Many natural resources are not sold in competitive markets. For example, irrigation water is not often sold in a competitive market, because federal, state, or local laws restrict its use or distribution, but yet we can derive a value of irrigation water by looking at market transactions surrounding the use of irrigation water. Sometimes trying to observe the economic value of hydropower is also difficult, but since the electricity is eventually sold, we can often infer this value. To estimate the economic value of these quasi-marketed goods, we can use one of four approaches:
(1) market or transactions evidence; (2) demand estimation; (3) residual valuation; or (4) change in net income (Davis and Johnson, 1987; Gray and Young, 1984).
1.1 Market or transactions evidence
Market or transactions evidence requires observation of similar sales of resources in competitive markets to infer a value for the resource of interest.
For example, to value wetlands the city may own, the analyst might look at what private organizations such as the Nature Conservancy have paid to
purchase wetlands. The key requirement for accurate valuation with this approach is finding market sales of resources with comparable characteristics to the publicly owned resource.
1.2 Demand curve approach
A demand curve approach can be employed if there is a large enough number of past sales, or a data series of prices and quantities sold over time or across the country, to statistically estimate a demand function. Regional or time variation is important in order to get variation in price; without price variation, it is impossible to determine how the quantity responds to price.
This approach has been performed for regional and national timber demand (Adams and Haynes, 1980) and for municipal demand for water (Young, 1973, Foster and Beattie, 1979; Hewitt and Hanemann, 1995).
1.3 Residual valuation
Residual valuation involves subtracting from the total value of the output produced all of the costs of inputs except the “unpriced” input, such as water or hydropower. The value remaining after all other costs (including a normal profit, return to management, capital, etc.) is then attributed to the unpriced or underpriced public input. Thus the irrigation value of unpriced water flowing from a National Forest is the value of the agricultural crop minus all of the priced inputs, such as land, seed, fertilizer, machinery, labor and management. The key assumptions here are that all other inputs are priced and that total value of output can be apportioned according to the marginal product of the inputs (Gray and Young,
1984:171).
1.4 Change in net income
Change in net income involves simulation of a firm's or producer's net income with and without additional quantities of the environmental quality.
For example, the value of additional water to a farmer is frequently calculated by simulating how the farm enterprise would modify its operation if it had an additional 1000 acre feet of water at a given time of the year. Often this simulation is performed using farm budget data and linear programming models.
1.5 Water as a Quasi-Market Resource
Valuation of water begins our transition from marketed natural resources to nonmarketed natural resources. What is the value of an additional acre- foot of water? The first challenge in valuing this water is determining to which of its many uses this incremental flow will be allocated. Will the additional water be used in irrigated agriculture or municipal uses, or rather be left in the river to add to instream flow? In general, additions to existing water supplies are usually assumed to go to the lowest valued use of water, such as irrigated pasture or irrigated agriculture. The reason is that higher valued municipal and industrial users can normally purchase water from these lower value uses and therefore are already supplied. This is not always the case, however, as rigidities in the prior appropriation doctrine of water law in the Western U.S. gives historic senior rights to the first users rather than to the highest valued users.
After determining which water uses are most likely, the next step is to determine which of the four techniques to use. This is frequently done based on the type of water use to be valued. If the water use is irrigated agriculture, a change in net income or residual valuation approach is often used. Here, farm budgets are used to simulate the increase in crop values stemming from additional water. From the change in crop values the cost of putting this additional water to use and associated farm inputs such as additional seed, fertilizer, tractor time, etc. are subtracted to yield the change in net income.
If the use of water to be valued is municipal, then demand estimation or market transactions will frequently be employed to calculate a value of water in this use. For a discussion of valuing water, see Gibbons, 1986, or Fredricks et al., 1996.
Of course, if the additional water is to be left in the stream to enhance fisheries or recreational boating, then in most areas of the U. S. you must rely on slightly different techniques for valuation of water in these cases.
We say “slightly” different because the first technique discussed basically falls under the category of demand estimation. This technique is called the travel cost method and will be discussed in the next section on valuing recreation.