Charlotte Bernhard Master thesis University of Groningen August 2008 Student number: 1134728 Supervisor: Dr. D. Wiersma

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With this master thesis I finish my study Economics at the University of Groningen. When I started this study I had the plan to just do it for one year and then going to study International Organizations. However, during the first year my fascination for economics grew more and more and I decided to go on studying this subject. Later on in my study I attended lectures about Environmental Economics which triggered a former interest of mine. As a child, my sister, a friend and I established a small nature club so we could make people aware of the environment. Because of the Environmental Economics course this past interest grew again and that is why I wanted to do my master thesis about an environmentally linked subject. And that is what I did by writing this thesis. I am very pleased with the result I can show you now.

However, it took a lot of effort to get this far and therefore I want to thank all the people who helped and supported me during my study and the process of writing this thesis. I cannot thank everybody in person in this preface, but to some I want to pay my special attention. First of all I want to thank my mother, who I could always call with whatever problem, and that disappeared after her pep talk. And we walked miles together to get new inspiration for my research. Furthermore, I want to thank my father for his (financial) support and all the information he provided me with. And then there are Emma, Henk, Janny, Jetty, Robert, Swaniek and Yvonne, together with (among others) Ciska, Esther, Jasper, Lotte, Louise, Petra and Vanessa to whom I am very grateful. They encouraged me to begin with my thesis and to believe in myself.

Besides them, I want to pay attention to my friends and family who kept believing in me, who brainstormed with me, to whom I could always complain to and with whom I did many other things to get my mind of the economic value of Schiermonnikoog’s national park and on to something else. Special thanks to Annet, Lenore, Lideweij, Margreet and Yvonne for reading and commentating a chapter of my thesis. And to Annet, Florine, Marleen, Rob, Roel and Ruth for their pep talks over the phone and during dinner and breaks.

I also want to thank Anke, Hanneke, Monique and the others for their weekly assistance by setting up a planning and the many breaks we had together in the library. This all kept me motivated to continue working on my thesis. In addition to this, I want to express my gratitude to Inger who helped me to set up a basic idea for this research and supported me through almost the end of the process.

Furthermore, I would like to thank the tourist information centre of Schiermonnikoog for providing me with the necessary data regarding the visitors of the island. Besides that, I am grateful to dr. G.H. Kuper, drs. S. Knypstra and Dirk for helping me out with Eviews, the statistics and the mathematics. And finally, I want to show my appreciation to dr. D. Wiersma, my supervisor, who gave me inspiration, motivation and support during the period we worked together on my master research.

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Groningen, August 2008 ii By: Charlotte Bernhard Summary

In this paper I estimate an economic value for the national park of Schiermonnikoog, one of the Wadden Islands of The Netherlands. Nature is not sold on a market which makes it a challenge for economists to put a price on an environmental asset like this. That is why they developed valuation methods as a way to value non-market goods. In my case of Schiermonnikoog I choose to use the zonal Travel Cost Method (TCM), an indirect observed behavior market demand curve valuation method. This means that it estimates the use value of the national park by looking at the real behavior of consumers towards a good in a related market which has a market price. In a TCM model this is done by looking the travel costs that can be seen as a price tourists pay to visit the national park. The approach assumes an inverse relation between these travel costs and the number of visitors or visits, and so in the end a demand curve can be found. This curve can be used to estimate the Marshallian Consumer Surplus (MCS), which gives an indication of the recreational value of the national park.

To perform a TCM study about Schiermonnikoog I used data provided by the tourist information of the island. These data show information about tourists of three countries, The Netherlands, Germany and the Flemish part of Belgium, divided over nineteen zones who visited the island in 1999. Based on these data and additional information I found at different organizations, I could carry out my research.

In my model I have found the inverse relationship between the visitor rate per zone of origin and the travel costs per zone The visitor rate is the number of visitors coming to Schiermonnikoog from a certain zone divided by the absolute number of inhabitants of that zone, so that one corrects for differences in population size between the nineteen used zones. The travel costs in my model exist of five elements: traveled distance; travel time; on-site time; on-site expenditures; and other expenditures. I include all these elements as I believe the entire spend costs to get to and be at the site should be taken into account in the model. Therefore the costs for traveled distance are based on the full running costs per kilometer as these show the total per kilometer expenditures people have to make when driving. And that is also a reason to include both travel and on-site time. The value of time is equal to an average estimated net wage rate per hour, as I believe this gives a good notion of the opportunity costs of time. This average estimate of the net wage rate is based on the average hourly labor costs, which differs per country. Furthermore, only the net portion of expenditures people have to make as a consequence of their journey are included, by taking in 50% of the total on-site expenditures. I assume that are the extra costs bared for visiting the area. And the other expenditures exist of costs for the boat ticket and for parking.

The found inverse relation by performing an OLS regression analysis can be expressed by the following visitor generating function:

ሺ݅݊ℎܾܽ݅ݐܽ݊ݐݏ௜∗ ݒ݅ݏ݅ݐ݋ݎݎܽݐ݁௜ሻ =

݁ଽଵ.ଶଶଶ଻ସ

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Groningen, August 2008 iii By: Charlotte Bernhard When incorporating a price change, which can be seen as an entry fee for the national park, into this equation new data points are found. These points can be used to do another OLS regression analysis to find a demand equation. In my Schiermonnikoog case the next demand curve was established:

݌ݎ݅ܿ݁ = 1,789.020 − 152.4493 ∗ ln ሺݒ݅ݏ݅ݐ݋ݎݏሻ

With this demand equation and associated demand curve the Marshallian Consumer Surplus can be calculated as the area under the curve and above the price, which is in my case zero since no entry fee is raised. The estimated MCS is equal to € 18,962,728.45, which can be seen as a value of Schiermonnikoog’s national park for the year 1999. This means a value of €64.70 per person per visit and a value of €7.08 per visitor per day.

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Groningen, August 2008 iv By: Charlotte Bernhard The index

Chapter 1: The introduction………...

1.1. The case………...

1.2. The research question………..

1.3. The outline of this thesis……….

Chapter 2: Theory of valuation of non-market goods……….. 2.1. Cost-Benefit Analysis (CBA)………. 2.1.1. Environmental Costs (EC)……….. 2.1.1.1. The value of the EC for a market good………... 2.1.1.2. The value of the EC for a non-market good………... 2.2. Valuation methods……….. 2.2.1. Non-market demand curve approaches………... 2.2.2. Market demand curve approaches………..

