OTHER REVEALED

PREFERENCE METHODS

MARKET ANALOGY METHOD

INTERMEDIATE GOOD METHOD
ASSET VALUATION METHOD
THE HEDONIC PRICE METHOD
TRAVEL COST METHODS
DEFENSIVE EXPENDITURES METHOD
 MARKET ANALOGY METHOD

Using Only Price or Market Expenditures of an Analogous Good

– The market price of a comparable good in the private sector
– Problematic when beneficiaries don’t pay market prices
Using Price and Quantity of an Analogous Private-Sector Good to
Estimate the Demand Curve for a Publicly Provided Good
– Use private-sector data to map the demand curve for a publicly-
provide good if the goods and their markets are similar.
– Using expenditures alone ignores consumer surplus.
Example: Using Price of Analogous good
 MARKET ANALOGY METHOD

Using the Market Analogy Method to Value

Time Saved
– The obvious analogous market for time saved is the
labor market.But…
1) Wages ignore taxes and fringe benefits.
2) People could be working while traveling or waiting and,
therefore, time saved would be worth less than the wage
rate (plus benefits).
3) People value different types of time differently.
Importantly, many people enjoy traveling.
4) Method assumes working hours are flexible – (ignores
structural rigidities and failures).
5) Firms may not pay employees their marginal social product.
 Using the Market Analogy Method to
Value a Life Saved
Forgone earnings method. Value of a life saved =
discounted future earnings. Higher values for
young, high-income males than old, low-income
females.
– ignores consumer surplus
– WTP for a small reduction in risk of death
Consumer purchase studies. How much people pay
for life-saving devices, such as safety belts.
Consumer Purchase Method

If people are
willing to pay an
extra $220 to
reduce the
probability that
they will die by
1/10,000, then
they value life at
$2.2 million.
 Using the Market Analogy Method to
Value a Life Saved
• Labor market studies. If a person is willing to
forgo an extra $2,000/yr to increase the
probability that he will not have a fatal on-the-job
accident by 1/1,000, then he values his life at $2
million (or more).
This method assumes labor markets are efficient and no self
selection bias (some people may like to take risks which
would lead to a relatively small gap in the salary between
risky and less-risky jobs).
 INTERMEDIATE GOOD METHOD

If a project produces an intermediate good that is not

sold in a well functioning market (e.g.,
improvements in human capital), then its value
can be imputed by determining the value added to
the “downstream activity”:
Annual Benefit =
NI(with project) – NI(w/o project)
where, NI = net income of downstream business. The total benefit of a
project can be computed by discounting these annual benefits over the
project’s life.
 ASSET VALUATION METHOD

The impacts of a project or policy can be imputed

from changes in the price for certain capital goods.
For example, the “value” of noise can be inferred from comparing the
price of a house in a noisy neighborhood to the price of a similar
house in a quiet neighborhood.
An advantage of using prices is that information is
quite quickly and efficiently capitalized into prices
so that price changes or price differences provide a
good estimate of the value of the policy change.
 THE HEDONIC PRICE METHOD

The hedonic price method can be used to

value an attribute, or a change in an
attribute, whenever its value is capitalized
into the price of an asset, such as houses or
salaries.
It consists of two steps.
Suppose one wants to estimate the value of a
scenic view.
 THE HEDONIC PRICE METHOD

The first step estimates the effect of a marginally better

scenic view on the value (price) of lots (a slope parameter
in a regression model), while controlling for other
variables that affect lot prices. For example, we may
postulate the following multiplicative model:

P = β 0 CBDβ 1 SIZEβ 2 VIEW β 3 NBHDβ 4 eε

This equation is called a hedonic price function or
implicit price function. The change in the price of a lot
that results from a unit change in a particular attribute
(i.e., the slope) is called the hedonic price, implicit
price, or rent differential of the attribute.
 THE HEDONIC PRICE METHOD

For example, the hedonic price of scenic views, which we

denote as rv, measures the additional cost of buying a
lot with a slightly better (higher-level) scenic view.
For the above multiplicative model:

P
rv = β3 > 0
VIEW
Lot/house Price
 THE HEDONIC PRICE METHOD

The second step estimates the WTP for scenic views, after controlling
for “tastes,” which are proxied by income and other socioeconomic
factors.
To account for different incomes and tastes, analysts should estimate the
following WTP function (inverse demand curve) for scenic views:

rv = (VIEW, Y, Z), where rv is from step 1, Y is

household income, and Z is a vector of household
characteristics that reflects tastes (e.g., socioeconomic
background, race, age, and family size).
 THE HEDONIC PRICE METHOD

