Cost-Benefit Analysis is a method of project appraisal which seeks to determine whether the social benefit of a new project or change in policy. The underlying principles behind CBA concerns whether how the impact of a chance will affect the utility of each person concerned affect by the proposed project. Every project is likely to have winners and losers, the purpose of CBA therefore is to determine whether the net impact on social welfare is positive (Perman, Ma, McGilvray, and Common, date).
Specifically, this involves a systematic approach identifying all the potential benefits and costs of a given project or good and categorising these into a single valuation. The total economic costs and benefits can be used to determine to net benefit of a project (Boardman, Greenberg, Vining, and Weimer, 2001).
Economic Valuation: Concept
The principles of economic evaluation are rooted in the theories of welfare economics and the notion of human preference. The value gained from a change in project or policy can be measured by the individual's preference for the change in question. A change in individual preference is linked to a corresponding change in 'utility' or wellbeing' (Pearce, Atkinson, and Mourato, 2006). Preferences are measured in that individuals 'willingness to pay' to secure an improvement, or avoid a loss (Bateman et al., 2002). To measure the benefit gained from a particular change we can measure the extent to which an individual is willing to give up achieving that change. The greater the WTP for a particular good represents how large the benefit the individual feels they will gain from it. Likewise, preferences can also be measured by individuals 'willingness to accept' compensation to forgo an improvement or suffer a loss.
In neo-classical economic theory the valuation of goods and services can be achieved through market processes where goods are bought and sold at a price evaluated by society. Market prices can be determined by the quantities of the good available and the level of demand for these goods. The economic value of the good can be measured by the price individuals are willing to pay for it and the minimum sellers are willing to accept for the good. When the price a buyer pays for a particular good is lower than their WTP, the difference between the price and WTP is the surplus value the individual gains from the good over and above the amount required at market price. The difference between the price and WTP is known as the 'consumer surplus' (veb).
However, the difficulty of valuation of non-marketed goods is that although they have value within society, this value is external to markets and therefore does not have a price (Maurato and Mazzanti, date).Therefore, measuring individual preference and accordingly economic valuation is complex in the absence of a market price. Nevertheless, valuation of non-marketed goods is essential in effective cost-benefit analysis (Pearce et al., 2006). Take for example a decision to expand a new railway. CBA will attempt to measure the benefits against the costs. While the financial benefits - e.g. revenue from ticket sales - and financial costs - e.g infrastructure, labour, land purchase - are quite clear, the economic benefits are harder to establish. In this instance for example, there is an importance to determine the non-marketed benefits e.g. improved travel time, improvements in safety, and costs e.g. increased noise, adverse visual impact.
To measure society's preference for a given change the net sum of all relevant WTPs and WTAs can be calculated to define the total economic value of a change in well-being (Bateman et al, 2002). The extent to which individuals are prepared to trade-off a change in policy or project against money corresponds to the overall value placed on the change. This value is likely to result from a variety of motivations behind the individuals' preference. In measuring non-marketed goods TEV can be categorised into two broad values known as use-value and non-use value in order to capture this value.
Total Economic Value
Use Value refers to the direct use an individual gains from a good or service, planned use, or possible use (Bateman, et al. 2002). For example, this can refer to an individual's use of a national park - individual's may place value on the park as they currently use it, intent to use it in the future, or may possibly want to use it in the future.
Direct Use
Option
Non-Use Value
Non-use value refers to the amount individuals would be willing to pay to keep a good in existence even although there is no actual direct, planned or possible use. Bateman et al (date) highlights that existence value can be classified into three elements.
Existence Value - Existence value refers to the WTP to ensure that a good remains in existence even although there is no direct use. This can be for a number of reasons, for example individuals may place an existence value on the Amazon rainforest as they believe that destruction could lead to the extinction of an endangered species, or the individual feels they have an intrinsic duty to keep the rainforest preserved.
Altruistic Value - Altruistic value refers to the value placed on a good in the belief that the good should be available to others in the current generation.
Bequest Value - is the value placed on a good for the benefit of future generations.
Source: Pearce et al. (2006)
In order to determine non-use and use values there are a number of economic techniques that can be used to determine a value.
Economic Valuation Techniques - Contingent Valuation
Revealed Preferences
Revealed preference techniques involve identifying t
Stated Preferences
However, revealed preference techniques main disadvantage is that they only capture individuals 'use' value on a particular landscape.
Contingent Valuation is survey-based techniques which can be used to estimate monetary values for goods and services which otherwise do not have a market price. Essentially, stated preference techniques presents respondents (users and 'non-users') with a hypothetical scenario and requests them to determine how much they would be 'willing to pay' (or 'willingness to accept) given a particular range of choices or scenario for a particular benefit or loss (Pearce and Ozdemiroglu, 2002).
Through creating this scenario a value can be placed on what respondents would be willing to pay for the conservation of the landscape against other alternatives. The valuation, however, is does determine the 'true' value of landscape, however it is an effective means of valuing a landscape against alternatives - what is the value with, or without a golf course?
