Valuation Techniques for Social Cost-Benefit Analysis: - HM Treasury

The two most common revealed preference methods are 1 :
- The Hedonic Pricing Method, which involves examining people‘s purchasing decisions in
markets related to the non-market good in question; and
- The Travel Cost Method, which involves observing costs incurred in the consumption of
the non-market good in question.
3.2.1 The Hedonic Pricing Method
The hedonic pricing method has most commonly been applied using data from housing and
labour markets. In the former, the intuition is that the price differential between otherwise
identical houses that differ in their exposure levels to non-market goods and bads such as
pollution, noise, crime or education facilities reveals information regarding individuals‘ WTP for
such goods. Labour market applications follow a similar logic, though the focus is typically on
the compensating wage differentials that are paid in relation to job characteristics such as health
and safety risks or job security.
Applications consist of estimating a hedonic wage or price regression function to capture the
effect of a non-market good on wages or prices (Leggett and Bockstael, 2000; Chay and
Greenstone, 2005). The price (p i) of a house (h i), for example, can be written as a function of its
n characteristics 2 . Example characteristics include the number of bedrooms, size of the garden,
commuting distance to nearby cities, quality of schools in the area and environmental qualities
such as air quality:
p f h , h , ...... h )
(9)
i
( 1i 2i
ni
In a competitive market, the marginal implicit price of any of these characteristics (e.g.
represents a household‘s WTP for a marginal increase in that characteristic.
3.2.2 The Travel Cost Method
p )
The travel cost method has most predominantly been used to estimate the value of recreational
sites (e.g. a river, a park, or a beach). It has also been used to value changes in the
characteristics of sites (e.g. ease of access).
The number of visits (q i) to a site by an individual i over, for example, a year is likely to be related
to the price they have to pay to visit the site (p i), the price of substitute sites available to them
(ps i), and their income (m i). It might also be suspected that visit frequency will vary across factors
such as age, gender, education level and whether the individual has children (x i). A simple travel
cost model is given by
q (10)
i
f ( p , ps , m , x )
i i i i
1 Behaviour can also be observed through the actions people take to insulate themselves from things that lower their utility. This forms the basis for the
defensive expenditure method for non-market valuation. For example, in response to traffic noise or air pollution, households may purchase double
glazed windows or hire window cleaners. Therefore, expenditures on market goods can be related to levels of non-market bads. This can be used to
derive estimated changes in expenditure (the benefits) that result from exogenous changes in noise or pollution. Dickie (2003) gives an overview of this
less commonly utilised revealed preference method.
2 Any equation relating the price of a good to the good‘s characteristics is called a hedonic price function. The partial derivative of a hedonic price
function with respect to any characteristic is called the marginal implicit price of that characteristic.
i
h
ni
13