Public Goods and Externalities

Chew Khai Yen

March 19, 2018

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Part (a)

Evaluate available methods for eliciting peoples’ valuation of externalitiesand public goods.

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Valuation

Direct valuation: contingent valuation surveys on willingness-to-payfor public goods

Indirect valuation: happiness data

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What are CV survey responses measuring?

True economic preferences (i.e. true valuation of WTP)

Casual cost-benefit analysis

”Warm glow”

Attitude towards a public good expressed on a dollar scale

Reaction towards actions that have been taken (e.g. cleaning up anoil spill)

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Contingent Valuation (Diamond and Hausman, 1994)

Criteria to evaluate contingent valuation surveys:

Credibility - whether survey respondents are answering the questionbeing asked

Reliability - size and direction of the biases that may be present in theanswers

Precision - variability in responses (can usually be increased by simplyincreasing sample size)

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Credibility of CVS

Eliminate incredible responses that are unreasonably large / ”protestzeroes”

Verbal protocol analysis

respondents are asked to ”think aloud” as they respond to a surveytranscripts show the inherent difficulty in selecting a willingness-to-payresponse and the extent to which people refer to elements that oughtto be irrelevant to evaluating their own preferencesfindings strongly suggest that people are not easily in touch withunderlying preferences about the type of commodity asked about

Patterns of willingness-to-pay responses across individuals and acrosssurveys

Variation in WTP across individuals (income, preferences, etc.) nothelpful in distinguishing among the various hypotheses since theyroughly move in the same direction

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Variation in WTP Across Surveys

Multiple questions - should not matter whether the question is askedby itself, or with other questions - ordering should not matter too

Tolley et al. (1983) - WTP to preserve visibility at the Grand Canyon5x higher when this was the only question askedSamples and Hollyer (1990) - Seal value tended to be lower when askedafter whale value, while whale value was not affected by the sequenceof questions

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Variation in WTP Across Surveys

Single questions and the embedding effect

One group asked to evaluate X, another Y, and another X + YWTP for X + Y tends to be considerably less than the sum of WTPfor X and WTP for Y (adding up test)Diamond et al. (1993) found that stated WTP to preserve 1, 2, and 3wilderness areas are roughly the sameSimilar findings by Desvousges et al. (1993) in solving a problem ofkilling 2000, 20,000 and 200,000 birdsSchulze et al. (1993) find that a majority of respondents recognise anembedding effect in their own responses when asked for WTP forcleanup of a contaminated site

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Reliability of CVS

It is common to calibrate responses to surveys about behaviour (e.g.marketing surveys) due to systemic bias

How this calibration should be extended to the public good context isunclear

Lack of study of appropriate calibration factors

Meta-analysis of 28 studies by Murphy et al. (2005) found that 70%of the calibration factors are below 2 (with severe positive skewness)

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Diamond and Hausman’s Conclusion

Stated WTP from CVS are not measures of nonuse preferences overenvironmental amenities

Welfare analysis by treating the responses as if they were a measureof nonuse preference would not be a guide to good policy

”Some number is better than no number” fallacy

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Happiness Data (Levinson, 2012)

Question in General Social Servey which asks, ”Taken all together,how would you say things are these days? Would you say that you arevery happy, pretty happy, or not too happy?”

Responses linked to county in which respondents were surveyed andthe air quality in that location on that day

Fixed effects regression with household demographics as controls

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Results

Hijt = αPjt + γlnYi + X ′ijtβ + δj + ηt + δj × yeart + εijt

Happiness is related ”in sensible ways” to daily local air pollution

Estimate MRS between pollution and income to implicitly calculateWTP for improved air quality

MRS = ∂Y∂P

∣∣∣∣dH=0

= −Y α̂γ̂

Found that people are willing to pay roughly $35 for an improvementof one SD in air quality for one day

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Evaluation

Advantages

Free from sorting biases (eliminated by fixed effects and interactions)Not susceptible to strategic biases and framing problems of CVSServes as a complement to existing approachesShows that subjective well-being captures something meaningful aboutpeople’s circumstances

Issues

Treats happiness as a proxy for utility and makes interpersonalcomparisons”These days” is vague - months? years?Is income endogenous wrt to happiness?Study was feasible only due to well-monitored and extensive pollutiondata

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Part (b)

Using a supply-demand diagram explain how to interpret the implieddead-weight loss arising from (i) consumption externalities (ii) productionexternalities.

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Consumption Externalities

Positive Externality Negative Externality

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Production Externalities

Positive Externality Negative Externality

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Part (c)

Consider the pollution externality from the production of cars, but assumethat the externality damage is uncertain. Illustrate the ex post welfare lossfrom a tax policy that is based on the expected damage. Do the same fora policy that regulates car production based on the expected damage.Which policy seems better when the demand become more price-inelastic?

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Setup

Negative consumption externalityTwo realisationsPolicy set before externality is ”realised”

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Prices vs. Quantities (Weitzman 1974)

Taxation Quotas

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Price-inelastic demand - prefer taxes

High PED Low PED

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References

Diamond, P. & Hausman, J. (1994). Contingent Valuation: Is SomeNumber Better than No Number? Journal of Economic Perspectives,8(4), 45-64.

Levinson, A. (2012). Valuing public goods using happiness data: Thecase of air quality. Journal of Public Economics, 96(9-10), 869-880.

Murphy, J., Allen, J., Stevens, P., & Weatherhead, G. (2005). AMeta-analysis of Hypothetical Bias in Stated Preference Valuation.Environmental and Resource Economics, 30(3), 313-325.

Weitzman, M. (1974). Prices vs. Quantities. The Review ofEconomic Studies, 41(4), 477-491.

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