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When the tanker Exxon Valdez collided with Bligh Reef on March 24, 1989, it released 11 million gallons of oil into the pristine waters of Prince William Sound and subsequently induced a torrent of valuation studies on the economic damages of the spill. The potential magnitude of Exxon’s liability unleashed a conflict between oil companies and resource trustees over measurement of these damages that has had a lasting influence on environmental valuation. The con- flict led to the investment of a vast quantity of resources in valuation methods by both sides. In the struggle to establish the magnitude of economic damages something of greater significance emerged: a universal admission that resource damages represent real losses to people. Although defendants challenged the use of stated choice methods in measuring values associated with toxic spills, both plaintiffs and defendants accepted the concept of measuring damages for injury to public resources by the amount of compensation individuals in society would need in order to restore their well-being. This acceptance, characteristic of both the Exxon Valdez oil spill and other important but less spectacular cases, implicitly ratified the economic model of individual choices as the basis for economic value.

The phrase has come to be applied to the practice of evaluating the social gains and losses from environmental degradation or improvement. Economists practice valuation by applying welfare economics to environmental outcomes. There is, of course, a good deal of debate as to what is meant by valuation, particularly among the broader science community. Evaluation of benefits and costs often evokes strong objections, even when applied in the well-defined context of welfare economics. Because the objections have an even greater propensity to emerge in environmental applications, the principles of applied welfare economics deserve a quick reminder. This chapter reviews the theory of welfare measurement, but as with the entire book, the ultimate empirical application remains foremost in our minds. The methods for recovering the welfare measures we seek (or good approximations of them) are indirect and will depend on careful reasoning and sound econometrics. Although the importance of the econometric details can not be underestimated, in this book we focus on the logic that connects behavior with estimation.

The previous chapter presents the model for welfare measurement of price changes. This model relies on the result that a change in the price of a good is related to quantity demanded of that good by way of the envelope theorem. The same link naturally holds for factors (such as labor) sold at parametric prices. But many problems in the allocation of resources and the protection of the environment involve services that enter directly into a consumer’s utility function or a firm’s production function. For example, a household living in an industrial city will enjoy air quality determined not by their own consumption decisions but by the city’s level and composition of transportation and manufacturing. A household may purchase the quantity of its drinking water, but the quality of the water will be determined by public water supply policies. In these cases, environmental quality is a direct determinant of utility, and government actions or exogenous events affect the level of the environmental good or service entering the individual’s preference function. In such cases one cannot rely on the conceptual basis developed for price and income changes for measuring the welfare effects of changes in public goods. In this chapter we begin to develop the basic theory and extensions that support a more general set of welfare measures dealing with changes in the level of goods and services that enter preference functions exogenously.

The message from Chapter 3 is clear. To use revealed preference methods and only revealed preference methods to value changes in public goods, specifically changes in environmental quality, requires imposing some added restrictions on the individual’s decision problem. The most commonly employed restriction is weak complementarity. In this chapter we deal with an array of conceptual and empirical problems that arise in making the weak complementarity model of environmental valuation operational in a conventional demand setting. The first section considers how one might go about specifying demand functions or systems that incorporate prices, income and quality characteristics. Subsequent sections treat conceptual issues that arise when the weak complement is really a household-produced good. When this is true, time enters the problem in a number of ways, complicating both specification and welfare measurement. Finally we consider how to make conceptual and empirical sense of welfare evaluation when individuals do not have perfect information about quality changes.

In their daily lives, consumers choose discretely–what model of car to buy, which beach to visit, whether to use public transportation, and so on. On the surface, the neoclassical model of preferences and demand appears ill-suited to analyzing such discrete choices or to providing a framework for welfare analysis. Nevertheless, there is a well developed and useful literature on econometrics and welfare measurement in this choice setting. The heart of this literature is the McFadden (1974) random utility model, which found its initial applications in transportation. Hanemann (1978) was the first to develop and apply this approach to valuing environmental and natural resources.

More often than not economists treat marketed goods as homogeneous and estimate demand curves for goods with homogeneous quality. An economist might be interested in estimating the demand for water from a public water supply, where public water is viewed as a homogeneous good whose quality declines as a result of contamination. Bottled water would normally be considered a separate although related good. A market demand curve would exist for each, although each demand would be conditioned on the price and quality of the other.

For at least two hundred years, economists have argued that a competitive labor market will generate higher wages in return for less desirable working conditions, such as hazardous conditions or poorer on-the-job amenities. This expectation has lead to the development of the theory of compensating wage differentials and the estimation of hedonic wage models, the second type of hedonic model that has engaged environmental economists. In this chapter we investigate how wage differentials have been employed in valuing changes in environmental amenities.

In this chapter we continue the analysis of the household production models introduced in Chapter 3. Now we investigate models in which the non-market or public good is used as an input together with privately purchased goods to produce a commodity that the household values.

In Chapters 3 through 8 we explored the problem of measuring the economicgains and losses experienced by households affected by environmental improvements and degradation. These chapters addressed the ways in which households respond when such things as their health or recreational opportunities are affected by the environment. In this chapter we investigate environmental effects on production opportunities for enterprises that sell some part of their output.

A book on conceptual issues in revealed preference approaches to valuation does not lend itself to linear reading from beginning to end. Nevertheless, we conclude the book with some ideas about more general issues surrounding valuation, and some thoughts about challenging and potentially fruitful research directions.