It is straightforward to use the equation in the previous slide to calculate

the change in consumer surplus to a household due to a change in the
level of scenic view.
These changes in individual household consumer surplus can be
aggregated across all households to obtain the total change in
consumer surplus.
 TRAVEL COST METHODS

The clever insight of the TCM is that, although

admission fees are usually the same for all persons
(indeed, they are often zero), the total cost faced
by each person varies because of differences in the
travel cost component.
Consequently, usage also varies, thereby allowing
researchers to make inferences about the demand
curve for the site.
 TRAVEL COST METHODS

The full price paid by persons for a visit to a site is more than
just the admission fee.
It also includes the costs of traveling to and from the site.
Among these travel costs are the opportunity cost of time
spent traveling, the operating cost of vehicles used to
travel, the cost of accommodations for overnight stays
while traveling or visiting, and parking fees at the site.
The sum of all of these costs gives the total cost of a visit to
the site.
 TRAVEL COST METHODS

To estimate demand for access to a particular site,

we expect that the quantity of visits demanded by
an individual, q, depends on its total cost, p; the
cost of substitutes, ps; the person’s income, Y; and
variables that reflect the person’s tastes, Z:
q = f(p,ps,Y,Z)
 TRAVEL COST METHODS

Estimating the demand schedule for a particular site with

the TCM is straightforward.
1. select a random sample of households within the market area of
the site.
2. survey these households to determine their numbers of visits to
the site over some period of time, all of their costs involved in
visiting the site, their costs of visiting substitute sites, their
incomes, and other characteristics that may affect their demand.
3. specify a functional form for the demand schedule and estimate
it using the survey data.
 Zonal Travel Cost Method

To us this method
1. survey actual visitors rather than potential ones
2. allocate visitors to a particular zone, depending on their “travel
costs” (usually distance).
3. For each zone, compute the average number of visits per year
and the average total travel cost.
4. Estimate the relationship between cost/trip and the number of
trips per person.
The consumer surplus for a visitor from a particular zone is
given by the area below this curve and above the cost of
a visit from that zone
Estimating Consumer Surplus

By repeating
this
calculation
for each zone,
it is possible
to calculate
the total
consumer
surplus.
 Zonal Travel Cost Method

• It is also possible to estimate the market

demand curve, which is shown in the next
slide.
• The consumer surplus may be obtained
from the market demand curve in the usual
way.
Estimating Demand Schedule
 Limitations of the TCM
1. It is restricted to sites where people (in the zones) have
different travel costs. Without variation in total cost, it’s
hard to estimate a demand curve
2. There may be analytical problems in measuring the price
of a visit. How does one measure opportunity cost of
travel time? Does one include the marginal cost of
capital goods used at the site? Should multiple purpose
trips be included in the data (desirable if costs can be
accurately apportioned to the site)? Also, the journey
may have value (and hence the trip has multiple
purposes).
 Limitations of the TCM
3. Travel cost may be endogenous not exogenous. People
who plan to travel to the site frequently may choose to
live near the site (hence number of visits and travel costs
are determined simultaneously). OLS estimators could
be biased.
4. There may be other econometric problems, such as
truncation (drawing sample from only visitors rather
than the population at large – resulting in biased results).
Also, there may be omitted variables (if tastes or
substitutes vary across zones).
 Limitations of the TCM

5. The method estimates the WTP for the entire site rather
than features of the site. It’s possible to value features if
people in zones can choose among alternative sites with
different attributes – by using the “hedonic travel cost
method,” which treats total cost as a function of both
distance from zone to the site and the various attributes
of the site.
 DEFENSIVE EXPENDITURES METHOD

A defensive expenditure is an expenditure in

response to something undesirable, such as
pollution.
If smog improves (worsens) you may spend less
(more) on having your windows cleaned. The
change in expenditures can be used as a measure
of the change in pollution.
 Problems with this Method
1. Reduced spending on a defensive expenditure
underestimates the benefits of cleaner air.
2. It assumes people adjust quickly to the new equilibrium,
such as new smog levels.
3. Defensive expenditure may not remedy entire the
damage.
4. Defensive expenditures may have benefits other than
remedying damage, which should be included.
5. Not all defensive expenditures are purchased in markets,
for example, some people clean their own windows;
changes in these “expenditures” should also be included.