Economic Valuation Methods for Non-market Goods or Services

by

Bengt Kriström, Per-Olov Johansson

• LAST REVIEWED: 30 October 2019
• LAST MODIFIED: 30 October 2019
• DOI: 10.1093/obo/9780199363445-0044

Introduction

Economic valuation methods for non-market goods and services comprise a range of empirical approaches to estimate a monetary value for the trade-off a person would be willing to make to increase the amount or the quality of a good or service for which there exists no market. After a period of more than fifty years of improvement, the approaches have reached a certain degree of maturity and professional acceptance; for example, they are routinely used in US court cases as a starting point for oil-spill damage assessments (which can run into several billions of US dollars). There are probably more than 10,000 papers published, covering a range of issues about economic valuation methods. While environmental and health studies dominate, an increasing number of applications appear in, inter alia, cultural economics. Since the number of things people care about is virtually without limits, the set of applications for measuring these types of trade-offs is very large; e.g., how much would students be willing to pay to reduce campus crime risk? What is the value of telecare programs that make it possible for elderly people to live independently? Is there an extra-market value of the Tour des Flandres (a cycling race)? How much would you pay to avoid the consequences of spam mail? We will divide our exposition into two parts, covering the most used stated-preference and revealed-preference methods. The stated-preference methods are based on what respondents state in interviews/questionnaires, generally targeting a person’s choices for a proposed change in a well-defined object of choice (such as one’s health status or some aspect of environmental quality). A revealed-preference method uses observed decisions for private goods related to the non-market good and theoretical assumptions to create the equivalent of surrogate markets, such as property markets, to measure values. There are two general lines of development; an increased focus on heterogeneity and an increased understanding of how to deal with the discrete/continuous type of consumer behavior that is common in the cases studied.

General Overview

Ideas about how economic value should be defined can be traced back all the way to the classical Greek writers (Gómez-Baggethun, et al. 2009 provides a historical account). Today, economic value of a good/service is typically understood as being proportional to the change in utility resulting from getting slightly more or less of the good/service under scrutiny. With this view, the basic quantity targeted by non-market valuation methods is subjective utility change. Utility is not an observable quantity; we need to convert the utility change into something we can measure. Sir John Hicks provided a solution to the measurability problem in the 1930s by introducing two new concepts. Willingness to pay (WTP) is the maximum amount of money a person is willing to give up to secure an improvement (or avoiding degradation of the good/service in question). Willingness to accept compensation (WTA) gives the minimum amount of compensation the individual is willing to accept not to get an improvement (e.g., of a non-marketed service). Hicks explained why both are money measures of welfare change. WTA and WTP do not necessarily coincide, but they are quite similar if the good or service in question has a low budget share (additional assumptions are needed when public goods are involved; see Hanemann 1991) or if the change is small. WTP/WTA is the total value to an individual of a particular change, and decomposing it turns out to be useful. The simplest decomposition suggests that total value has a “use” and a “passive use value” part. Krutilla 1967 argues the case for “passive use value,” suggesting that economists have misconstrued some dimensions of consumption. We may derive utility just by knowing something exists and appreciate the option of your own use or others’ use; Krutilla also points to cultural and religious practices that hold areas as sacred. In short, passive use is an economic value. Weisbrod 1964 reasons that we need to consider the option value, which is related to potential use in the future. The ideas of Krutilla and Weisbrod were controversial, even radical, at the time (Smith 2004). The importance of the decomposition for non-market valuation is that revealed-preference methods can capture only use values, while stated-preference methods can capture both. Passive use value was at the epicenter of the Exxon Valdez controversy in the beginning of the 1990s.

• Gómez-Baggethun, Erik, Rudolf de Groot, Pedro L. Lomas, and Carlos Montes. 2009. The history of ecosystem services in economic theory and practice: From early notions to markets and payment schemes. Ecological Economics 69.6: 1209–1218.

  DOI: 10.1016/j.ecolecon.2009.11.007

  Provides a broad historical overview of non-market valuation in the context of ecosystem services.

• Hanemann, W. Michael. 1991. Willingness to pay and willingness to accept: How much can they differ? American Economic Review 81.3: 635–647.

  Hanemann shows that for non-market goods the WTA-WTP disparity depends on the substitution elasticity and the income elasticity.

• Krutilla, John V. 1967. Conservation reconsidered. American Economic Review 57.4: 777–786.

  Discusses the value of “unique” resources for which property rights cannot be established. Krutilla’s argument led to the notion of existence value (“passive use value” is the modern term), heavily debated in the US courts after the Exxon Valdez oil spill in 1989.

• Smith, V. K. 2004. Krutilla’s legacy: Twenty-first-century challenges for environmental economics. American Journal of Agricultural Economics 86.5 (1 December): 1167–1178.

  DOI: 10.1111/j.0002-9092.2004.00662.x

  Provides a perspective on the contribution of John Krutilla to environmental economics. In particular, explains the origins of the classic paper Krutilla 1967 and how it transformed thinking about economic value. Available online.

• Weisbrod, B. A. 1964. Collective-consumption services of individual-consumption goods. Quarterly Journal of Economics 78.3: 471–477.

  DOI: 10.2307/1879478

  Proposes that a good can have an economic value even if a person is uncertain if he or she will ever use it. This paper introduced the idea of “option value.”