2.2.2.1. Direct and indirect valuation methods……… 2.2.2.2. Revealed and expressed preference methods……….. 2.2.2.3. Dividing the market demand curve approaches……….. 2.2.2.3.1. Hedonic Pricing Method (HPM)………. 2.2.2.3.2. Travel Cost Method (TCM)……… 2.2.2.3.3. Contingent Valuation Method (CVM)……… 2.3. Conclusions………. Chapter 3: Literature survey of the Travel Cost Method……… 3.1. Historic overview……… 3.1.1. The TCM according to Trice and Wood (1958)………. 3.1.2. The zonal TCM according to Clawson and Knetsch (1966)……….. 3.1.3. Further development of the TCM………... 3.2. Problem of the TCM………... 3.2.1. Determining the demand………. 3.2.2. Determining the price……….

3.2.2.1. Valuation of time……… 3.2.2.2. Multiple destinations or multi-purpose trips………... 3.2.3. Other shortcomings………. 3.2.4. Other forms of the TCM………. 3.3. Empirical research of the TCM……….. 3.3.1. Determining the demand………. 3.3.2. Determining the travel costs………... 3.3.3. Empirical analysis………... 3.4. Conclusions………... Chapter 4: Developing a TCM model for Schiermonnikoog………... 4.1. Data collection……… 4.2. Data description……….. 4.2.1. Visitor rate……….. 4.2.2. Travel costs………. 4.2.2.1. Traveled distance……… 4.2.2.2. Valuation of time……… 4.2.2.2.1. Travel time costs………. 4.2.2.2.2. On-site time costs……… 4.2.2.3. On-site expenditures………... 4.2.2.4. Other costs……….. 4.2.2.5. Estimating the total travel costs………..

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Groningen, August 2008 v By: Charlotte Bernhard 4.3. The TCM model……….

4.3.1. Visitor generating function………. 4.3.1.1. The results………... 4.3.2. Demand function………. 4.3.2.1. The results………... 4.4. Conclusions………. Chapter 5: Discussion and conclusions……….. 5.1. The choice for the TCM approach……….. 5.2. Visitor rate……….. 5.3. Travel costs………. 5.4. The choice of the functional form……….. 5.5. The final conclusions……….. References………. Abbreviations list………. Appendices………

I: National park Schiermonnikoog………...

II: Summaries of five TCM case studies………... III: Reasons of people to visit Schiermonnikoog………

IV: Consumer Price Index (CPI)……….

V: Exchange rates………..

VI: Absolute numbers of visitors for every zone of origin………. VII: Traveled distance and traveled time………. VIII: Average full running costs per kilometer………. IX: Average amount of people traveling in one car……… X: Average number of persons in a family………

XI: Average length of stay………..

XII: Average on-site expenditures per family per day………. XIII: Boat prices for a return ticket per person……….. XIV: All available data for a TCM research of Schiermonnikoog……… XV: Description of Eviews variables………... XVI: Estimated points to predict a demand curve………. XVII: The primitive function of the demand equation……… XVIII: Calculating the MCS when the semi-log dependent functional form is chosen

to determine the visitor generating function………. XIX: Estimated points to predict a demand curve using the semi-log

dependent visitor generating function………... XX: Future visits to Schiermonnikoog……….

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Groningen, August 2008 1 By: Charlotte Bernhard Chapter 1: The introduction

On April the second of 2008, the Dutch minister Verburg of the ministry of Agriculture, Nature and Food Quality, opened a landscape auction where people can buy little pieces of nature in The Netherlands. Buyers do not really own this piece of landscape, but by buying it one secures that piece to be maintained and saved for a certain future period.1 This is an initiative to save more nature in The Netherlands, one of the most densely populated countries in the world where a lot of natural areas were abandoned to create residential areas. However, in 1969 The Netherlands joint the agreement of the IUCN (the World Conservation Union) to protect the most important ecosystems of the country.2 Nowadays twenty national parks exist in The Netherlands and a lot of protection projects are evolved. For example, besides the recent development of the landscape auction, farmers are also stimulated to give their agricultural land a natural objective.3

These and other projects are all very interesting developments in the Dutch landscape in which green becomes an important policy objective for sustaining the densely populated country livable. But as an economist I wonder whether this new implementation of land is an economically appealing purpose. What becomes the economical value of the land when the area is fulfilled with a nature protection goal? The economic value of such an area is not that clear as when the land is used for agriculture for example. Then the benefits of the products grown on the land give an impression of the value of the land. However, when land has a nature protective objective it is not easily to detect the value of that place. Nature is not sold on a market and consequently it has no price. That is why in economic literature valuation methods are developed which can estimate a price for for instance nature, although these valuation methods do have their limitation. However, the value of nature development could well be higher than the benefits of agricultural land. To prove that is the case, is a challenge for economists.

1.1. The case

I want to take this challenge by estimating the economic value of a national park in The Netherlands. Because there are several national parks4 I choose the national park of Schiermonnikoog. Investigating this national park has my interest for several reasons. First of all, Schiermonnikoog is the smallest of the five inhabited Wadden Islands of the Netherlands, with its almost 40 square kilometers. Almost the whole island is a national park since 1989, only the small village and the polder are excluded. This leaves the island with a protected area of about 5,400 hectare land. It is one of the few areas in The Netherlands where nature largely determines the landscape. And in a television program in 2006, the

1

Website Landschapsveiling. 2

Website Nationaal park. 3

Website Ministry of Agriculture, Nature and Food Quality. 4

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Groningen, August 2008 2 By: Charlotte Bernhard Dutch people chose Schiermonnikoog to be the most beautiful spot of The Netherlands.5 Being crowned this title shows that people in The Netherlands attach a value to the island and its nature.

