4Environment and Natural Resource Economics Course4 irreversibility.ppt

Environment and Natural Resource Economics Course
Nanjing Agriculture University
September 4 to September 30, 2006
Lecturers: Volker Beckmann, Humboldt University  Max Spoor, ISS, The Hague
Justus Wesseler, Wageningen University
Lecture 4
Environmental Cost - Benefit - Analysis
under Irreversibility, Risk, and Uncertainty
Lecturer: Dr. Justus Wesseler, Wageningen University
Option Value
Value relates to the willingness to pay to guarantee the availability of the services of a good for future use by the individual.
Concept was introduced by Weisbrod (1964) in considering a national park and the prospect of its closure. He argued the benefit of keeping the park open would be understated by just measuring current consumer surplus for visitors and that there should be added to that a measure of the benefit of future availability -> called option value.
U(Y)
U
U(A)
U(N)
YN
Y*
Y**
YA
Y
N
A
Figure Risk aversion, option price and option value (Perman et al.: page 448)
C
YA-Y*: option price, OP, the maximum amount that the individual would be willing to pay for the option which would guarantee access to an open park.
YA-Y**: expected value of the individual’pensating surplus1), E[CS].
Option value, OV: OP - E[CS]=Y**-Y*.
“Option value is a risk aversion premium”(hetti and Freeman, 1971, )
Option Value (OV)
1) Compensating surplus: WTP for improvement of the environment to happen.
Irreversibilities
Examples:
loss in biodiversity
landscape changes
GHG emissions
several forms of pollution (pesticides, SO2)
sunk investment costs
Irreversibility with future known.
A: amenity value of wilderness area
MC: marginal costs
MB: marginal benefits
NB: net benefits
MNB: benefits
Irreversibility with future known.
A1: amenity value now, period 1
A2: amenity value in the future, period 2
MNB2 > MNB1
A1NI: MNB1 = 0.
A2NI: MNB2 = 0.
A2NI > A1NI
Irreversibility with future known.
Considering irreversibility:
Optimal preservation at AI1, AI2
Cost