Rationality Concepts in Environmental Valuation H O H E N H E I M E R V O L K S W I R T S C H A F T L I C H E S C H R I F T E N Oliver Frör Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Survey based valuation techniques like the Contingent Valuation Method (CVM) rely particularly on the premise of respondents‘ rationality when answering willingness to pay (WTP) questions. Results of CVM surveys have repeatedly put this fundamental assumption into question. This study adopts a more realistic view of rationality accounting for respondents‘ limited capacities to process information. Based on cognitive psychology a technique to detect and analyze the bounds of rationality inherent in WTP statements is developed. Using an empirical example, the influence of bounded rationality on the validity of CVM results is analyzed. It is shown that individual differences in information processing play a major role. From these results recommendations for future survey design are developed. Oliver Frör; 1998 Degree of a Diplom-Geoökologe, University of Bayreuth; 2000 M.A. in Economics, State University of New York at Albany, NY; 2000–2001 Consultant at the New York State Department of Economic Development; 2001 Adjunct faculty at Siena College in Loudonville, NY; since 2001 Scientific Assistant at the Department of Economics, especially Environmental Economics, Regulatory and Consumer Policy at the University of Hohenheim; 2007 Doctoral degree. H O H E N H E I M E R V O L K S W I R T S C H A F T L I C H E S C H R I F T E N Oliver Frör Rationality Concepts in Environmental Valuation Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Rationality Concepts in Environmental Valuation Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Hohenheimer Volkswirtschaftliche Schriften Herausgegeben von Prof. Dr. Michael Ahlheim, Prof. Dr. Thomas BeiBinger, Prof. Dr. Ansgar Belke, Prof. Dr. Rolf Caesar, Prof. Dr. Harald Hagemann, Prof. Dr. Klaus Herdzina, Prof. Dr. Walter Piesch, Prof. Dr. lngo Schmidt, Prof. Dr. Ulrich Schwalbe, Prof. Dr. Peter Spahn, Prof. Dr. Jochen Streb, Prof. Dr. Gerhard Wagenhals, Banctss ~ PETER LANG Frankfurt am Main •Berlin• Bern •Bruxelles• New York• Oxford . Wien Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Oliver Fror Rationality concepts in Environmental Valuation £ PETER LANG Frankfurt am Main. Berlin. Bern• Bruxelles• New York• Oxford• Wien Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Open Access: The online version of this publication is published on www.peterlang.com and www.econstor.eu under the interna- tional Creative Commons License CC-BY 4.0. Learn more on how you can use and share this work: http://creativecommons. org/licenses/by/4.0. This book is available Open Access thanks to the kind support of ZBW – Leibniz-Informationszentrum Wirtschaft. ISBN 978-3-631-75515-0 (eBook) Bibliographic Information published by the Deutsche Nationalbibliothek The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data is available in the internet at <http://www.d-nb.de>. :£ Zugl.: Hohenheim, Univ., Diss., 2007 D 100 ISSN 0721-3085 ISBN 978-3-631-57336-5 © Peter Lang GmbH lnternationaler Verlag der Wissenschaften Frankfurt am Main 2007 All rights reserved. All parts of this publication are protected by copyright. Any utilisation outside the strict limits of the copyright law, without the permission of the publisher, is forbidden and liable to prosecution. This applies in particular to reproductions, translations, microfilming, and storage and processing in electronic retrieval systems. Printed in Germany 1 2 3 4 5 7 www.peterlang.de Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Acknowledgments The work on this dissertation has been a long journey and during its course many people kept me company and have contributed to its completion in one way or many others. Most importantly, I would like to thank my first adviser and academic mentor Prof. Dr. Michael Ahlheim who guided my work in many late- evening discussions and provided invaluable advice and support. I am also indebted to my second adviser Prof. Dr. Dr. h.c. Franz Heidhues for numerous helpful discussions and important comments and suggestions on earlier versions of this dissertation. Special thanks shall be given to my former colleague at the institute Dr. Ulrike Lehr who was never too busy to listen to my unfinished thoughts and who was always available for comments, consultation and consolation, if needed. During the final phase of my work, my colleagues Isabell Benignus and Andreas Zahn took over some of my duties, for which I am very grateful. I am especially indebted to my family and my parents who never ceased to believe in my ideas and supported my work with a lot of understanding despite the long evenings and weekends I had to take off for this purpose. The completion of this work is certainly as much a relief for them as it is for me. I would also like to thank the team of the Sonderforschungsbereich 564, both in Germany and in Thailand, whose support in all matters of the research project was of great help. In Thailand, special thanks shall be given to my colleague and fellow researcher Nopasom Sinphurmsukskul, as well as to his assistant Ailada Yathuam. Without their ceaseless help the research project on which my dissertation is based would simply not have been possible. Finally, I would like to thank the Deutsche Forschungsgemeinschaft DFG who funded the research project and provided for this particularly rich and interesting time. V Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Table of content List of Figures ............................................................................... XI 11 List of Tables ................ .......... ...... ................................................ XIII iii 1 1.1 1.2 2 2.1 2.1.1 2.1.2 2.1.3 2.1.3.1 2.1.3.2 2.1.4 2.2 2.2.1 2.2.2 2.3 3 3.1 3.2 3.2.1 3.2.2 3.3 List of Abbreviations ...................... ......................... .. ................... XV Introduction ................................................................................. 1 Motivation and scope ....................................................... ............. 1 Further outline of the study........................................................... 