Research in Applied Econometrics Chapter 2. Valuation Theory

Research in Applied Econometrics Chapter 2. Valuation Theory

Pr. Philippe Polomé, Université Lumière Lyon 2

M1 APE Analyse des Politiques Économiques M1 RISE Gouvernance des Risques Environnementaux

2018 – 2019

Outline

Economic Theory of Value

Social Use of Economic Values

Utility

I Value

is a word heavy with multiple meanings

I In economics, there is a meaning as “price”

I But also, when it refers to individuals, a formal meaning : I The difference in expenditures to reach a certain “welfare”

with or without the thing we intend to value

I

There are 2 approaches, that are dual

I That is, 2 sides of the same idea I Utility-based and Expenditure-based

Utility theory

I

Recall that individual’s preferences

I For anything from apple to social justice I Can be represented by a Utility functionU(.)

I That has certain properties

I and depends on quantitiesx of goods & services

I

Individuals behave as if they are maximizing such function

I Under a budget constraintpx ≤y

I pis the vector of prices (some of these prices are ficticious) I y is income (that comes, among others, from labour, so it is

endogenous, but we takey as exogenous)

I

Individual’s choices lead to “optimal” demands

x

(

p,y

)

I That have mathematical properties

Duality theory

I

Plugging such demands in the utility function

I Leads to theIndirect Utility Function

V(p,y) = maxU(x)|px≤y

I

But we can also look the income that would be needed

I to achieve such utility level

I given preferencesU(.) and pricesp I This is theExpenditure Function

E(p,U) = minpx|U(x)≥U

I

The Duality Identity

y ≡E

(

p,v

(

p,y

))

shows that the 2 approaches are equivalent

Values from Prices

I

John Hicks, a famous economist,

I asks a straightforward question

I What change in income would be equivalent to a given change of the vector of prices p ?

I

“Equivalent” means here “at the same level of utility”

I Clearly the answer(s) must depend on individual preferences I So onU(.)

I But it also depends on thereference point I Before or after the prices change ?

Hicksian Measures of Value

Compensating Variation

of a

price change

from

p₀

to

p₁ I

Reference Utility :

initial p₀

I CV

(

p₀,p₁

)

I =E(p₁,V(p₀,y))−E(p₀,V(p₀,y)) =E(p₁,V(p₀,y))−y I s.t.V(p₁,y+CV) =V(p₀,y)

Equivalent Variation I

Reference Utility :

final p₁ I EV

(

p₀,p₁

)

I =E(p₁,V(p₁,y))−E(p₀,V(p₁,y)) =y−E(p₀,V(p₁,y)) I s.t.V(p₁,y) =V(p₀,y−EV)

Hicksian Measures of Value

I

Are the standard notions of value in applied economics

I Other measures lack a similar fundamental construction I

So economic value

I is about (individual) utility

I the value is the (individual) conversion of a price change in an income change

I is NOT a price or a cost I is NOT financial or accounting

I May be purely immaterial, no actual (or future) transaction is required to define a value

Non-market Values

Hicksian Measures of an environmental change

I

Let

z

the “level” of environment (quality...)

I Public good, pollution, externality

I States of the world : wealth distribution, justice, equity...

I All that is non-market I

Issues

I Commensurability

I Is the environment really amenable to a single quality index measure ?

I e.g. what is air “quality” what pollutants ? How do you combine them ?

I Measurement, actually getting proper data

I Substitutability : can people actually compare coffee and whales ?

Non-market Values

I

Insert

z

in the previous functions

I V(p,z,y) Indirect Utility &E(p,z,U) Expenditure I Simplify notation : removep

I Since we will not discuss changes of prices I V(z,y) Indirect Utility &E(z,U) Expenditure

Non-market Values : definitions

I Compensating Variation

(Reference Utility =

initial z₀

)

I CV(z₀,z₁)

I =E(z₀,V(z₀,y))−E(z₁,V(z₀,y)) =y−E(z₁,V(z₀,y)) I s.t.V(z₁,y−CV) =V(z₀,y)

I Improvementz₀toz₁ ⇒Willingness To Pay to secure it (+) I Deteriorationz₀toz₁ ⇒Compensation To Support it (-) I Equivalent Variation

(Reference Utility =

final z₁

)

I EV(z₀,z₁)

I =E(z₀,V(z₁,y))−E(z₁,V(z₁,y)) =E(z₀,V(z₁,y))−y I s.t.V(z₁,y) =V(z₀,y+EV)

I Improvementz₀toz₁ ⇒Compensation To Support it (+) I Deteriorationz₀toz₁ ⇒Willingness To Pay to avoid it (-)

Compensating or equivalent : Which one to use ?

I

Property rights

I

Compensating Variation : right to level

z₀

I Improvementz₀toz₁ ⇒Willingness To Pay to secure it (+) : The person must “buy”z₁

I Deteriorationz₀toz₁ ⇒Compensation To Support it (-) : Compensate the person for the deterioration

I

Equivalent Variation : right to level

z₁

I Improvementz₀toz₁ ⇒Compensate the person to forfeit the improvement (-)

I Deteriorationz₀toz₁ ⇒To avoid the deterioration, the person must “buy”z₀ (+)

Nonmarket Values

I

As for the change in prices : the values are not limited to

“fninancial” ones (price, cost, flows...)

