I. Economic Valuation Methods

Economic valuation methods can broadly be categorized into Physical Linkage and Behavioral Approaches, both referring the valuation techniques based on the identification of cause-effect links and people’s/user preferences.

A. Physical Linkage Methods

• This approach to economic valuation is based on the measurement of physical effects of the changes in environmental quality.
• Identification of physical linkages or cause – effect relationship includes establishing the links between:

a) Environmental degradation and productivity;

b) Deforestation;

c) Soil nutrient levels and productivity;

d) Water and air pollution and health effects; and

e) Recycling and energy use, etc.

B. Behavioral Approach

• The behavioral approach directly measures people’s preference and concerning changing in their economic welfare which is subjective judgment and affecting education, time, age, sex and cultural background.
• This unpriced approach involves a process of measuring people’s preference for changes in risk of human life and other environmental changes rather than providing direct value of the environment or human life or health.

II. Direct Measures of Externality’s Impact:

a. Measuring productivity changes (Production Function Approach):

• The project may create an externality that affects the productivity of other producers and consumers. This productivity change can be measured in terms of the value of the net output produced.
• For example, the minimum economic cost of the air or water pollution that destroys the local crops will be the market value of these crops over the lifetime of the project that produces them or while the damage continues to occur. If some less sensitive or less profitable crop can be grown instead, the difference between the value of the preferred crop and less valuable substitute can be used to measure the cost of pollution.

b. Change of earning capital Approach:

• The loss or gain of earning can measure this, or change in the value of human capital or those affected.
• For example, air pollution from local mining or brick factory or project may cause some miners to develop lung disease, reducing their working life or even causing premature death. Their lost earnings will be measure of their decreased productivity and minimal estimate of the cost of pollution.
• The increased earning of workers who received trainings on a project and the go on to work for other employees in another use of the human capital approach to measure the value of externalities. In this case, such earnings are a measure of the positive externalities generated by a project’s trainings.

c. Opportunity Cost Method

• one method of handling this is to measure the Net Present Value (NPV) of the project that generates the externality and compare it with the NPV of the next best alternative project, which does not.
• The difference between the two project’s NPV is the opportunity cost of the externality. The decision-maker can then decide if the cost or benefit of the externality exceeds the difference in the project’s NPV.

d. Preventive Expenditure Approach

• Another readily identifiable cost of negative externality will be the preventive expenditures that people incur to reduce or avoid the damage from the sun an externality.
• Such expenditures are made in order to maintain the productivity of their economic activities or their level of environmental amenity.
• The cost sound insulation installed be people living near the airports is an example of such preventive expenditure.

e. Replacement Cost Approach

• The replacement cost method measures the cost of environmental degradation in terms of the resources that must be used to replace the environmental services lost as a result of this degradation.
• For example, the benefits of a project to provide clean river water may be measured in terms of the saving in water treatment costs.

III. Indirect Measures of Externality’s Impact:

 These measures rely on prices that indirectly measure the externality’s impact on welfare.

a. Hedonic Pricing Method:

• The hedonic pricing technique is particularly useful in measuring changes in environmental amenity such as noise or air pollution.
• It involves comparing the prices for residential or agricultural land or properties in areas close to a source of pollution, such as an airport, with those for land in similar suburbs away from such pollution sources.
• Controls are introduced it eliminate differences due to the intrinsic value of the house or land using large samples and econometric regressions.
• The difference in land prices that cannot be explained by any of these other factors will represent the present value of the occupant’s expected loss of environmental amenity by living close to the pollution source.

b. Travel Cost Method:

• This approach can be used to measure both negative externalities like traffic congestion and positive externalities from environmental amenities like national parks or scenic area generally.
• for example, the additional travel time costs of road users, valued in economic prices will provide an estimate of the welfare loss as a result of the unmarketed externality, congestion.
• The basic rationale of this approach is that people will reveal the utility gain from a recreational facility by the amount they are willing to pay to visit it each year.
• The travel cost method can be used to provide a minimum valuation of other unmarketed items like historical and cultural sites.

c. Contingent Valuation Method

• Sometimes, the externalities created by a project cannot be measured either directly or indirectly in market prices because there is no actual or even surrogate market for the good or service concerned. For rg: Sites of cultural, historical or spiritual importance
• Furthermore, people may get utility or pleasure, from mere knowledge of existence of environmental or cultural amenities even if they have never used or seen them and do not intend to. This utility is called non-use or passive value.
• Contingent valuation market methods have therefore been developed to directly ask people what value put on environmental and other amenities, including facilities from which they get only passive value.

There are three problems associated with this method.

I) The first is the possible existence of hypothetical bias because of the difficulty of obtaining meaningful responses to hypothetical questions. This can be remedied by the careful construction of questions and conduct interviews.

ii) The second problem relates to whether the respondent is asking to pay for an amenity.

Iii)  A third problem is the free rider problem, which may bias responses. People may undertake the amount they may be put to retain a positive externality, or social service or public good, if they believe that they will be required to pay this amount.