulated by questions surrounding natural resource damage assessment (NRDA) and liability cases. Sparked by the government's use of CVM in the Exxon Valdez oil spill case, the debate has focused on whether CVM can provide plausible estimates of value for individuals who may not be familiar with the good in question (i.e., individuals whose total value is made up entirely or largely of nonuse values). In 1992 NOAA, part of the U.S. Department of Commerce, convened a panel of blue-ribbon economists to provide guidance concerning the potential use of CVM in measuring lost nonuse values in promulgating regulations, pursuant to the Oil Pollution Control Act of 1990. The NOAA panel essentially reaffirmed application of CVM, provided rigorous guidelines are followed (Arrow et al., 1993). The panel recommended high-quality survey research (e.g., appropriate sampling and thorough pre-testing of instruments, etc.) and concentrating on more specific concerns related to CVM. The overall effect of the NOAA panel report is to make CVM very expensive and limit its application in many settings. A litigation-quality study conducted by a consulting firm for an NRDA in accord with the NOAA guidelines could cost several million dollars. Perhaps because of the increased cost of CVM studies and the continuing controversy surrounding the theoretical basis of CVM-based measurement of nonuse values, NOAA proposed new rules for assessing natural resource damages under the Oil Pollution Control Act of 1990 (NOAA, 1995). The new proposed rules eliminate "compensable values" in natural resource damage claims and instead focus on actions to restore natural resource services. The proposed rules thus downplay valuation of resources (including nonuse values). Values, including those from CVM studies, may still be used in making restoration decisions.

Not all CVM studies need be done with the exacting care required for NRDA litigation. One of the open questions in this area is the reliability of less expensive CVM studies (done via mail rather than by in-person surveys, for example) regarding goods familiar to people (like water availability).

CURRENT KNOWLEDGE OF GROUND WATER VALUES

Chapters 2 and 3 of this report discussed the interdisciplinary nature of the ground water valuation process. Each discipline has made significant progress in understanding and modeling components of this valuation process. To obtain an accurate accounting of the value of ground water resources, we must combine these components into an assessment framework. This in turn means that each discipline must understand what information the other disciplines need in the assessment process.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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For the economic component of the assessment framework, we need reliable and valid estimates of the benefits to society of ground water protection. This requires correct application of economic valuation techniques. This section reviews selected studies of ground water valuation, with emphasis on two categories of studies: those based on CVM and those that use averting behavior approaches. At the outset, we should note that past ground water valuation studies have focused primarily on a small part of the known ground water functions and services identified in Chapter 3. Thus our current empirical knowledge of the values of ground water is quite limited.

Results of Indirect Approaches

Relatively few empirical studies of ground water values have been conducted employing indirect methods. Of the studies that focus on services related to ground water quality, the averting behavior approach has been most commonly used.

Ground Water Studies Using the Averting Behavior Method

At least five studies have used the averting behavior approach to measure household-level costs associated with ground water contamination. As noted earlier, depending upon whether key assumptions are met, the results of such studies may not accurately represent lower bound estimates of WTP for ground water services. Also, values obtained from averting behavior methods must be combined with estimates of other ground water services to get an estimate of the total value of ground water. Despite these limits, results from carefully done averting behavior studies can provide important information needed for policymaking. For example, as a lower bound estimate of benefits of ground water protection, they can be used as an initial screening step in comparing benefits and costs of protection alternatives and in helping to decide if more in-depth valuation efforts are needed (Abdalla, 1994). The results of five averting behavior studies are highlighted below. Additional information on the studies can be found in Table 4.2.

Smith and Desvouges (1986) found in a sample taken in the Boston area that bottled water and water filters were purchased for the sole purpose of avoiding hazardous waste by 30 and 7 percent of households, respectively. Losses due to water quality degradation were not estimated, however, since they lacked detailed data on household averting behaviors and their costs.

