Handbook of Environmental Economics

Chapter 14

VALUING THE ENVIRONMENT AS A FACTOR OF PRODUCTION

KENNETH E. MCCONNELL AND NANCY E. BOCKSTAEL

Department of Agricultural and Resource Economics, University of Maryland, USA

Contents

Abstract 622

Keywords 622

1. Introduction 623

2. The context of the problem 625

2.1. The individual or household’s decision problem 626

2.2. The firm’s decision process 628

2.3. Issues of scale, interactions, and complexities 630

3. The environment affects the firm’s production opportunities 635

3.1. Exact measures of the change in producer surplus 636

3.2. The single output firm 636

3.3. The multiple output firm 638

3.4. Using input demand functions 640

3.5. Implications 642

3.6. Practical approaches to measuring the change in profits from a decline in quality of the

environment

642

3.7. Valuing changes in output using a damage function 642

3.8. Valuing actual changes in output 645

3.9. Using changes in costs 647

3.10. Further complications 647

3.11. Price changes and multiple markets 648

3.12. Instability and uncertainty 649

3.13. Taking the institutional and regulatory environment into account 650

3.14. Market distortions 650

3.15. Environmental inputs and open access resources: the case of the fishery 651

3.16. Environmental influences on forestry productivity 655

4. The environment affects output produced by the household 657

4.1. The case of household production for consumption and exchange 657

4.2. Separable production and consumption 657

4.3. When production and utility maximization are nonseparable 658

4.4. The case of pure household production 661

Handbook of Environmental Economics, Volume 2. Edited by K.-G. Mäler and J.R. Vincent

© 2005 Elsevier B.V. All rights reserved

DOI: 10.1016/S1574-0099(05)02014-0

622 K.E. McConnell and N.E. Bockstael

4.5. Can the demand for the household produced good be estimated?

661

4.6. Averting behavior by the household 662

4.7. Some further considerations 665

5. Conclusions 665

Acknowledgements 666

References 666

Abstract

This chapter explores the theory and practice of measuring the economic costs and

benefits of environmental changes that influence production, both in the context of firms

and of households. The theory uses models of household and firm decision making to

map the influence of environmental changes to changes in human welfare. The goal is

to measure, by compensating or equivalent changes in incomes, the welfare effects on

people, in their roles as owners of firms, owners of factors of production, and consumers.

The developing country context is most common for valuing the environment as an

input, because agriculture and natural resource extraction are so much more important

than in industrialized countries.

When households or firms produce goods for sale on the market, and the environ-

ment influences the costs of production, we show the circumstances when one can

use information embodied in the supply curve of the marketed good or the demand

curve for an input into the production of the good to extract welfare measures for en-

vironmental change. When the environment affects the cost of production of goods

households produce and consume, we show the restrictions on production technology

that will permit welfare measure for changes in the environment. We also look at cir-

cumstances that permit the calculations of bounds for the exact welfare measures. We

explore welfare measurement under a variety of institutional structures, including gov-

ernment support for agricultural commodities and open-access fisheries. Exact welfare

measurement makes extensive demands for data. Because these demands are not often

met in practice, researchers resort to a variety of approximations of welfare measures.

We assess these approximations, comparing them with the more exact measures.

Keywords

environment as an input in production, household production, applied welfare

economics, environmental valuation, revealed preference methods

JEL classification: Q51, Q57, D13