Garrod and Willis (1999) highlight that fundamental to the use of the CV method is the issue of property rights. If the individual does not own the right to a good or service, then the measurement of utility represents the maximum they would be willing to obtain it. Alternatively, if the individual currently owes the good the measure of utility can be acquired through obtaining the amount the individual would be 'willing to accept' as compensation to forgo the good. Through creating a scenario where respondents are given a choice between two alternatives this allows individuals to consider the good in question as 'tradable' allowing them to behave as if the good was marketable. Mention WTA vs WTP
The most widely utilised stated preference technique to determine the value placed on non-marketed goods is the contingent valuation method.
Within economics, stated preference techniques have become dominant as a methodology in the valuation of landscapes (Perman, date).
Total willingness to pay is represented by the sum of the mean or average WTP multiplied by the population to which is being considered. The total WTP, either positive or negative, can then be used in the Cost-Benefit Analysis in contributing to the net value of the project.
Given a particular scenario the extent to which individuals are prepared to trade off goods and services against another reflects the total economic value an individual places on that good (Maurato ans Mazzanti, date).
Although stated preferences techniques are now the most widely utilised form of measuring the economic value of non-marketed goods, it is important to recognise that there is often disparity in the economic valuation of a good dependent on the methodology used.
Arrow et al. (1993) highlight that following the Exxon mobile disaster .... contingent valuation studies are a reliable technique to be included in the judicial assessment of environmental disasters.
As mentioned, contingent valuation studies place a value on public goods by asking households how much they are willing to pay for a change, or willing to accept as compensation if they change was not to happen. In general, most contingent valuation studies only consider either the cost or benefit specifically
The use of contingent valuation as a method for environmental valuation gained support following a report by the National Oceanographic and Atmospheric Administration (NOAA). The NOAA issued guidelines' on the design of CVM studies in env
The NOAA issued a number of guidelines in measuring environmental change, for example...
Although, the guidelines issued by the NOAA
Negative + Positive WTP
Criticisms of CV
Positive and Negative Bidding
Typically, in CV the most popular form of eliciting the respondent's valuation is through requesting respondents WTP in to ensure (or prevent) a change. However, in many instances, a change in quality of public good can result in externalities regarded as benefits by some and costs as others. Clinch and Murphy (date) suggest that if a public good exhibits both positive and negative features, measurement of consumer surplus must investigate the loss of utility as the result of a change as well as the gain. Traditionally, CV studies have always excluded negative values from being recorded where respondents are only recorded as having a 'zero bid' or 'protest bid', therefore any negative responses may be excluded or not accurately recorded in analysis.
More recently, there has been recognition that within contingent valuation studies it is likely that externalities can be perceived as costs to some respondents and benefits to others (Clinch and Murphy, 2001). One of the first attempts allowing respondents to elicit positive, negative, and zero bids was illustrated by Clinch and Murphy (2001). Respondents were given both advantages and disadvantages of increased forestation in Ireland and asked whether they believed increased forestation would be beneficial for the environment. Respondents who reported negatively or positively, in regard to their preference were filtered into two different contingent categories dependent on their response. Respondents who reported a positive preference of increased forestation were asked whether they would be willing to pay to ensure an increase, whereas those that reported a negative preference were asked how much they would be willing to pay to avoid a decrease. The study found that of all respondents 82% showed a preference towards an increase in forestation compared to the remaining 18% avoiding any increase.
The study by Clinch and Murphy (2001) demonstrates that given a change in public good, the assessment of welfare loss should be considered as well as welfare gains. This is particularly the case as a public good whereas consumers are unable to avoid a given change. Ultimately, Clinch and Murphy suggest that in addition to the guidelines proposed by Arrow et al (1993) contingent valuation should be structured in order to enable respondents to allow for positive, negative, and zero bids. Moreover, they suggest that allowing for negative willingness to pay can be used as a proxy against some of the practical problems in studies which consider willingness to accept.
Hanley, Colombo, Kristrom, and Watson (2008) highlight that CVM studies which exclude negative bids are likely to provide biased results in situations where it is likely that a proportion of the sample may dislike the proposed scenario, leading to inaccurate conclusions about any net social benefit. Hanley et al (2001) followed a similar methodology used by Clinch and Murphy and examined individuals willingness to pay to ensure landscape management in a National Park. Individuals were required to reveal their preferences towards landscape management choosing either between an increase or decrease in forestation.
This methodology has also been advocated in the evaluation of electricity pylons (Atkinson, Day, Mourato, and Palmer, 2004) and the evaluation of road options (Maddison and Mourato, 1999).
Depending on their preference, respondents were asked to either state their maximum WTP for either a reduction in forested area or increase. Creating both a positive and negative scenario allows the combination of two different preferences in order to create a more accurate measure of willingness to pay. Allowing for welfare losses as well as gains is essential in conducting effective CVM and ensuring accuracy in cost-benefit analysis.