Besides that, Schiermonnikoog attracts with its scenery yearly about 300,000 tourists who come to seek peace, rest and nature. That is why the main goal of the community of Schiermonnikoog is to protect the nature of the island. In the development plan of the community, just limited land is available for habitation, which makes that for example houses are scarce and property prices increase. But there is plenty of natural world available. And the community’s goal to protect the nature of the island is a fruitful one. The main source of income for Schiermonnikoog is from the tourism industry. 60% of the 1,000 inhabitants of the island depend on this industry. This also illustrates that the nature of Schiermonnikoog is valuable.6

A third reason why the national park of Schiermonnikoog interests me has to do with an issue that led to a lot of discussion in The Netherlands for almost 15 years. This issue is about the idea of drilling gas from under the Wadden Sea. Many people were afraid that this would damage the nature and environment of the Wadden area. However, since 2007 permission is given to gain gas from under the Wadden Sea. And although there is paid attention to the protection of the nature and the environment, still many people are fearful that this drilling for gas will damage the natural environment in the future. The value of the gained gas from that area is pretty easy to determine, as it can be sold on the market. However, determining a value for the nature of the area is not that easy to determine. While it might be interesting to know that value as well. Certainly, as people are frightened the nature gets damaged.

Based on these grounds I think it is attractive to examine the national park of Schiermonnikoog as my case for which I want to estimate an economic value. The Dutch people and many tourists show that they value the nature of the island a lot. Besides that, I think it is interesting to have a value for the nature of some part of the Wadden area which can be compared with the benefits of the gaining of the gas in that area.

1.2. The research question

Now that I have decided that I want to do my research about the valuation of nature. And that for several previously described reasons I chose the national park of Schiermonnikoog to do my research into, I can work out the questions that I want to answer in my research. The main question I want to answer by doing my research is:

What is the economic value of the national park of Schiermonnikoog?

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Website Schiermonnikoognet. 6

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Groningen, August 2008 3 By: Charlotte Bernhard To be able to answer this question, a lot of other questions are raised. These other sub questions should be answered first, before I can deal with my research questions. The sub questions that have to be attacked first are the following:

- How can the economic value of a national park be determined? - Which method should be used in my case of Schiermonnikoog? - How does this preferred method work?

- What data are necessary to do this research with the selected model? - What is the estimated outcome of the chosen model?

- How good of an estimate is the found value?

I will build the outline of these master thesis on these questions. In that way I can work to an answer of my main question. In the next section I describe what the framework of the thesis is going to be.

1.3. The outline of this thesis

First I will handle the question: “How can the economic value of a national park be determined?”. The economic value of a non-market good, like a national park, can be estimated by using a non-market valuation method. The theory behind this way of valuation is attended in chapter two. Also in this chapter the answer on the following sub question: “Which method should be used in my case of Schiermonnikoog?” is given. There are several valuation methods, which are explained in chapter two and one of them is chosen to be used in my case study of Schiermonnikoog.

Subsequently an answer is found for the question: “How does this preferred method work?”. An overview of literature and other researches done using the selected method is given. So an impression is derived about the method which can be used further on to develop a model for the Schiermonnikoog case. This is all worked out in chapter three.

The following chapter will deal with the question: “What data are necessary to do this research with the selected model?”. All available data are described in order that the research with the chosen valuation method can be performed. This research is also carried out in chapter four, and therefore this episode ends with an answer to the question: “What is the estimated outcome of the chosen model?”.

The last chapter of this thesis will examine the final sub question, namely: “How good of an estimate is the found value?”. The outcome of my case study is open to questions as the selected method has its disadvantages and many necessary assumptions are made to be able to work with the available data. And then, after all this discussion and having found an answers to the six sub questions, chapter five can conclude with the answer to the main research question: “What is the economic value

of the national park of Schiermonnikoog?”. This answer is an estimate of the economic value of the

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Groningen, August 2008 4 By: Charlotte Bernhard Chapter 2: Theory of valuation of non-market goods

This chapter starts with the first sub question “how can the economic value of a national park be determined?”. Estimating a value for the nature of Schiermonnikoog requires a special method to do so, since nature is not dealt with on a market. However, in economics valuing a good is important, because it decides how people act. A person will consider the costs and benefits of an action, so he knows if it is profitable to continue or not. In contrast to this individual decision process, there is the Cost-Benefit Analysis (CBA), which makes that kind of decision for society as the whole.7 It considers the costs and benefits of a project for the entire population and, with that information, can determine what to do with the project.

In explaining the theory of non-market valuation it is vital to understand the CBA for comprehending how non-market goods can be valued. This method of analysis and its environmental variant will be elaborated in the next paragraph. It includes also the theory of preferences and placing a value on them by utility levels. As people place various kinds of values on an environmental asset, utility can be used to determine these values. However, it is complicated to determine the exact values. For that reason special valuation methods are developed. They are manners to estimate the value of the “Willingness to Pay” (WTP) or “Willingness to Accept” (WTA).

I also want to find an answer for the second sub question: “which method should be used in my case of Schiermonnikoog?”. Therefore I will first describe the diverse valuation methods in section 2.2. The chapter concludes with the valuation method which best suits to the particular case of Schiermonnikoog.

2.1. Cost-Benefit Analysis (CBA)

To be able to consider the costs and benefits of a project for the entire community, the CBA looks at people’s wellbeing. When people prefer to posses something, it is a gain and if people do not want to posses it, it is a loss.8 Therefore, one can say that when total wellbeing increases a benefit is yielded, while society’s wellbeing decreases when a loss is generated. In a formula it looks like this:

ܸܰܲ = ܤௗ− ܥௗ

The Present Value of the Development Benefits, Bd, is the output of the project. It is for example the income a company gets when selling the products they make. The Present Value of the Development Costs, Cd, is the input that is necessary to run the project. To be profitable, a project should be proceeded when the Net Present Value, NPV, is positive, thus Bd > Cd. Subsequently, the wellbeing of the society will improve. When the opposite occurs, the project should not be carried out, as community’s wellbeing will decrease.9

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Turner, Pearce and Bateman (1994), p.93. 8

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Groningen, August 2008 5 By: Charlotte Bernhard However, when considering environmental commodities, the costs of environmental improvement or deterioration should also be accounted for in the CBA, next to the material costs and benefits. In this situation an Environmental Cost-Benefit Analysis (ECBA) is needed. To better implement this, it is convenient to take in an extra factor into account: the Environmental Costs (EC). The EC show what the affected individuals are willing to pay for the environmental products if they were sold on a market.10In a formula it looks as follow: 11

ܸܰܲ = ܤ_ௗ− ܥ_ௗ− ܧܥ

Now a project, which in an ECBA normally is an action that damages the environment, should continue when NPV > 0 and therefore Bd – Cd > EC. If the opposite is true, the project should not proceed. This looks simple, but that is not the case. It is not that difficult to determine the values of Bd and Cd, but determining the value of EC is. The next section will therefore go deeper into this subject.

