Stages in Practical Application

As suggested by Bateman and Turner (1995), the practical application of CVM can be split into six distinct stages. We outline and discuss each stage below:

Stage 1: Preparation

The first step is to devise a hypothetical market for the environmental in question. For example, a study by Quah and Chong (1999) set a scenario as follows:

“Suppose the government wants to make the East Coast Park smaller in size so that more houses can be built. In exchange, the government will develop a park exactly similar to the East Coast Park but located in an urban, built-up area.”

The second step is to define the payment vehicle. There are many different payment vehicles through which the WTP bids can be collected: income tax, value added or sales taxes, trust fund payments, entry charges, property taxes, and changes in utility bills.

However, different types of payment vehicle have different types of obstacle. Some payment vehicles may encourage free riding and some payment vehicles might cause a lot of protests. For example, a survey of local residents on the WTP additional local water or sewerage charges to fund improved water quality might result in protests against the payment if the principle beneficiaries of the improved water quality are tourists in the area who do not share any of the costs. But if instead, we surveyed

tourists, they may reveal large WTP values for an increase in local tax which they do not have to pay. In the latter case a hotel room tax might be a more appropriate payment vehicle.

The third step is to define the elicitation method. Here, individuals are asked to state their maximum WTP for the environmental good (either to increase the quantity of the good, or to prevent a decrease in the quantity of the good); or their minimum WTA compensation for the environmental good (either to forgo an increase in the quantity of the good, or to accept less of the good). The principle elicitation methods are:

1. An open-ended question in which no value is specified and individuals are asked a simple question on their maximum WTP for the good, for example

“Suppose the National Park authority charged a fee to enter this recreation site. What is the most you would be willing to pay to use it per person per day?”

Where the respondents have the experience of purchasing similar goods (e.g. access to other private recreation sites), then open-ended questions offer a relatively easy method to elicit bids. However, where the respondents have no prior experience of purchasing environmental goods, they may experience considerable difficulty with this format. For this reason the National Oceanic and Atmospheric Administration (NOAA) report by Arrow et al. (1993) advocated that open-ended formats should

not be used to elicit non-use values for environmental goods: those very situations for which there is no market in the good or similar good.

2. A close-ended question in which a range of values are specified and the respondent chooses one of the values, for example:

“Suppose the National Park authority charged a fee to enter this recreation site.

What is the most you would be willing to pay to use it per person per day?

(please circle one value)”

1 2 3 4 5 6 7 8 9 10

Such a format anchors the respondent’s answer to the range of values presented, although they can be offered another category in which they specify the value. This type of format might be applicable to non-priced open access recreational areas, where values in the range presented have already been determined for other comparable sites.

3. A dichotomous choice or referendum type question in which a single payment amount is presented to the respondent who either agrees or disagrees with the amount, for example

“Suppose the National Park authority charged a fee of $5 per person per day to enter this recreation site. Would you be willing to pay this fee?

YES/NO”

The payment amount varies across the sample questionnaire survey across a pre-determined range. This is the elicitation method which is advocated by the NOAA.

But the price range must be determined, which is normally done by doing a pilot test. This method is also rather inefficient in a sampling sense where it needs a larger number of observations.

4. An iterative bidding format or multiple-bounded dichotomous choice questions. The iterative bidding approach begins as a dichotomous choice question. Depending upon the response, the respondent is then asked if she would be willing to pay a higher or lower amount than the first.

Stage 2: Survey

WTP or WTA bids are obtained through a questionnaire survey. CV questionnaires typically obtain three sets of information from the respondents:

1. attitudes to environmental goods in general and preferences for the particular good under investigation vis-à-vis others; awareness of substitute goods; use of the good

perhaps in relation to uses of other goods; and any perceived non-use benefits of the good;

2. WTP and/or WTA bids for the good using one or more of the elicitation methods, with questions to respondents exploring their reasons for their bids, which can be used to eliminate illegitimate responses; and questions to gauge the respondents’

ambivalence; and

3. socio-economic information on the respondent and his or her household. This data is gathered to assess: (i) whether the sample is representative of the general population, and representative of visitors if profiles of visitors are available; (ii) the theoretical validity of the WTA or WTP bids, using a regression model relating bids to price, quantity demanded, income, preferences, and other variables which theory suggests should explain the inverse demand curve.

The survey can be administered in a number of ways; the most popular include face-to-face interviews; self-filled questionnaires; telephone interviews; and mail shots.