Abdalla (1990) and Abdalla, Roach, and Epp (1992) documented averting expenditures of households served by public water systems in two Pennsylvania communities that had organic chemicals in their water supplies. At a central Pennsylvania site, 96 percent of the households were aware of water contamination and 76 percent of those with such knowledge undertook averting behaviors.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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TABLE 4.2 Summary Information on Averting Behavior Studies

Author(s) Publication Date(s)

Study Location

Current Ground Water Condition

Type of Contamination

Source of Drinking Water

Avoidance Actionsa

Average Annual Household Avoidance Cost

Average Annual Household Bottled Water Purchases

Smith and Desvouges, 1986

Suburban Boston

Uncertain—one town had experienced several prior episodes of contamination of drinking water by hazardous wastes

Hazardous waste

Public water supply

Bottled water Water filters

NA

NA

Abdalla, 1990

Township in Centre County, Pennsylvania

Contaminant in water for 26 weeks before new source provided. 96% knew of drinking water contamination

Perchloroethylene No drinking water standard in effect at time of contamination

Public water supply serving 1,600 households

New bottled water purchase (47.8%); Increased bottled water purchase (15.2%); Boiling water (23.0%); Hauling water (29.3%); Water filter (3.3%)

$252 (1987)

$142 (1987)

Abdalla, Roach, and Epp, 1992; Roach, 1990

Borough in Bucks County, Pennsylvania

Contaminant in water for 88 weeks—43% knew of drinking water contamination

Trichlorethylene Drinking water standard exceeded

Public water supply serving 2,760 households

New (11.1%); Increased (19.1%); Boiling water (27.8%); Hauling water (18.9%); Water filter (10.4%)

$123 (1989)

$75 (1989)

Powell, 1991

Selected communities in New York, Pennsylvania, and Massachusetts

7 Communities experienced contamination in past 10 years. 16% of households knew of contamination within last 10 years

Trichlorethylene in 6 communities; diesel fuel in one community (NY)

18% private wells; 82% public water supplies

Restricted water use (31%); Boiled water (26%); Bottled water purchase (17.5%); Supply cutoff (6.3%)

NA

$32 (1990)

Collins and Steinbeck, 1993

West Virginia (statewide)

Private individual well owners with contamination problems that agree to survey

Bacteria, minerals, organics

Private individual water systems. 90% used ground water as source

Clean/repair water systems (56%); Water treatment, new source, contaminant source contol (45%)

$320 to 1090 (1990) depending on contaminant type

NA

a Percent of households taking averting actions of those aware of contamination

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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Only 43 percent of the households in the southeast Pennsylvania site were aware of contamination. Of those, 44 percent undertook avoidance actions. Costs averaged $252 and $123 for each household that chose to avoid the contaminant in the central and southeast study sites, respectively.

Powell (1991) documented household bottled water expenditures as part of a CVM study of ground water benefits in eight "clean" and seven "contaminated" communities in Massachusetts, New York, and Pennsylvania. Even though almost half of the communities had recent contamination problems, only 16 percent of mail survey respondents indicated that their water had been contaminated. For those that were aware, the average household bottled water expenditure was $32 per year, about three times that spent in uncontaminated areas. Respondents aware of contamination were willing to pay $82 per year for increased water supply protection compared to $56 for those that were not. Households relying on private wells were willing to pay $14 per year more for protection than those served by public systems.

Collins and Steinback (1993) documented responses to knowledge of water contamination of rural households relying on individual wells in West Virginia. Eighty-five percent of those who were informed about their household's contamination problem were found to engage in averting activities. The most frequent actions were cleaning and repairing water systems, hauling water, and treatment. Information from mail and telephone surveys was used to compute a weighted average annual economic avoidance cost of $320, $357, and $1090 for households with bacteria, minerals, and organic contamination problems, respectively.

Direct Methods: CVM Studies of Ground Water Values

CVM, given its potential ability to measure all components of economic value, has been used in a number of studies to estimate ground water protection benefits. Boyle (1994) compared eight CVM-based ground water valuation studies as part of a review by EPA's Science Advisory Board of an EPA-funded study of the national level benefits of cleaning up ground water contaminated by leaching from landfills. He compared the results of a CVM study completed in 1992 by researchers at the University of Colorado (McClelland et al., 1992) on the national level benefits of cleaning up ground water degraded by landfill leachate to seven other quite diverse ground water valuation studies conducted using CVM. The national-level McClelland et al. study results were compared with estimates from state and community-level studies in Massachusetts (Edwards, 1988); Michigan (Caudill, 1992; Caudill and Hoehn, 1992); Georgia (Jordan and Elnagheeb, 1993); Wisconsin (Poe, 1993; Poe and Bishop, 1992); New York, Pennsylvania, and Massachusetts (Powell, 1991; and Powell and Allee, undated); New Hampshire (Shultz, 1989; Shultz and Lindsay, 1990; Shultz and Luloff, 1990) and Georgia (Sun, 1990; Sun et al., 1992). A more recent review of these CVM-based estimates is provided in Crutchfield et al. (1995). These authors also