2.1.1. Environmental Costs (EC)

The difficulty with determining the value of EC is that it measures people’s preferences. When everyone is clearly better or worse off due to a certain action, or people are indifferent, it is straightforward what should be done. But in most cases some people are better off, several are indifferent and others are worse off. If this is the situation, one has to compare the gains and losses of the different individuals involved. Comparing preference is thus complex as it is subject to people’s tastes and values. However, the way in economics to determine the value of EC is by estimating the Willingness to Pay (WTP) or the Willingness to Accept (WTA). These are two manners in which people state how they value a certain asset. The WTP is the maximum amount of money an individual is willing to give up, to pay, to preserve an environmental asset. In contrast, the WTA shows the minimum amount of money a person wants to receive as compensation for the damage of an environmental commodity.12

When determining EC, one has to take into account several ways in which individuals value assets. First of all there is Use Value (UV). This originates from the idea that an individual values planning current or future use of environmental assets. Thus it deals with actual use of these environmental assets. The second value is Existence Value (ExV). This derives from the knowledge that an environmental good exists, regardless whether people make use of it or not. Besides these two values, there is also Option Value (OV). This is a value for the guarantee that the asset will still be available in the future. The last value is Quasi-Option Value (QOV). This is a value to prevent an unchangeable commitment to an environmental good from happening. People expect that future

10

Perman, McGilvray and Common (2003), p.373. 11

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Groningen, August 2008 6 By: Charlotte Bernhard development of knowledge can be more appropriate for further development of the asset and therefore the asset has to be saved now. Out of all this follows that: 13

ܧܥ = ܷܸ + ܧݔܸ + ܱܸ + ܱܸܳ This can also be written as EC being the Total Economic Value (TEV):

ܶܧܸ = ܷܸ + ܷܸܲሺ݋ݎ ܷܸܰሻ

According to Willis and Corkindale (1995) use value is a value that is related to some form of activity, monetary expenses or time expenses. It can be divided into direct and indirect UV. The first category is what is described above as use value. Under the second type fall the other life supporting services that the natural environmental offers. In the description of Perman et al. (2003) used above, this value is covered by the EV.

The terms Passive Use Value (PUV) and Non-Use Value (NUV) can be used indistinctively. According to Turner et al. (1994)14 non-use values are non-instrumental values which are in the nature of the good, but which are not connected to real or optional use. It is a value that cannot be associated with any form of economical behavior. However, the term non-use value can give confusion, therefore some researchers choose to use the name passive use value. That is what this paper will do too, as in the model outlined here, option value in included in the passive use value. 15

After understanding these different types of value, it is essential to know how these values are estimated to get the value of the EC. To be able to estimate these values, one looks at the changes in utility.

2.1.1.1. The value of the EC for a market good

In the ECBA this value of utility is found by looking at the Marshallian Consumer Surplus (MCS). The MCS is the difference between what a consumer is willing to pay for a good and the price that he or she truly pays.16 This is the area under the demand curve and above the price which has to be paid; the shaded area in figure 2.1. shows the MCS. When comparing an old and new situation, the MCS is the area under the demand curve and between the two different prices. In the case of an environmental good, the MCS is commonly determined by looking at the difference in the utility level before and after the damage. By measuring this change in utility, an economist can for example measure how much a consumer is harmed by environmental destruction.

13

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Groningen, August 2008 7 By: Charlotte Bernhard Figure 2.1. Marshallian Consumer surplus (MCS).

An important assumption made with the MCS is that the marginal utility of income is constant. The marginal utility of income is the additional utility that is generated by an extra unit of income. When that is constant, every extra unit of income ensures the same amount of additional utility.17 It is not ideally to accept this assumption and therefore Hicks developed a set of measures where this condition and other restrictive assumptions are not necessary.18 He developed a monetary measure that makes one able to place a monetary value on an utility change, instead of a change expressed in quantity demanded as with the substitution and income effect. The monetary measures of utility change associated with a price change developed by Hicks are:

- Compensating Variation (CV); this is the income adjustment that would compensate for the change in price.19 Or otherwise said, it is the amount of money by which an individual would need to be compensated for a price change to remain at his initial level of utility.20

- Equivalent variation (EV); this is the correction in income that is equivalent for the announced change in price.21 Which means a change in income that is equivalent in its effect on utility to a change in the price of a commodity.22

17

Katz and Rosen (1998), p.90. 18

Katz and Rosen (1998), p.101. 21

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Groningen, August 2008 8 By: Charlotte Bernhard In the case of an increase in price, the CV is the minimum amount of income a person wants to receive to stay on the same utility level as before the price change. This is the same as the Willingness to Accept (WTA). The EV is the maximum amount of money an individual is willing to pay to keep the price increase from happening ending up on the same utility level as if the price increase had occurred. This is the Willingness to Pay (WTP). When a drop in price takes place, it is just the other way around. The CV illustrates then the WTP, while the EV shows the WTA.23 This can also be seen in table 2.1. Which one of these two values can be used best depends on the situation one is in and on how the property rights are distributed. When in the current situation the site is untouched, the consumers have the implicit property right of that public good and this situation is taken as reference point, one should ask about the WTA. However, when the site is disturbed, the individuals have no property rights and this situation is taken as the reference point, consumers should be asked about their WTP.24

Table 2.1. Compensating Variation and Equivalent Variation25

CV EV

price fall WTP WTA

price rise WTA WTP

The CV and EV can only be seen in a figure with a Hicksian demand curve. A Hicksian, or also called a compensated demand curve shows the relation between the quantity demanded and the price of a good, while the prices of other goods and the utility level remain the same. So consumers are compensated with enough income to keep them at their initial utility level. This is contrary to the Marshallian, or uncompensated demand curve which explains the relation between the demanded quantity and the price of a good while keeping the price of other goods and the income level constant. When having a Marshallian demand curve, a change in price will give a substitution and an income effect, while a Hicksian demand curve only shows a substitution effect. In a figure with a Hicksian demand curve the CV and EV can be distinguished, as explained above, while in a graph with a Marshallian demand curve, it is not possible to determine the CV or EV, and only a MCS is found. The Hicksian demand curve, however, gives a true value of WTA and WTP since it compensates for income differences. As the Marshallian demand curve is not able to compensate for that, a change in price and thus a change in utility, results in the MCS.