7 Environmental valuation ............................................................ 11 Theory and practice of environmental valuation .......................... 11 Environmental valuation - why? .. .................................. .............. 11 Environmental valuation and benefit-cost analysis in neoclassical economics ................................................................. 14 Methods of environmental valuation ............................................ 20 Indirect methods ............ .. ...................... .. .. .... .. .. ............... ... ......... 21 Direct methods .. .. ............. .. ............... .. ......................................... 23 Statistical estimation models for the CVM ........... .. .... .................. 34 Rationality problems in environmental valuation ........................ 39 Biases in Contingent Valuation .................................................... 40 Rationality problems due to preference uncertainty ..................... 45 Summary....................................................................................... 49 Rationality in economics ... ......................................................... 51 Outline of the chapter .. .. .. ...... .. .... .. ................ .. .. .. ...... .. .. .. .. .......... 51 Rationality concepts in economics an overview ........................... 52 What is rationality? ....................................................................... 52 Extensions of the neoclassical rationality concept ....................... 55 Bounded rationality ................................................. ............ ........ .. 61 VII Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access 3.3.1 The emergence of bounded rationality in the literature ............... . 61 3.3.2 Evidence of bounded rationality in economics and the social 3.3.3 3.3.3.1 3.3.3.2 3.3.3.3 3.3.4 3.3.4.1 3.3.4.2 3.4 4 4.1 4.2 4.2.l 4.2.1.1 4.2.1.2 4.2.2 sciences ................... .. ............................ ............................... .. ....... 64 The psychological foundations of bounded rationality in environmental valuation ....................... ... .............. ....................... 69 Why deal with psychology? .. .. .. .... ......................... .. ....... .............. 69 Cognitive psychology and its relation to the discipline of psychology ....... .... ................................ .. ........... .... .. .. .. ..... .......... .. 72 Fundamentals of cognitive psychology ........................................ 75 Psychological models ofreasoning: dual-process approaches ..... 80 The concept of dual-process approaches ...................................... 80 Specific model approaches of dual-processes in the context of environmental valuation . ...................... ............. .. .. .... ..... ............ .. 83 Summary....................................................................................... 91 Bounded rationality in environmental valuation ..................... 93 Review and outline of the chapter . .. .. .. .................. .............. ......... 93 Theoretical considerations ............................................................ 95 Dealing with preference uncertainty: a fuzzy approach ............... 95 Fuzzy logic and fuzzy preferences . ... .. .............. ................... .... .. .. 96 Is it possible to assess fuzzy preferences regarding the environment? ... .. .. .. ...... .......... .. .. ...... ........... ........ ................. .... .. .... 99 Considering bounded rationality in environmental valuation ...... 100 4.2.2.1 What constitutes rationality in environmental valuation? The normative view .............. ......... .............. .... .................. ..... .............. 101 4.2.2.2 Why is bounded rationality a problem in environmental valuation? ...................................................................................... 102 4.2.2.3 Research questions and hypotheses .............................................. 106 4.3 Development of empirical instruments for analyzing bounded rationality in CVM ......... ,.............................................................. 109 4.3.1 A measure for individual differences in decision making: the rational experiential inventory (REI) ... ..... .......... .. ...... ........... .... ... 110 4.3.2 Adaptation of the REI to the context of the CVM ........................ 115 VIII Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access 4.4 An empirical example ........................ ........................................... 121 4.4.1 Background of the empirical research project: The Uplands Program ......................................................................................... 121 4.4.2 General research ideas and hypotheses of the subproject in northern Thailand .......................................................................... 122 4.4.2.1 Problem definition ........................................................................ 122 4.4.2.2 The empirical design..................................................................... 125 4.4.2.3 The measurement scales of bounded rationality in northern Thailand - research implementation in the survey design ........... 130 4.4.2.4 Practical implementation of the survey ........................................ 131 4.4.3 Empirical results of the project ..................................................... 132 4.4.3.1 Socio-economic and demographic characteristics of the respondent population ................................................................... 133 4.4.3.2 Estimates of willingness-to-pay for the tap water improvement program ......................................................................................... 134 4.4.3.3 Determinants of willingness-to-pay.............................................. 137 4.4.3.4 The measurement scales of bounded rationality........................... 140 4.4.3.5 Characteristics of the task independent and task dependent types .............................................................................................. 153 4.4.3.6 Bounded rationality and WTP ...................................................... 158 4.4.3.7 Detection of procedural biases and their relation to the measures of cognitive type ...... ................ ..................................... 164 4.5 Discussion and implications of the empirical results of the study .............................................................................................. 171 5 Summary and conclusions ......................................................... 179 6 References .................................................................................... 191 7 Appendix ........................ .............................................. ................ 211 7 .1 Survey questionnaire ..................................... .. .............................. 211 7 .2 Correlations of socio-economic and attitudinal variables with TIF and TDF ....................... ............. ....................... ...................... 232 IX Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access 7 .2.1 Task independent factors ............... ...... .......... ....... ........................ 232 7.2.2 Task dependent factors ................................................................. 235 X Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access i List of Figures 2-1 The concept of total economic value ............................................... 13 3-1 Classification ofrationality concepts in economics......................... 60 4-1 The fuzzy set "high income" ............................................................ 97 4-2 Possible combinations ofNFC versus FI scores .............................. 114 4-3 Three-dimensional view of the study area in Chiang Mai province, northern Thailand, schematic delineations of the Mae Sa water catchment and the survey area .......................................... 123 4-4 Split sample design of the WTP elicitation question ....................... 128 4-5 Relative frequencies of categorical socio-economic and demographic variables .... ............ .... .................... .............. .............. .. 134 XI Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access ii List of Tables 3-1 The development of the Bounded Rationality field from 1840- 1995 ·································································································· 62 3-2 Features of the four elementary dual-process designs ..................... 83 4-1 The Rational Experiential Inventory ................ .. .. .. .......... .. ... ....... .. .. 111 4-2 Task independent scale - the question items ................................... 118 4-3 Task dependent scale - the question items .................... .................. 119 4-4 Bid design of the DC and the PC elicitation question formats ........ 129 4-5 Distribution ofresponses in the split-sample design ....................... 132 4-6 Values of household size, age and income....................................... 133 4-7 Average household WTP for the tap water improvement scenario.. 136 4-8 Parameter estimates of the explanatory variables (covariates) of WTP for the DC and for the PC samples ......................................... 140 4-9 Factor loadings of the task independent bounded rationality scale ... 143 4-10 Factor analytical results of the REI items only ................................ 145 4-11 Results of the single question items of question 18 ... .. .... ...... .......... 146 4-12 Factor loadings of the task dependent bounded rationality scale (DC) ...................................................................................................... 148 4-13 Factor loadings of the task dependent bounded rationality scale (PC) ...................................................................................................... 150 4-14 Correlations among the task independent factors (TIF) and the task dependent factors (TDF) ........................................................... 152 4-15 Bounded rationality scales as explanatory factors of WTP for the DC dataset ... .. .. ... ....... ........... .. .. .. ................ .. .. ..... .. .. .. .. .. .. ..... .... .. .... 161 4-16 Bounded rationality scales as explanatory factors ofWTP for the PC dataset .. .. ... .. .. .. .. .. .......................... .. .. .. .. .. ........... .. ......... .. ........... 163 4-17 Number of respondents classified in each cognitive type factor (DC format) ... ................................................................ ................... 165 4-18 Number ofrespondents classified in each cognitive type factor (PC format) ....................................................................................... 165 4-19 Determination of the starting point bias for the DC format .... ......... 168 4-20 Determination of the anonymity and range biases .................. .. ....... 169 XIII Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access iii ABM ABCM cdf CEST CRT CV CVM DBDC DC EBA EEG ELM EV FI fMRI FtF HPM HSM MBDC MRWW MS NFC NOAA OE PC PET PVM REI List of Abbreviations Averting Behavior Method Attribute Choice Modelling cumulative (probability) distribution function Cognitive-Experiential-Self Theory Cognitive Reflection Test Hicksian Compensating Variation Contingent Valuation Method Double-Bounded Dichotomous Choice Dichotomous Choice Elimination By Aspects heuristic Electro Encephalography Elaboration Likelihood Model Hicksian Equivalent Variation Faith-in-Intuition functional Magnet Resonance Imaging Face-to-Face Hedonic Pricing Method Heuristic Systematic Model Multiple-Bounded Dichotomous Choice Mae Rim Water Works Mail Survey Need-for-Cognition National Oceanographic and Atmospheric Administration Open Ended format Payment Card Positron Emission Tomography Participatory Valuation Method Rational Experiential Inventory xv Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access REil REI2 RUM SBDC SFB TCM TDF TDFl DC TDF2 DC TDF3 DC TDFl PC TDF2 PC TDF3 PC TDF4 PC TIF TIFl TIF2 TIF3 TIF4 w. r. t. WTA WTP XVI Intuitive-experiential REI Analytical-rational REI Random Utility Model Single-Bounded Dichotomous Choice Collaborative Research Center (Sonderforschungsbereich) Travel Cost Method Task Dependent Factor Uncertain TDF for the DC respondents Analytical TDF for the DC respondents Elimination TDF for the DC respondents Uncertain TDF for the PC respondents Analytical TDF for the PC respondents Equal TDF for the PC