Economic Valuation

Dr. Katrin Rehdanz

Research Unit Sustainability and Global Change

Depts. GeoSciences & Economics

Contact

• Bundesstrasse 55, Room 027• Tel: 42838-7047• Email: katrin.rehdanz@zmaw.de• Web-site:

http://www.fnu.zmaw.de/> courses > valuation

• The sheets are there as well

The Course

• The theory and practice of the monetary valuation of environmental goods and services not traded on markets

• Prior knowledge: micro, calculus• Reader• Other courses

The Lectures, before whit week

3.4. Introduction; The nature of value10.4. Demand and welfare theory17.4. Cancelled !!!24.4. Econometrics1.5. Free8.5. Contingent valuation I15.5. Contingent valuation II22.5 Choice modelling

The Lectures, after whit week

5.6 Production function approaches I12.6 Production function approaches II19.6 Hedonic pricing26.6 Benefit transfer and meta-analysis3.7 Footprints

Exam 10.7. or 17.7.?

Economic Valuation, lecture 1

• Course aims and set-up• Price and Value• Total Economic Value• Why and what to value?• Uses of economic valuation

An economic theory of value

• “Theory of value” is a generic term and encompasses all the theories that explain the exchange value or price of goods and services

• Key questions:– Why are goods and services prizes as they are?– How does the value of goods and services comes

about?– How to calculate the correct price of goods and

services (if such a value exists)?

• Main categories:– Intrinsic theories (objective): the value is contained in

the object itself (e.g. costs involved in the production process)

– Subjective theories: The object must be useful in satisfying human wants (desired) and it must be scarce

Price & Value: Greeks

• Their economy can be described as „premarket“ • Anthropocentric view• They concentrated on human control

• One of the earliest economists was Xenophon (427-355 BC)– His ideal leader would pursuit pleasure and avoid

discomfort

„the greater the number of superfluous dishes set before man, the sooner a feeling of repletion comes over him“

„a flute is wealth to one who is competent to play it, but to an incompetent person it is no better than useless stones ... unless he sells it“

Price & Value: Greeks -2• Xenophon developed the idea of

subjective utility further in a dialogueAristippus asks: „Do you mean that the same things are both beautiful and ugly?“

Socrates replies: „Of course – and both good and bad. For what is good for hunger is often bad for fever; and what is good for fever is bad for hunger; what is beautiful for running is often ugly for wrestling and what is beautiful for wrestling ugly for running. For all things are good and beautiful in relation to those purposes for which they are well adapted ...“

Subjective evaluation in the measurement of good versus bad

Price & Value: Greeks -3• Protagoras (480-411 BC)

– For him there was no objective truth, only subjective opinion and „man is the measure of all things“

– Therefore, although truth can not be discovered, utility can

– It is up to the citizens to decide what constitutes social welfare and how to achieve it

• Aristotle (384-322 BC)– Interested in ethics rather markets– Discusses value in terms of incremental comparisons

based on subjective marginal utility– Value in use versus value in exchange– Trade only if surpluses exist and mutually beneficial– Scarcity: „What is rare is a greater good than what is

plentiful“

Price & Value: Early Christian Writers• The rise of Christianity overlapped the decline of the

Roman Empire and offered a different kind of civilizing influence

• Thoughts center on the „right“ use of material gifts• Wealth came to be looked upon as a gift of God• Primarily interested in the morality of individual

behaviour• No interest in how and why of economic mechanism• St. Augustine (354-407) went further than others and

confirmed the subjective nature of value

„There is ... a different value set upon each thing proportionate to its use ... Very frequently a horse is held more dear than a slave, or a jewel more precious than a maid. Since every man has the power of forming his own mind as he wishes, there is very little agreement between the choice of a man who through necessity stands in real need of an object and of one who hankers after a thing merely for pleasure“.

Price & Value: Medieval• From 700 to 1200 Islam led the world• They preserved and developed the contribution of the

Greeks while the west was sinking into the „dark age“

• In the medieval the Catholic church had a monopoly on learning

• The medieval economics, therefore, was a product of the clergy (particularly the Scholastics)

• The main interest was justice, not exchange– One form of justice is exchange justice

• Albertus Magnus (1206-1280) – Value in exchange must comply with cost of production

(labour and expenses)• Thomas Aquinas (1225-1274)

– reaffirmed value in use versus value in exchange– he argued that price varies with need

Price & Value: Medieval –2• Henry of Friemar (1245-1340)

– was the first to look at aggregate (average) demands and scarcity, again without separating the two demand and supply

• Jean Buridan (1295-1385) – introduced effective demand – differentiated between consumers‘ wants (luxuries,

necessities) and recognized that they operate in the same market

• Gerald Odonis (1290-1349) – introduced scarce and differentiated labour– relative efficiencies of different skills and costs of education