This can be seen in figure 2.2. which shows the values of CV, EV and MCS when a price fall occurs. The curve HD1 is the Hicksian demand curve at the initial utility level (U1). It shows the maximum amount of money people want to give up for the price decline to happen so that they stay at their initial utility level (U1). This WTP or CV value is equal to the area between P1, P2, A and C.

23

Perman, McGilvray and Common (2003), p.405-407. 24

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Groningen, August 2008 9 By: Charlotte Bernhard While the HD2 curve is the Hicksian demand curve at the new utility level (U2). This one shows the minimum amount of money consumers want to receive when the price decline does not happen in order to stay at their new utility level (U2). This WTA or EV value equals the area between P1, P2, B and D. The MD curve is the Marshallian demand curve. The value of the Marshallian Consumer Surplus is equal to the area between the points P1, P2, A and D.

Figure 2.2. The values of CV, EV and MCS

As one can see, the MCS is a value that lies in between the WTP and WTA in the following way: WTA > MSC > WTP. 26 The WTA is most of the time higher than the WTP as people value a loss higher than a gain and they thus want to get more compensation when something bad happens then they want to pay for something bad not to happen.27 Except when the income elasticity of demand for the good is zero. Then the CV and EV values are equal.28

These values of EV, CV and MCS are the possible results for a market good, depending on if one can get a Hicksian or a Marshallian demand curve. However, for a non-market good the situation is somewhat different. Therefore this will be explained in the next section.

26

Hanley et al. (1997), p.395. 28

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Groningen, August 2008 10 By: Charlotte Bernhard 2.1.1.2. The value of the EC for a non-market good

In contrast to the previous section Hicks uses Compensating Surplus (CS) and Equivalent Surplus (ES) for a non-market good. These two surpluses measure the change in utility due to a change in quality or quantity of the good, changes that are often linked when discussing environmental goods. Besides that, the quantity or quality measure is non-exclusive and non-divisible.29 This means that every individual can make use of the commodity; one cannot exclude him of herself from using the good. Thus everybody in society has to pay for it. And as the asset cannot be divided among individuals, one cannot get just a part of the good.

A quality improvement or a rise in quantity has the same effect as the price fall explained before, at least when nothing else changes. The same is true when the opposite occurs. This means the following connection for the CS and ES values with WTP and WTA which can be seen in table 2.2.

Table 2.2. Compensating Surplus and Equivalent Surplus30

CS ES

Improvement WTP WTA

Deterioration WTA WTP

When CV and EV are used, a relationship with MCS is found. However in this case, research of Bockstael and McConnell (1993) says that these assertions cannot just be incorporated for ES, CS and MCS values. And therefore, the MCS should not be determined for an environmental asset. On the other hand, it is not known with which errors a MCS value has to deal in relation to the true values of WTA and WTP. Therefore still many researchers do use the MCS value as an estimation for the value of an environmental good and they hope that the involved errors with respect to the values of CS and ES are not too large.31

Thus, to value non-market goods CS, ES and also the MCS values are used. However, now it is important to know how these values are estimated. This is done by using valuation methods. And these are described in the subsequent paragraph.

2.2. Valuation methods

Regarding to the previous paragraph WTP and WTA should ideally be calculated, but the MCS is frequently determined. Even though it is unclear how appropriate that value is, compared to the ES and CS. However, to get one of these values a valuation method is necessary. In this section, the various valuation methods for valuing an environmental asset will be discussed. Several of them estimate the real values of WTP or WTA. Nevertheless, most methods give an approximation of the MCS as an indication of the value of an environmental commodity.

29

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Groningen, August 2008 11 By: Charlotte Bernhard Valuation methods are developed by economists to determine the value of goods and services that are not traded on a market, like environmental assets. One of the reasons is that it is easier to decide what to do with for example a natural area, when one knows its value. But the most important ground is that environmental valuation makes it possible to measure environmental impacts. These impacts should be taken in when measuring economic performance. And since the end of the 1980’s, courts in the USA use the value of the environmental impact as a basis for the amount of compensation that polluters are forced to pay when causing environmental damage. Also this environmental impact value is used in the ECBA as an estimate of the environmental costs.

As said before, the various valuation methods estimate a value for WTP, WTA or MCS. Which one of these is estimated depends on the method used. According to Turner et al. (1994)32, one can divide the different valuation methods in two main groups. Specifically, methods that use a demand curve to value an environmental asset and a group of methods that do not use the demand curve. I will explain the diverse methods of these two groups below, by first telling more about the group that does not use a demand curve.

2.2.1. Non-market demand curve approaches

Non-market demand approaches are not able to provide precise valuation information and welfare measures. Nonetheless, they are still used a lot by governments to measure the costs of environmental impacts and to determine policy responses. They can be divided in four methods as can be seen in table 2.3. later on in section 2.2.2.3. First there are the dose response methods. These methods need data which link the physiological response of humans, plants and animals with stress of pollution.33 When talking about a firm, this method measures the direct effects which environmental damage can have on the profits of a company. This is especially the case for firms that depend on natural inputs, like wood or vegetables, which can be affected by pollution and thus lose profit. On the other hand, other companies that produce pollution profit from polluting and raise their profit. Despite all this, the damage of the pollution is bigger than just the loss or gain of companies. All these other aspects are not included in the value of the environmental damage measured with the dose response methods.34

Secondly, there are the replacement costs methods. With these, one considers the costs of repairing or replacing a damaged good as the value of environmental damage. However, the difficulty with this method is to determine to what standard the damaged good has to be repaired or replaced.

The third non-market demand curve approach deals with mitigation behavior. This is measured in terms of averting expenditures. One can think of individuals that buy for example isolation material to protect their house against noise nuisance. The expenses for these materials express the value of the noise pollution.

32

Turner, Pearce and Bateman (1994), p.114-115. 33

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Groningen, August 2008 12 By: Charlotte Bernhard The last method is the opportunity cost method, otherwise known as the effect on production approach. It values the benefits of environmental protection in terms of what is spent to achieve it. It assumes that the landowners or land users posses the property rights to the area. If the government wants to make use of that area they have to compensate the land owner. This compensation sum is then the value of the area.35

In contrary to these non-market demand curve approaches there are also the approaches that make use of a market demand curve. These are defined in the next part of this thesis.

