Chapter 13. Revealed Preference Methods
Nonmarket Valuation Methods
Travel Cost Method
- Most applications of the travel cost method (TCM) have been to value
recreational sites. Suppose that we want to estimate the value of a particular
recreational site. We expect that the quantity of visits demanded by an
individual depends on its price, the price of substitutes, the
person’s income, and variables that reflect the person’s tastes.
- The TCM recognizes that the full price paid by persons for a visit to a
recreational 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.
- The clever insight of the TCM is that, although prices are usually the
same for all persons, 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
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. This method
offers a way to overcome problems from omitted variables and self-selection
bias. It consists of two steps. Suppose one wants to estimate the value of a
- The first step estimates the effect of a marginally better scenic view
on the value (price) of houses (a slope parameter in a regression model),
while controlling for other variables that affect house prices. This
equation is called a hedonic price function or implicit price function. The
change in the price of a house 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 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 a WTP
- Value of statistical life: Similarly, if a person is willing to forgo
an extra $3,500/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 $3.5 million (or
more). The imputed value of life varies according to the initial risk and
the additional level of risk people are asked to assume due to diminishing
marginal utility for safety.
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.
- There are at least five 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
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.
- Value of a statistical life: This method estimates the value of
life by observing how much people pay for life-saving devices, such as
safety belts. If people are willing to pay an extra $300 to reduce the
probability that they will die by 1/10,000, then they value life at $3
Simple Valuation Methods
The Value of Time Saved, VTTS
In the absence of market imperfections (i.e., people can choose the number of
hours they work and there is no unemployment), the wage rate is a first
approximation of the marginal value of time. However, there are some problems in
using the wage rate to value time saved:
- First, wages ignore benefits. As benefits are a form of compensation for
work, they should be added to wages.
- People could be working while traveling or waiting and, therefore, time
saved would be worth less than the wage rate (plus benefits).
- It should take account of taxes and, for people who are not working, use
the after-tax wage rate (plus benefits).
- People value different types of time differently. Importantly, many
people enjoy traveling.
- The wage rate may not be appropriate due to rigidities in the market or
- Firms may not pay employees their marginal social product.
The Value a Statistical Life, VSL
- Forgone earnings method - This method suggests the value of a life saved
equals the person’s discounted future earnings. It generates higher values
for young, high-income males than old, low-income females. For retired
people, the resultant value of life may be negative. Conceptually, the main
problem with this method is that it does not reflect what people are WTP for
a small reduction in risk of their death.
Intermediate Good Method
- If a project produces an intermediate good that is not sold in a well
functioning market, then its value can be imputed by determining the value added
to the “downstream activity”:
Annual Benefit = Income(with project) – Income(without project)
- This method can be used to value improvements in human capital, such as
training programs, by comparing the average incomes of those in the program to
those who are not.
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. Changes in the market values of firms
following a regulatory change can be used to estimate the change in producer
surplus of the new regulations (an event study). An advantage of using prices is
that information is quickly and efficiently capitalized into prices so that
price changes or price differences provide a good estimate of the value of the
policy change. Also, appropriate data are often available in machine readable
Problems with Simple Valuation Methods
- Omitted variable
- Self-selection bias