Distinguishing Externalities and Internalization

Externalities on theory, and
monetary valuation

Y. Matsuki
August 7, 2009
14:00 – 15:00
Presented at the NTUU “KPI”

What is “externality”?

Values that are not included in the market price
of electricity
Damages to Human health (death, injury, illness)
Damages to Biological resources (crops/vegetation,
forests, fisheries, aquatic, terrestrial, groundwater)
Climate change, visibility
Policy needed to secure energy supply

Graphic expression of the
externality

Demand curve
Supply curve
Price equilibrium
Marginal externality
How to adjust the externality?
External damage
External benefit

Demand curve

Effect in change of price
Shift in demand curve?
Income
Price of closely related good
Taste, or preference of consumers
Negative slope?
Lower price – more consumers

Supply Curve

Sales depend on:
Technological know-how
Cost and productivity
Input such as workers, energy
Expectations
Employee-management relations
Produce more when price is higher

Price and Quantity

Demand curve – what consumers wish to purchase at
various prices
Supply curve – what producers wish to sell
The intersection – the equilibrium price and quantity
in the market
Disequilibrium?
Excess demand, or shortage
Shortage – higher price
Excess supply, or surplus
Excess supply – down ward pressure on price

Externality

Marginal externality
Each production generates a waste
Greater the industry output – greater
pollution
The slope upward
Summing the marginal cost of each
person harmed

What happens?

With the marginal external cost, the
competitive out put is too large.
Efficiency requires that output be to the
point where the curves intersect.
But, the competitive market pressures to
an output larger than the efficient output.
What should the government do?

How to fix the problem?

To levy an excise tax on the product
To reduce the production to the
efficient level
The pollution cannot be fully
eliminated…

How can you calculate the externalities?

How to calculate the monetary
value of the health impacts

D= (x)·f(x,C(x,Q))·Uv(x) dx
impact of Area
D: damage cost (Euro, US dollars, UAH)
(x): population density (person/m2)
f(x,C(x,Q)): Exposure-Response Function
cases/(year.person. g/m3)
Uv(x): unit cost (Euro/cases)
C(x,Q): Concentration of the pollution ( g/m3)
Q: Emission of the pollution ( g/year)
x: Distance from the emission source (m)

Factor the most responsible for the
valuation
Quantity of emissions
Boundary or spatial extent of analysis and
geographic distribution of population
Dose-response functions, especially
exposure to secondary particulates and
chronic illness
Estimate of global warming impacts
Probabilities of severe accidents
Existence of highly valued ecosystems

Significant but less important
factors
Source parameters (e.g. stack height and
diameter, exit velocity of emissions)
Background levels of pollutants and
atmospheric chemistry
Meteorology
Local topography
Dispersion and transformation models used
to estimate concentration levels
Assumptions about thresholds
Economic valuation

How much economic valuation
important?
Step by step analysis = Impact
Pathway Approach == Logical
Assessing the future impact –
discount rate…?
Economic valuation is less responsible
for the impact value….

What are difficult in economic
valuation
Country specific cases
Aggregated information
Only practice can determine the
monetary values
Only that are sold have monetary
value ….?
Assessing the future impact –
discount rate…?

Monetary valuation of the damages
Damage based approach
Control cost approach
Contingency valuation
Willingness to Pay

Morbidity values.
Health end-point Recommended central unit values,
€ price year 2000
Hospital admissions 2,000/admission

Emergency Room Visit for respiratory 670/visit
illness
General Practicioner visits:
Asthma 53/consultation
Lower respiratory symptoms 75/consultation
Respiratory symptoms in asthmatics:
Adults 130/event
Children 280/event
Respiratory medication use – adults 1//day
and children
Restricted activity days 130/day

Summary of morbidity values. (2)

Health end-point Recommended central unit values,
€ price year 2000
Cough day 38/day
Symptom day 38/day

Work loss day 82/day

Minor restricted activity day 38/day
Chronic bronchitis 190,000/case

Unit cost Uv for
Long-term Mortality
Value of 1 YOLL = v = constant
v v v
Uv = v + ---- + ----- + ……+ -----
1+r (1+r)2 (1+r)N

r = discount rate of one year
N = years of human life

How to get v for long-term
mortality?
Contingent Valuation
BY asking “how much you pay for
your one year life extension”

WTP (€ price year 2002)for one year of life at age 75 and
corresponding values for one year of life immediately.
(Source:M.Johannesson and P-O Johansson (1996))

Age of Payment WTP for 1 Life WTP for 1 Life
Year at 75 Year Now

18-34 1676 7176

35-51 2120 6327

52-69 2433 3733

Value transfer model

EU UKRAINE
PPP GNP (1998) in US$ 20, 269 3,130
Unit cost
Unit cost EU UKRAINE
Chronic mortality (YOLL) 101,000 15,600
Acute mortality (YOLL) 174,000 26,900
Chronic bronchities (adults) 177,800 27,500
RAD 116 17
Respiratory Hospital
Admission 4,540 700

PPP GNP: Purchasing Power Parity Gross National Product

Value of life
ExternE project series has been using
a valuation in terms of LE loss since
1996.
With the central value of the discount
rate (3%) the resulting VOLY for total
mortality is approximately 100,000 €.