2.2.2. Market demand curve approaches

The approaches that use a market demand curve are divided in various categories in literature. Sometimes a distinction between direct and indirect methods is made, while others make a difference between revealed and expressed preference methods. I will explain both divisions in the next two sections, beginning with the direct and indirect methods. After that the specific methods will be explained. Three of them in more detail as they are the most frequently used.

2.2.2.1. Direct and indirect methods

In books like Perman et al. (2003), Van Kooten and Bulte (2000), Hanley, et al. (1997) and Tietenberg (2003) the market demand curve approaches are separated into direct and indirect methods. The direct approach just examines the good it wants a value for, while an indirect approach considers prices of other goods that are necessary to use this environmental asset, as a reasonable manner to value the environmental good. The indirect approach looks at goods in a related market that do have a price and that have a link to the unpriced environmental commodity. Assumed is that when the quality of the environmental good changes, the demand curve of the related good changes as well. If one can put a value on this observed change, a value for the change of the environmental asset is found.

The idea behind this is that when a change happens and one has a Hicksian demand curve, the area above the price and between the two compensated demand curves is the CV. And this CV is equal to CS if the following requirements are met. First, the related good has to be non-essential. This means that if someone cannot buy any of the related good, he can be compensated for that by a certain amount of income so that he keeps the same level of utility. Beside this, the weak complementary condition has to be met. When somebody does not make use of the related good, he does not place any value on the quality of the environmental good. Hence, then a change in quality of the environmental commodity does not influence the individual’s level of utility.

However, this would ideally be the case, but when using an indirect approach, it is impossible to determine a Hicksian demand function and thus one has to work with an uncompensated,

35

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Groningen, August 2008 13 By: Charlotte Bernhard Marshallian, demand function. Then only the MCS can be estimated as a value of the environmental asset, which only estimates the use value of the asset.

When using a direct method, this problem does not occur, because one directly determines the CS value and consequently one can estimate the use and passive use values. Nonetheless, these direct methods are in many cases impossible to use as a compensated demand curve cannot be found. That is why the indirect Marshallian demand curve methods are still popular. 36

So the direct method can measure the use and passive use value by estimating the CS or ES value of the researched good. The indirect approaches measure only the use value by looking at what happens to a related market, and thus priced, good when a change in quality or quantity occurs for the investigated asset. This is the distinction between the direct and indirect methods. Now I will discuss the difference between the revealed and expressed preference methods.

2.2.2.2. Revealed preference and expressed preference methods

The other distinction that is made in books like Turner et al. (1994), Hodge (1995) and Willis and Corkindale (1995), is between revealed preference methods and expressed, or stated, preference methods. The revealed preference methods assume that the demand curve for an environmental good can be revealed by looking at the purchases of related goods which are dealt with on the market. These related goods can be complementary of other products which are inputs in a household production function. The demand of an environmental commodity can be measured by examining the individual’s real behavior towards these related goods compared to their demand for other goods.37

The stated or expressed preference methods avoid looking at a complementary good to determine a demand curve for a non-market environmental asset. Instead, these techniques estimate how much an individual implicitly values an environmental product by explicitly asking how much he or she values the good. This is often done by using a questionnaire in which hypothetical situations are created to ask how a person values the asset.38

The advantage of revealed preference techniques is that they observe choices made in the real world and not, as the expressed preference methods, in a hypothetical situation. Another advantage of revealed preference approaches is that the results can be tested which is not the case for expressed preference techniques.39 On the other hand, these last manners can measure the use and passive use values of an environmental asset. While the revealed preference methods can only measure the use values of the good.

36

Turner, Pearce and Bateman (1994), p.116 and Willis and Corkindale (1995), p.146 and p.149. 38

Hodge (1995), p.73-74. 39

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Groningen, August 2008 14 By: Charlotte Bernhard 2.2.2.3. Dividing the market demand curve approaches

The distinction of direct and indirect methods looks similar to the revealed and expressed preferences separation, but there is a small difference due to the ability of the indirect and direct methods to split up into observed and hypothetical behavior.40 This can be seen in table 2.3. on the next page. This results in a separation into four main categories. And one can see that the direct hypothetical methods are identical to the expressed preference techniques and the indirect observed behavior methods are the same as the revealed preference techniques.

Table 2.3. Dividing valuation methods41

Method Market demand curve approaches Non-market demand curve

approaches

Direct Indirect Dose response methods

Replacement costs methods

Mitigation behavior methods

Opportunity costs or effect in production methods Observed behavior Market price Simulated markets Revealed preference methods

Travel Cost Method (TCM) Hedonic Price Method (HPM) - Hedonic property values - Hedonic wage values Avoidance expenditures Hypothetical behavior Expressed preference methods

Attribute based models: - Conjoint Analysis - Choice Experiment - Contingent Ranking Contingent Valuation Method (CVM) Choice Modeling

The first group, of the direct observed behavior methods, can estimate a value for the environmental good by looking at individuals and their behavior towards the actual researched good. When looking at a market good that has a price on the market, one values the asset according to the market price. This is just the situation we know and see in the market.42

The second group of approaches is that of the indirect observed behavior methods, or the revealed preference methods. This means that these methods observe the actual behavior of individuals, though, concerning a good that is related to the environmental asset. It is this related market good that has a market price in a related market. Therefore it infers a value for the environmental asset, instead of estimating it directly. The most popular methods of this group are the

40

Tietenberg (2003), p.38. 41

Tietenberg (2003), p.39 and Turner, Pearce and Bateman (1994), p.115. 42

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Groningen, August 2008 15 By: Charlotte Bernhard Hedonic Pricing Method (HPM) and Travel Cost Method (TCM); literature and research pay a lot of attention to them. This is why these two manners will be considered in more detail further on in this section.43

The third category is that of the direct hypothetical methods, also called the expressed preference methods. These look at hypothetical or expressed behavior concerning environmental assets. The most used approach of this group of methods is the Contingent Valuation Method (CVM), to which more attention is paid later on in this section. The other method of this group is Choice Modeling. This approach asks people about different hypothetical situations. In every situation the level of attributes varies and by doing that the environmental situation changes. An individual does assign a value to an environmental attribute when choosing between the diverse situations.44

The last group of methods is that of the indirect hypothetical methods. These are approaches in a hypothetical situation which consider goods that are related to an environmental asset. Contingent Ranking is one of these methods and it gives respondents a set of hypothetical situations that differ in the environmental amenity available. People are asked to rank these situations. The situations thus ranked can be compared and one can see tradeoffs made between the environmental amenity and other characteristics. If some of these characteristics have a monetary value, this value can be used to assign a value to the environmental amenity.45 In the next paragraph, the three most used methods which I skipped before, the HPM, TCM and CVM, are dealt with more in depth.