Stage 3: Calculation

From a given survey, the mean WTP or WTA amounts can be derived by averaging the observed bid responses. However, a CV survey permits many different statistical values to be calculated: means; medians; modes; trimmed estimators; modified estimators

(with biased and ineligible responses omitted); standard deviations and other measures of dispersion. At large, mean WTP values, or trimmed or modified estimators based on mean WTP values, are commonplace. However, median bids are increasingly popular because they are unaffected by large bids in the upper tail of the distribution. In practice, whether to use the mean or median bid value only arises when the distribution is skewed, so that the median and mean are typically different. In the case of the WTP responses in a CVM survey, a common problem is one of right-skewness, with a large number of people being willing to pay small amounts of money and a few of them are willing to pay a very large amount of money. In this matter, the median is invariably much smaller than the mean. Hanemann (1984) stated in his paper, “a purely statistical argument can be made in favour of C*” where C* is the median of the distribution”.

Hanemann shows that the mean is very sensitive to slight changes in the shape of the distribution resulting from different estimation methods or outliers in the data, while the median is relatively robust.

Harrison and Kristrom (1996) explicitly look into the issue of whether to use the mean or the median of the sample for 2 different cases: a) the Exxon-Valdez oil spill and b) mining activity in the Kakadu Conservation Zone of Australia. They favour the median value. This is because, “(i) since …. the mean can not be reliably estimated and the median can be reliably estimated” (p.101), and (ii) the median is a “…. lower bound for the damage estimate” (p.11) in the Exxon-Valdez case. Their calculations of the mean show that the mean is primarily determined by the shape of the right tail of the distribution, rather than by the actual data. Hence the mean is likely to be higher than the one with the median. Another point in favour of the median is that it provides a

more conservative measure of aggregate damages since it gives a lower value. This is one argument used when it involves a real monetary compensation as in the Exxon-Valdez case.

The conclusion that the median should be preferred to the mean is also reached by Leon (1996). He was in favour of using the median because a) it tends to be more robust to the influence of extreme observations; and b) it is consistent with the referendum approach to policy decision, i.e. with a majority rule social welfare criterion.

The issue of outliers can be a problem. One or two outliers can increase the average WTP dramatically, and can provide an over estimation of the worth of a public good.

Some zero WTP responses may also be erroneous values. Trimmed estimators can be employed if outliers exist. The problem with trimmed estimators is the determination of the observations that are ‘erronous’, and hence those which should be excluded from the calculation. A common practice is to trim the top and bottom 5% or 10% of the distribution of WTP observation.

Other modified estimators are mean WTP values with biased and illegitimate responses removed. Biased and illegitimate responses are identified by a series of questions designed to find out why respondents gave that particular WTP response. Modification are also done with protest responses (where respondents that are not willing to pay any amount even though they value the good) are omitted from the sample.

Stage 4: Estimation

A bid curve can be estimated to investigate the determinants of WTP bids. For a continuous question format (open-ended type question), standard OLS estimation techniques can be applied:

WTPi = ƒ(Y, V, S) + e

Where y = income, V = visits, and S = substitutes. There is no theoretical correct form of this function. But if a log-log function is used, it will provide the Hicksian compensated demand curve for the good, and permits the average Hicksian consumer surplus per visitor to be estimated, as the area under the demand curve for the average visitor who is assumed to make the mean number of visits in a given time period.

Besides traditional open ended question, a close ended question like a bidding format can also be used. In the bidding process, the respondent is asked a series of dichotomous choice questions until some point estimate of WTP is reached. The dichotomous choice question was pioneered by Bishop and Heberlain (1979), where a single dichotomous choice question is asked, and the dollar amount is treated as a threshold. If the good is valued more highly than the threshold dollar amount, the person answers “yes”, otherwise “no”. As concluded by the NOAA panel report,

“….asking respondents to give a dollar valuation in response to an open ended question presents them with an extremely difficult task. At the same time, CV proponents also recognize that presenting respondents a set of dollar amounts

from which they are to choose is likely to create anchoring and other forms of bias. Thus, we recommend as the most desirable form of CVM elicitation the use of a dichotomous question that asks respondents to vote for or against a particular level of taxation, as occurs with most real referenda” (Arrow et al., 1993).

To obtain Hicksian compensating and equivalent welfare measures from discrete response data, a Logit or Probit model is typically estimated (Hanemann, 1984).

A double-bounded CVM approach was first proposed by Hanemann (1985) and first implemented by Carson, Hanemann and Mitchell (1986). In double-bounded CVM, the respondents are engaged in two rounds of bidding: participants respond to a first dollar amount and then face a second question involving another dollar amount, higher or lower depending on the response to the first question. Hanemann et al. (1991) have proved that the double-bounded dichotomous choice model is asymptotically more efficient than the single-bounded model. Therefore the confidence intervals are tighter in double-bounded compared to the single-bounded model.