• John Crell (1590-1633) – combined the supply theory of value (Odonis) with the

demand theory of value (Buridan), – or in Scholastic terms, scarcity in the face of need (raritas)

with need in the face of scarcity (indigentia) – he did not realise that the two were merely components of a

single principle

Price & Value: Early• A period of emerging commercial capitalism

when empiricism and objectivism became important

• Sir William Petty (1623-1687) – his methodological approach attempted to separate

morals from science– tried to unify land and labour in one value system– recognised that money is the standard of value,

medium of exchange, and store of value

• Richard Cantillon (1680-1734) – he distinguished between actual (market) price and

intrinsic value (equilibrium price)

• Physiocrats (18th century) – claimed that only agriculture can create surplus– a supply theory of value, with land rather than labour

Price & Value: Classical

• After 1776, when “The Wealth of Nations” was first published, the field of economics got more organised and gathered steam

• Adam Smith (1723-1790)– Value in use versus value in exchange– Actual versus natural price– Labour theory of value: „The value of any commodity

... not to use ... but to exchange .. is equal to the quantity of labour which it enables him to purchase or command. Labour is the real measure of the exchangeable value of all commodities“

• David Ricardo (1772-1823) – simplified and consolidated Smith‘s labour theory of

value

Price & Value: Classical -2

• Jeremy Bentham (1748-1832) – introduced utility as a measure of a person‘s

happiness and social welfare as the sum of individual utility

• Thomas Malthus (1766-1834) – argued for a supply-and-demand value

• William Nassau Senior (1790-1864) – recognised that value depends on (1)

relative utility, (2) relative scarcity, and (3) exchangeability

Price & Value: Neo-Classical

• William Stanley Jevons (1835-1882)– distinction between total and marginal utility– nature of marginal utility– equimarginal utility in decision and exchange

• Alfred Marshall (1842-1924) – Theory of demand; elasticity, substitution,

input factors– Consumer and producer surplus

Current Thinking

• Neo-classical revolution: Value is relative, value measures demand versus supply, value is based on consumption and production

• Price is marginal value, value is the area under the demand curve, value equals utility

• Basis of valuation: People‘s preferences, what people want

• Values depend on context– Supply, demand– Uncertainty: Something that is uncertain is worth

less, an uncertain loss is worth more– Uniqueness: Something that is unique is worth more

Recent developments

• Total economic value = Use value + Intrinsic value

• Use value = Actual use value + Option value + Quasi-option value

• Option value = Value in potential use by self + Value in potential use by others + Value in potential use by future individuals

• Quasi-option value = Value of avoiding irreversibilities in the light of expected future knowledge

• Intrinsic value = Existence value

Existence Value

• Existence value is unrelated to any actual or potential use

• Existence value may be related to sympathy, or stewardship

• Existence value is not right-based, as rights are absolute, and values are relative

• People express, and seem to have existence values

What to value?• Individuals can derive value from

environmental goods and services from more sources than direct consumption

• Types of environmental services:– source of materials input: fossil fuel, wood

products, fish, water etc.– life-support services: liveable climatic

regime, breathable atmosphere– amenity services: recreation, wildlife

observation, scenic view, passive use values– sink for the assimilation of wastes

Resources and Markets

• Many environmental resources are not transacted at markets– Atmosphere, oceans, wilderness

• Many resources are public goods or open access

• Other resources are traded– Land, minerals, energy

• Markets are often far from perfect and externalities are present

Property Rights• Property is

– The right to use– The right to exclude– The right to destroy

• Property rights are often attenuated• Property rights can be

– Private– Common– Public– Government– Absent (open access)

• Environmental resources are seldom privately owned

Uses of Economic Valuation

• Regulation can either seek optimum or not

• If an optimum is sought, the marginal external cost function must be estimated, and expressed in money

• Find optimum: Marginal benefit equals marginal cost (Cost-Benefit Analysis)– Ex ante, e.g., Pigou tax– Ex post, e.g., evaluation of policy

• Demonstrate value of environment• Extend national accounts

Pollution Damage(billions of US$)

Netherlands

Germany USA*

Air 0.5-0.8 19.3-21.5 21.7

Water 0.1-0.3 3.0 4.8

Noise 0.0 11.6 n.a.

Total 0.6-1.1 33.9 26.5

%GDP 0.3-0.5 2.9 0.8

* Damage avoided

This course will ...• Present techniques to measure the

value, in the neo-classical sense, of commodities that are not traded in markets

• Present „neo-classical“ techniques to measure use values

• Discuss alternative techniques• Show empirical examples