2.2.2.3.1. Hedonic Pricing Method (HPM)

The HPM is one of the more frequently used indirect revealed preference techniques. It was first designed at the beginning of the 1970s and derived from the theory of value characteristics. The method is based on the idea that the a consumer’s utility for a good or service relies on the characteristics it has.46 The HPM wants to find a relationship between the levels of environmental services and the prices of marketed goods. And it has been used to value matters like noise trouble or air quality.47 The method uses the statistical technique of multiple regression analysis to derive the value of the environmental asset from a related market.48

There are different ways to handle the method, but the two ways in which the method is applied mostly are the Hedonic Property Values way and the Hedonic Wage Values manner. The Hedonic Wage Value manner looks at the wage compensation a person gets when exposing him or herself to certain dangers.49 However, the most common form of HPM is the Hedonic Property Value method. The idea is that house prices include also factors like air quality, noise and scenery. When

43

Perman, McGilvray and Common (2003), p.436-439 and Tietenberg (2003), p.39-41. 45

Garrod and Willis (1999), p.87. 47

Hanley and Spash (1993), p.74. 48

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Groningen, August 2008 16 By: Charlotte Bernhard keeping all other factors equal and changing only one feature it becomes possible to determine a price for that particular non-market good. These factors can be facilities in the neighborhood, the size of the house, air quality, and etcetera. In real life it is practically impossible to find two similar houses which have only one distinguishing factor. Therefore, it is necessary to consider a large amount of houses. Then the statistical analysis can take into account many different factors of influence on a property price. As a result it is conceivable to discover a relationship between the property price and the various attributes.

The method does have disadvantages. First the weak complementary assumption has to met.50 This means that the passive use values are not included in the estimated outcome. Furthermore it requires gathering a lot of information and data about factors of impact on house prices. The presence of the Geographical Information System (GIS) simplified the collection of data about property factors and therefore the use of the HPM. However, it is still a user unfriendly method, because a high statistical level is needed to separate out other impacts and factors of influence to estimate a relation between property price and an environmental asset or quality.51 Besides that, the approach assumes that people have the opportunity to choose a combination of preferred property conditions given their income constraint. However, the house market is not a perfect market. As it happens, prices can be prejudiced from outside. For instance, the government can stimulate prices by changing interest rates of taxes. Also, it is possible that demand for certain houses decreases when being too far away from a city where many people work.52

On the other hand though, HPM has the advantages of an indirect method. It looks at real behavior of people and the results can be tested. Besides that, it can estimate the value of one specific characteristic. When one wants to know the value of such an attribute, the HPM can be applied. Therefore the method is often used. However, if it is a good method to use in my Schiermonnikoog case is discussed at the end of this chapter.

2.2.2.3.2. Travel Cost Method (TCM)

In addition to the HPM, the TCM is the most used indirect observed, revealed preference method.53 The TCM was developed in 1947 with the objective to measure the revenues of a national park.54 For the park no entry fees were raised and as a result it was unfeasible to determine the returns of the park. Although introduced as a manner to estimate the recreational value of an environmental site, it also became a way to value a non-market good and a method to value environmental damage.

The method is based on the idea that it must be possible to find an inverse relationship between the travel costs and the amount of visitors coming to a certain site. Thus the recreational value

50

Turner, Pearce and Bateman (1994), p.120-122. 52

Hodge (1995), p.65. 54

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Groningen, August 2008 17 By: Charlotte Bernhard visitors give to a certain environmental asset can be determined by looking at how much it people cost to make use of the investigated good. It also enables one to estimate the value of environmental damage by revealing the value of the area before and after the harm.55 The simple TCM assumes that the costs for traveling, lodging and equipment are the costs to utilize the recreational area and can therefore be seen as the price for visiting a national park.56 The method supposes further that these travel costs can be compared with entry fees and that these incurred costs, in a certain way, reflect the recreational value of the site. Also is assumed that visitors react the same to changes in travel costs as they would to adjustments in entry fees Besides this, the TCM relies on the weak complementary condition and the non-essential assumption. And it is based on the marginal utility condition that explains the choice of the amount of visits to the site. 57

The TCM can be implemented by taking questionnaires. A researcher can establish the travel costs and, accordingly, the relation between the amount of visits or visitors and the travel costs can be discovered by setting up a trip or visitor generating function. Then an entry price can be included in the model and so the demand curve can be determined. 58 With this demand curve, the Marshallian Consumer Surplus can be derived indicating the WTP for using the site.

However, as mentioned before, the MCS is a value between the true values of WTP and WTA and for a non-market good one does not know how to compare MCS values to the real values of CS and ES.59 So predicting the MCS is a shortcoming of this method, and it is not the only one. In a simple TCM is assumed that the number of visits or visitors only depends on the travel costs, but this is a too straightforward statement. The decision about how many times to visit a recreational site also depends on other factors, like income, availability of substitute sites, personal tastes etcetera.60 Another factor of influence on determining the number of visitors is the availability of substitute sites. People can choose to visit a substitute site instead, but that does not mean that they do not place a value on the examined site.

Besides the factors that influence the choice of the amount of visits, the height of travel costs is hard to measure. Subject to a lot of discussion, is the consideration of travel time. Traveling to and being on a site takes time and time has an opportunity cost. This opportunity cost should be taken along in the travel costs. Difficult though is to know exactly what the opportunity costs of time are. In the economy, leisure time is often seen as time in which one could work, so there is a loss of income. Another aspect of travel costs is that people sometimes undertake a multiple destination or multi-purpose journey. This means that one visits more sites than just the researched site. It has to be decided which part of the travel costs can be subscribed to the site. In addition to these factors, a

55

Hodge (1995), p.66. 56

Willis and Corkindale (1995), p.81. 57

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Groningen, August 2008 18 By: Charlotte Bernhard researcher has to deal with more features of the travel costs, like dining out which is more expensive then eating at home.61

And there are also other issues that influence the value a person gives to a site that cannot be discovered when just looking to the travel costs. Travel costs can underestimate the value in the case of non-paying visitors, like hikers, that come to visit the site or people that move to a place nearby to be able to regular visit the site.62 It can however also overestimate the value of a person, when that person discovers the site to be congested when arriving there.63 And as being an indirect and a revealed preference method, the TCM has the disadvantage of determining only the recreational value of a site and it does not include the passive use values.