I

In a public sector context, no transaction is necessary

I e.g. a collectivity decides to set aside part of its forests w/o

exploitation

I Since the owner is the collectivity, it does not have to pay itself for the un-realized sale of wood

I its members do not have to “buy” the ecological services that they obtained in return

I It is true that they forfeit the revenue from the sale of woods, this indicates that their value is at least as high

I

Nonmarket Values are also not opportunity costs

I Or differences of commercial / industrial / agricultural yields

Nonmarket Values

I

WTP are limited by the individual budget

I =⇒ in this sense, they represent a capacity to pay I There is an interpretation in terms of public finance : the

budget that a collectivity could levy to finance the environnemental corresponding to the WTP

I =⇒ Other things equal, with the utility function, a rich person’s WTP will be higher than a poor’s

I So that the rich person’s “opinion” will weight more in the collectivity budget

I

WTP and compensations are expressed in money

I They are thus comparable between individuals and can be added

I Usually not the case w/ non-economic notions of value

Understanding the sources of economic value : a typology

Source Example in a forest context

Direct Consumptive Use (private goods)

Hunting and gathering products Wooden products / Cultivation Direct Recreational Use

(public goods)

Hunting and gathering practices Hiking / Nature watching

Indirect/functional Use

Water : Filter / Flood protection Air : Filter / Fixing carbon Soil : Erosion / Desertification Landscape

Option Use : Preserve future / 3rd party use Quasi-use : Value of information

Non-use

“Patrimonial” : Existence & Heritage

“Moral” : Role of humanity wrt nature, Non-human rights

Outline

Economic Theory of Value

Social Use of Economic Values

Public Cost-Benefit Analysis CBA

I

Should a certain public project should be pursued ?

I e.g. should we renovate Part-Dieu ? build a dam ? I What are the indirect or non-market benefits/cost ? I

This can be very difficult

I The project may span many years, have many uncertainties I There maybe loosers and gainers

I

This is currently a burgeonning industry

I

CBA is frequently used in business

I But a business measures project according to the net revenue they generate

I In the end, this is about sales generated

I So the question of eliciting non-market values does not exist

CBA as a Social Decision Rule

I

Inform (public) decision-makers

I By quantifying benefits & costs

I Associating them to socio-economic profiles

I e.g. is a certain project beneficial to the poor or to the rich people ?

I via econometric analysis

I

Legal Contexts

I Western countries legislation require evermore often that large public projects demonstrate that their benefits > their costs

I Including all non-market benefits (or costs) I EU Directives

I e.g. Water Framework Directive (“Cadre Eau”) I US “Acts”

I e.g. Clean Air Act epa.gov/oar/sect812/

French Guidelines (Valeurs tutélaires) for Transport

¹

I

Context of road infrastructure, mainly

I

Value of Statistical Life VSL (VVS) : 3 M€ 2010

I Value of a Year of Life VYL (VAV) : 115 000 € 2010 I Value of a seriously injured : 15 % of VSL, 450 000 € 2010 I Value of a lightly injured : 2 % of VSL, soit 60 000 € 2010 I

Value of carbon

I Value 2013 : 32 € 2010/tCO2 I Value 2030 : 100 € 2010/tCO2 I

Value of time depends on

I Motive (professional, holiday...) I Distance (urban, <20km, 20-80km, ...) I Mode

I

Multiples values in transport sector : Environment, noise...

1. Commissariat général à la stratégie et à la prospective, L’évaluation socioéconomique des investissements publics , www.strategie.gouv.fr, sept.

2013

Commissariat général au développement durable, Service de l’économie, de l’évaluation et de l’intégration du développement durable. Études & documents n°23 juin 2010

Environmental Public Goods Examples

I

Improve air or (surface) water quality

I

Risks reduction

I Contaminants in tapwater, in food (incl. GMO) I Transports

I Job-related accidents

I

Protect/restaure natural areas (wetlands, forests, rivers,

beaches...), endangered species

Non-environmental Examples

I

Improve public education, health services quality

I

Basic services in developping countries

I Water or electricity distribution, garbage collection de déchets...

I

Medical and health care research

I

Food research e.g. WTP for new food

I

Culture

I Protect / restaure cultural heritage sites I Value of a museum, an art company,...

Damages (dommages & intérêts) : Accidental Pollution

I

The other domain in which economic values are used

I

French “dommages environnementaux”

I Fairly new, relatively small amounts I

US Damages

I Routine, the EPA sues several times a year

Database of valuation studies : www.evri.ca

4000+ records

Benefit Transfert

By environmental asset By environmental use

By valuation technique By continents

To conclude on economic value

I

Economic value

I Defined for market and non-market goods and services I Following ecological or social functions (see the Forest

example)

I Individualistic (depends on preferences) I in a public finance context

I Quantitative

I But we will see that estimation may suffer many biases

I

Its context is

I CBA, to inform decision-makers I Damages