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

TABLE 4.3 Summary of CVM Studies—Major Characteristics

Author(s), Dates Study Site

Contaminant

Value

Focus

McClelland et al., (1992) national sample

unspecified

option price WTP to remediate contamination from landfills

NA

Caudill (1992) Caudill and Hoehn (1992) Michigan

unspecified

option price WTP to reduce the probability of contamination

NA

Doyle (1991)

unspecified

WTP to remediate contamination

$114-$163/HH/yr

Edwards (1988) Falmouth, Woods Hole, Mass.

nitrates

option price WTP to reduce the probability of contamination

$815/HH/yr for 25% reduction in risk

Jordan and Elnagheeb (1993) Georgia

nitrates

option price WTP to reduce nitrate contamination to safe levels

medians public $65.88/HH/yr private $88.56/HH/yr means public $120.84/HH/yr private $148.56/HH/yr

Poe (1993) Poe and Bishop (1992) Portage County, Wisconsin

nitrates

option price WTP to prevent nitrate contamination

NA

Powell (1991) Powell and Allee (undated) 15 communities in N.Y., Pa., Mass.

TCE in 6 communities diesel fuel in 1

option price current value of respondents subjective perceptions of safety

mean annual WTP $81.31 Mass $42.19 PA

Schultz (1989) Schultz and Lindsay (1990) Schultz and Luloff (1990) Dover, New Hampshire

unspecified

option price WTP protect/maintain ground water quality

$40/HH/yr median

Sun (1990) Sun and Dorfman (1992) Dougherty County, Georgia

nitrates and pesticides

option price

means log model $998/HH/yr linear model $930/HH/yr empirical model $961/HH/yr

Clemons et al. (1995) Martinsburg, West Virginia

unspecified

WTP for a Wellhead Protection Program

median for nitrates $21.20/HH/yr median for VOC $13.68/HH/yr

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

use selected estimates from this literature to derive potential benefits of ground water quality protection in four areas of the United States.

Table 4.3 provides a general summary of some CVM ground water valuation studies completed to date. The table is adapted from Boyle and Bergstrom (1994) plus others studies cited above. The table, along with the following sections, summarize what has been added to the body of knowledge of benefits estimation using CVM. The next few pages focus on three important themes: 1) comprehensiveness of ground water functions and services; 2) effects of information on valuation responses, essentially the commodity definition problem; and 3) the ways that the studies have dealt with uncertainty.

Comprehensiveness of Ground Water Functions and Services

Measurement of the total value of the benefits of ground water protection requires a succinct definition of the services that ground water offers. These services include extractive services and in situ services (both use and non-use values). While it is generally recognized that measuring use values can be accomplished with several methods, the challenge of measuring nonuse values for nonmarket goods is daunting. CVM offers flexibility and the ability to measure nonuse values of public goods whereas other nonmarket valuation techniques such as the travel cost and hedonic pricing models are intended to measure use values (Powell, 1991). Most studies to date have focused on the health effects of ground water contamination, without including some other important functions from which humans derive value.

Most studies presented information on the health effects of ground water contamination (e.g., McClelland et al., 1992; Jordan and Elnagheeb, 1993; Poe, 1993; Sun, 1990). The others purposefully omitted references to the effect of contamination on human health by either telling respondents that their water was being monitored (Edwards, 1988) or eliciting respondents' perceptions of the safety of drinking. There is significant uncertainty as to the susceptibility of human health to ground water contamination, compounded by the difficulties of measuring dispersion of contaminants in ground water. Nitrate contamination provides a good example. The EPA has established upper limits for nitrate in drinking water because nitrates in drinking water are linked to two health problems, methemoglobinemia and gastric cancer. The incidence of illness and possibly death for the former is extremely low, and recent scientific evidence shows that the link to the latter is not statistically significant. Isolating the dose response effects of nitrates in drinking water is further complicated by the fact that humans also consume nitrates from other sources (e.g., preserved meat products).

