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Lecture

# Economics 3220 Lecture Notes - Coliform Bacteria, Air Purifier, Demand Curve

Department
Economics
Course Code
Economics 3220
Professor
Ali Kamar

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Chapter 7-2
Preventative Expenditure Method
Preventive or Defensive Expenditure Method (PEM or DEM) can be used to
measure benefits on human health of pollution reduction program using
market data on the expenditures people make to prevent or protect
themselves from the exposure of pollution
o People install home air purifiers to avoid or reduce exposure to air
pollutants
o People buy bottle water and install water filters to avoid health
problems from contaminated water.
These expenditures are observable from market transactions
The money they spend approximated their WTP to avoid health damages due
to pollution
How to implement PEM?
Step 1: Describe what pollutant is to be reduced in what geographic region
and what preventative expenditure is considered
Step 2: Collect data on expenditures made to prevent deterioration of
environmental quality in two regions
o One with high pollutant and one with low pollutant
Step 3: Estimate market demand curves of the preventative goods with the
collected data from step 2 for each region using regression analysis
Step 4: Calculate consumer surplus for each region using market demand
curves estimated in Step 3. Change in CS between two regions would be the
benefits of pollution reduction between two regions
PEM Example
Step 1: Describe pollutant, regions and expenditures
o Suppose we are considering preventive expenditures of household in
two cities on home air purifiers with different levels of ozone
City 1 has high ozone, so high demand is expected for air
purifiers
City 2 has low ozone, so low demand is expected for air
purifiers
Step 2: Collect data
o Collect time series data on the number of air purifiers sold, their
prices, ozone levels and other variable that may influence the quantity
of sale in two cities
Step 3: Estimate market demand curves
o Using time series data, set-up and estimate a regression model with
the number of air purifiers sold (Q) as the dependent variable and
prices (P), ozone (O3), number of households (HH) and other factors
(X) as independent variable in each city i,i-1,2
Qi- a + p1pi_ b2O3i + b3HHi + b4xi + error

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o Use the estimated models to trace out the demand curve of air
purifiers in two cities. Note that b1 is expected to be negative.
Step 4: Calculate consumer surplus
o Using average price of an air purifier, calculate consumer surpluses
for two cities for that price
Difficulties with PEM
It may be difficult to determine which variables should or should not enter
the demand functions, especially what “other factors: should be included
It may be difficult to find long enough time series data on selected variable to
estimate the models
PEM is applicable for valuing benefits only for those good where a direct or
indirect market price is available
Non- market valuation techniques are needed for estimating full range of
benefits of pollution reduction
Hedonic Pricing Method (HPM)
Applicable when price of a market good can b decomposed into its
components
Example