However, this last aspect has also the advantage that it looks at the real costs people incur in order to use the environmental asset. The prices for these related goods are determined on a market. Furthermore, it looks at actual behavior, revealed preferences, instead of a hypothetical situation and therefore the outcomes can be tested. Furthermore, collecting data for a TCM model is easier compared to HPM and CVM, which is explained below. To solve many of the problems the TCM experiences research is done which has improved the method as answers are found to deal with the problems. And still more research and discussions take place to further enhance the approach. Therefore the method is used a lot as it is pretty simple to collect data and estimate an outcome. With all the improvements and discussions the results get closer to the true value of a site, even though it estimates only the MCS which does not include the passive use values. A method though that is said to estimate a value which includes use and passive use values is the CVM. This method is now explained in the following section.

2.2.2.3.3. Contingent Valuation Method (CVM)

Besides the HPM and TCM, the CVM is also one of the most commonly used methods. In contrary to the other two approaches, the CVM is a direct hypothetical and expressed preference method. It was first suggested around the same time as the TCM as its counterpart. It directly asks people how they value a certain asset and it thus shows their expressed or stated value for the good.64 And its valuation is contingent on hypothetical scenarios put to respondents.65 However, many economists at the end of the 1940’s considered the purchase of market goods as the only convincing expression of preference, and therefore the TCM was accepted faster than CVM.66 This changed though in time and nowadays the approach is commonly used to estimate the value of changes in the

61

Turner, Pearce and Bateman (1994), p.117 and Perman, McGilvray and Common (2003), p.416-417. 62

Hodge (1995), p.69. 64

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Groningen, August 2008 19 By: Charlotte Bernhard level of public goods and services which are not traded on a market and that are non-excludable and non-divisible.67

The CVM asks people what their WTP or their WTA is in a hypothetical situation by using questionnaires which poses questions about how people value the certain good. There are diverse ways to formulate a question. Those different ways exists to bypass some of the disadvantages of the method.68

Explicitly, the first constraint of this technique that rises is that it can cause strategic bias. This means that the respondents can give a strategic or biased answer which influences the decision making process, since they know they do not actually have to pay the value they say they are willing to pay. And this is only one of the many biases that exist when performing a CVM research.69

There can also be a starting point bias. Most questions to determine WTP give a bid and an individual can say whether he or she is willing to pay that amount of money. This is done for several different bids. Hereby it is important what the starting bid is, because most people want to do something price worthy, so they want an ultimate WTP bid which is above the starting bid. This is known as the warm glow effect; most people get a satisfied feeling when saying they are willing to pay a higher amount of money then the starting bid.70

Another difficulty of the CVM is that the answers depend a lot on how the question is formulated. Essential is whether the questionnaire deals with WTP or WTA, since these are totally different amounts. WTP asks people what they want to pay to preserve a certain environmental asset, while WTA requests what people want to receive as compensation for a deterioration of an environmental good. Some researchers prefer to ask for WTP, since people are more used to that. On a normal market WTP for a good is required and therefore people are not used to receive compensation. From this uneasiness with determining WTA rises that WTA outcomes are much higher than WTP results. This outcome is thought to be a result of showing what people would like to see happening, instead of being a real value for the asset. Another explanation is that individuals encounter the costs of a loss much more intense than that they experience the revenues of a gain. However, in particular situations people think it is unfair they have to pay for conservation of an environmental area. They see that as a job of the government. In that case it may be better to ask for WTA, although people can also feel that in this situation no amount of compensation will be enough.71 Furthermore, it turns out that when asking individuals what their WTP is for a certain part of an environmental asset, it is roughly the same amount of money as when asking what their WTP is for the whole environmental area. This is called part-whole bias, and derives from the fact that most people have an unclear idea of their recreational budget. To prevent this from happening, the

67

Hodge (1995), p.75. 71

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Groningen, August 2008 20 By: Charlotte Bernhard researcher has to make clear to every individual that he or she has its own limited recreational budget.72

Besides this, CVM can also raise vehicle bias. This deals with the choice of payment vehicle which can be for example paying taxes or giving money to a charity. The chosen payment vehicle in the questions is vital to respondents, because it has to be a realistic route of payment which has the confidence of the respondents.73

Most of these biases occur as a consequence of using hypothetical situations in the questionnaire. This is seen as the main shortcoming of the CVM, which is a direct expressed preference method. And related to this is that the outcomes of CVM cannot be tested, which applies to all direct methods.

Despite the constraints, the CVM does have some advantages compared to the indirect methods. The approach can measure both use and passive use values. Next to that, the answers given show directly the WTP or WTA and consequently give the theoretically correct monetary measure for changes in utility, the ES or CS values.74 And just as with the TCM, researched is done in literature to overcome the disadvantages. This resulted in the development ofa guideline on how to use the CVM in a way that deals best with its disadvantages. This guideline says that the most accustomed manner to make use of the CVM is by asking households what their WTP is to preserve an environmental asset. This WTP can best be collected through taxes, because people have much confidence in that kind of institution. A way to ask the questions about WTP is by mentioning particular amounts of money that can be paid to taxes. However, this guideline cannot conquer all biases as a researcher still depends on the answers of the respondents. One can partly overcome that by personally interviewing visitors, this is an expensive and time consuming way.

The estimated outcomes of a CVM study are said to be approximate values of ES or CS. However, as the method deals with hypothetical situations this can raise biases in the responses. And these biases will influence the outcome. A guideline is developed to overcome some of these biases, but as it depends on the answers of people they will always be of influence. To get the best results, personal interviews should be undertaken, but this takes a lot of time and is costly. If it is the best method for my case of Schiermonnikoog I will discuss in the final paragraph of this chapter.

2.3. Conclusions

At the beginning of this chapter I have described how valuation of non-market goods work. An economical value for a non-market good is determined by estimating the WTP or WTA of people. The CBA and utility theory are explained to better understand these WTP and WTA values and the non-market valuation technique as I want to have an answer to the question “how can the economic value

72