All CVM studies to date have attempted to measure option price relative to the good's future availability in some cases and to its safety from the human health perspective. Option price is the maximum sum an individual would be willing to pay to change from their present level of risk to one of no risk (Free-

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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man, 1993). As noted above, the human health focus ignores other functions of ground water that humans might value such as the use of ground water as a buffer stock, its role in other ecological functions, and its importance to economic development and agriculture. The exclusion of these other services and values may be a function of the current state of knowledge. Few studies have attempted to measure the value that people place on the ecological services that ground water supplies. Some of these functions have been addressed only in the physical sciences and measurement is complex. The time lag between a contamination event and its effects on ground water and the services it provides varies substantially according to physical characteristics of aquifers as well as the nature of the contaminant (Kim et al., 1993; Fleming et al., 1995). Moreover, the interplay between site specific characteristics, ecological functions, and resultant service flows makes possibility of benefits transfers difficult to assess.

Effects of Information on Valuation Responses

Commodity definition in CVM surveys often involves striking a compromise between a definition that is understandable and one that is technically accurate (Bishop and Heberlein, 1990). However, accurate information and definitions are essential in deriving accurate measures. When evaluating unfamiliar commodities, the less well-defined the commodity is, the greater the potential measurement error. Indeed, the likelihood that a respondent can even come up with a value decreases with lack of clarity of the commodity.

In general, the descriptions of the current, reference, and subsequent ground water conditions are quite vague in the eight studies. This vagueness makes it difficult to establish the linkages between changes in ground water policies, ground water conditions, services provided, and estimated values. Of particular concern is the difficulty of ascertaining how the value estimates correspond to actual biophysical changes in ground water resources and the resulting service flows. (Boyle and Bergstrom, 1994)

Resolving this vagueness is problematic given the uncertainty surrounding measurement of ground water resources and the effects of contamination levels on human health. Reducing the uncertainty of actual biophysical changes may not be possible given the current state of knowledge. Also, it may run contrary to how individuals make decisions. For example, the individual may not understand contamination in parts per billion, but instead makes decisions about willingness to pay based upon subjective perceptions. Knowing that large portions of the water supply do not meet federal safety requirements would affect WTP. Knowing what those requirements are does not necessarily affect preferences, just as knowing that crossing a highway is dangerous does not require precise knowledge of the physics involved when a car meets a human or the probabilities of serious injury. The problem with subjective perceptions is that the baseline

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
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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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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-

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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.

Suggested Citation:"4: Economic Valuation of Ground Water." National Research Council. 1997. Valuing Ground Water: Economic Concepts and Approaches. Washington, DC: The National Academies Press. doi: 10.17226/5498.
×

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Next: 5: Legal Considerations, Valuation, and Ground Water Policy »
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Because water in the United State has not been traded in markets, there is no meaningful estimate of what it would cost if it were traded. But failing to establish ground water's value—for in situ uses such as sustaining wetlands as well as for extractive uses such as agriculture—will lead to continued overuse and degradation of the nation's aquifers.

In Valuing Ground Water an interdisciplinary committee integrates the latest economic, legal, and physical knowledge about ground water and methods for valuing this resource, making it comprehensible to decision-makers involved in Superfund cleanup efforts, local wellhead protection programs, water allocation, and other water-related management issues. Using the concept of total economic value, this volume provides a framework for calculating the economic value of ground water and evaluating tradeoffs between competing uses of it. Included are seven case studies where ground-water valuation has been or could be used in decisionmaking.

The committee examines trends in ground-water management, factors that contribute to its value, and issues surrounding ground-water allocation and legal rights to its use. The book discusses economic valuation of natural resources and reviews several valuation methods.

Presenting conclusions, recommendations, and research priorities, Valuing Ground Water will be of interest to those concerned about ground-water issues: policymakers, regulators, economists, attorneys, researchers, resource managers, and environmental advocates.

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