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Chapter 7-2.docx

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ECON 3220
Ali Kamar

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 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 o Price of a house can be broken into components  Structural characteristics (S): age, lot site, square footage, number bathrooms, etc.  Neighborhood characteristics (N): crime rates, school quality, distance to hospital and fire station, etc.  Environmental characteristics (Z): air quality, open space, distance to landfill, visual amenities  If two houses have exact same physical and neighborhood attributes but one has a beautiful view outside, its price is likely to be higher  People are willing to pay extra money for that view. This is what the HPM tries to isolate from house prices.  The objective of the HPM is to estimate a demand curve of environmental quality indirectly from the market transaction data of a related good  This demand curve can then be used to measure the change in TWP (value of benefits) for a change in enviro quality  HPM has been widely applied to the real estate market to examine the effects of property values on environmental attributes such as: o Distance to a contamination site o Large farm operations o Open space and land use patterns o Water quality How to implemen
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