respondents Elimination TDF for the PC respondents Task Independent Factor Intuitive-experiential TIF Analytical-rational TIF Cautious TIF Cognitive miser TIF with respect to Willingness-to-Accept Compensation Willingness-to-Pay Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access 1 Introduction 1.1 Motivation and scope The use of economic valuation methods has become a regular instrument for the assessment of the desirability of public investment projects aiming at the improvement or conservation of environmental goods. This tendency reflects the understanding that the existence of environmental goods or amenities on the one hand has a beneficial impact on various functions in society as well as in the economy, however, on the other hand comes at the cost of forgone economic possibilities or at additional public funds to be expended for conservation or rehabilitation efforts. The improvement of urban air quality through a reduction of particle emissions or the conservation of natural areas by preventing industrial development, for example, require considerations regarding the expected benefits from such measures in relation to the costs to be incurred by society as a whole. Especially in times of increasing fiscal constraints it is of particular importance to possess reliable and transparent indicators for changes in society's well-being resulting from such environmental projects for the process of public policy decision making. The special properties of environmental goods, however, pose a number of problems for the measurement of benefits they generate for society. In principle, environmental goods belong to the so called non-market goods. Examples of such environmental goods are the possibility to breathe clean air or the knowledge of the existence of certain biological plant and animal species. As in the latter example, environmental goods often have the character of pure public goods characterized by non-excludability and non-rivalry in consump- tion. For non-market goods a number of difficulties with respect to the assess- ment of the benefits they provide to society are generally encountered. The assessment of such benefits becomes relevant in case projects are carried out that go along with changes in the quality or the quantity of environmental goods provided. As is well known in the case of market commodities for which excludability from consumption holds the minimum benefit an individual derives from the consumption of such a good can easily be inferred from its price. An individual will only consume a commodity if the benefit from con- suming it makes up at least for the costs of purchasing it, otherwise he would not be willing to pay the price asked. The absence of market prices for environ- mental commodities, therefore, constitutes the main difficulty of assessing the benefits derived from their existence or consumption, or, in case of a public project resulting in a change of their quantity or quality, of assessing the change of benefits to society. Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access The aim of assessing such social benefits from a project producing or conserving an environmental good is the determination of some figure that enables a comparison of derived benefits against incurred costs. Since costs are in general conveniently measured in monetary terms it has proven useful to develop methods that are able to express the economic value of the provision of environmental goods in monetary units, as well. From this perspective it is not surprising that methods for the valuation of environmental goods were developed much in analogy to established methods of market-good valuation where the price of the good serves as the measuring rod of benefits. The most prominent and most widely used method for the assessment of changes in social well-being due to changes in environmental goods is the Contingent Valuation Method (CVM) (see Mitchell and Carson 1989 for a detailed review of the method). This method constitutes the particular focus of this study. In principle, it aims at the elicitation of households' utility changes from some envisaged or planned environmental project. Its main feature is the creation of a hypothetical market which functions in analogy to a real market in which economic agents are given the possibility to purchase the environmental good under consideration. The CVM is based on surveying a representative sample of a population that is likely to be affected by some proposed environmental change scenario. During these interviews which can be carried out as face-to-face, mail or telephone interviews the selected respondents are confronted with a specific scenario of a change in the level of an environmental good and, e. g. in the common case of an environmental improvement, are then asked a monetary amount they would be willing to pay for this improvement to actually take place. In the case of a proposed environmental deterioration respondents would either be asked their willingness-to-pay (WTP) to prevent the deterioration and stay in the present state or, alternatively, their willingness-to-accept-compensation (WTA) for their loss in well-being if the deterioration actually took place. The WTP (or in the case of a perceived deterioration the WTA) is generally interpreted as the economic agent's Hicksian Compensating Variation (CV), a theoretical measure for individual welfare changes which represents the maximum amount of money which could be extracted from an agent so that he is not worse off after the change than before. The main advantage of the CVM, however, the simulation of a market for environmental goods where in fact no such market exists, is at the same time the method's weak point. Usually, in a market households reveal their preferences by making a purchase decision and paying for the purchased good in return. As stated above, it can therefore be inferred that the value they attribute to the purchased good is at least what they have paid for it. At the same time, in a market households usually participate actively, i. e. they play an active part in searching for commodities they desire, acquire information regarding their 2 Oliver Frör - 978-3-631-75515-0 Downloaded from PubFactory at 01/11/2019 03:56:05AM via free access