Johannesson & Johansson [1997]
2824 samples
Asked if they will pay to reach 70 y.o., after
which they will be offered high medical care
to live long.
The resulting VOLY values are very low, in
the range of $700 to $1,300. The average
of positive WTPs is about $2,700, which is
still a very low amount.
A half replied zero WTP.

Morris and Hammitt study [2001]
682 samples
hypothetical pneumonia vaccine
Half for benefit of LE gain, another
reduction of risk of deaths
30 % didn't take vaccine, because benefit
was small or uncertain.
LE gain answers, results were 52% higher
than the reduction of the risk.
Interviews were made by phone after
respondents received a mailed packet of
material.

Soguel & van Griethuysen [2000]
VOLY related to air pollution
Lausanne, 199 samples
Face to face interview
Value a bundle of health damages caused
each year, by incinerator,
6000 days of life lost, 1200 cases of
restricted activity days, 500 new cases of
chronic bronchitis and asthma.
a VOLY of 53,000 Swiss Francs (34,000 €)

Krupnick, 2002, Alberini 2001
In late ’90s, self administrated computerized CV
questionnaire
Benefits of air pollution reduction,
Cause is not mentioned
Canada, USA
1/1000 and 5/1000 risk reduction of dying during the
next 10 years, and at the age of 70 y.o.
Payment == medication and treatment for the next
10 years.
0.96 million USD for 5/1000 risk reduction
3.05 million for 1/1000 risk reduction

[DEFRA 2004]
Englnad, 665 samples, a reduction in air pollution
One, three, or six months of LE gain
In normal health and in poor health.
Avoiding hospital admission, avoiding breathing
discomroft
November 2002 and January 2003
Normal health 42,000 € for the one month sample,
15,000 € for the 3 months sample and 10,000 € for
the 6 month sample.
A VOLY in poor health is much lower (more than half
of the sample gave a zero valuation), ranging
between 7280. for the one month subsample, to 1290
. for the 6 month subsample.

NewExt [2003]
Between 2001 and 2003
A better estimate of VOLY
To minimize the cost, decided not to
develop a new questionnaire but to
apply the one of Krupnick et al.
[2002] in the UK, Italy and France.
a VOLY of 50,000€.
Only French team – additional
features….

Additional features by French team
Open question after each set of bids
And at the end of the questionnaire
WTP values were recalled to give the respondents the
chance to correct their values
Five variants were tested on samples of about 50
each, such as variants phrased in terms of LE gain
Each questionnaire was followed by detailed written
debriefing
To learn how the respondents interpreted the
questions.
The decision was made to develop a new
questionnaire.

WTP Survey EU version
Lesson 1

The study is concerned with the health consequences
that result from air pollution. It is important to take
public opinion into account.
One of the main health benefits we can attribute to a
reduction in air pollution is an increase in the life
expectancy of individuals.
The objective of this questionnaire is to find out how
much you value an increase in your life expectancy if
air pollution is reduced.
The same questionnaire is being applied in 8 EU
countries.
Answers will remain anonymous.
There are no right or wrong answers.
Just think about yourself.
Gender: __________
Age: _________

What is your profession? Or if you
are not employed, what does your
spouse do?

I. THE EFFECTS OF AIR
POLLUTION ON HEALTH
Q1 Does air pollution in your city (physically) bother
you?
. very often
. sometimes
. rarely
. never
When? Please describe (very often or sometimes)
Q2 Are you concerned with the effects of air pollution
on your health?
. very much
. somewhat
. not so much
. not at all
Interviewer: please take note of any comments made
here by respondent

In your city air pollution can mainly be
attributed to:
1. public and private transportation (cars,
trucks, buses, etc)
2. heating systems
3. household waste incinerators,
4. power plants and industry.
(show overhead “Air pollution aggression”)
In other words, through our lifestyle,
transportation needs and the goods and services
that we consume we are all responsible for
creating air pollution.

Q3 Are you aware that your consumption and lifestyle contribute to air
pollution?
. Yes
. No
Interviewer: please take note of any comments made by respondent
Breathing pollutants such as fine particulates and sulphur dioxide, is harmful
to our health; it is known to worsen respiratory and cardiovascular problems.
It increases the risk of heart disease and strokes.
It also causes eye irritation and increases the number and intensity of chronic
bronchitis, asthma attacks and emphysema.
Did you know this?
Interviewer: Take note of the individual’s level of knowledge on the subject
In order for to put this information in an everyday life context understand that
the level of air pollution in a big European city like Paris is like smoking 4
cigarettes a day.
Also, scientists have estimated that some lung cancers (perhaps ten percent
of all lung cancers) are due to air pollution.

Your health status and the heath status of your close family

Q4 To become familiar with your
health status and the health status of
your family, could you tell us if the
following individuals have ever had or
have:
YouSpouseChildrenFatherMotherBroth
ers/Sisters Eye irritation
Headaches/migraines AllergiesSinus
problems Chronic bronchitis Asthma
Cardio-
Cardio-vascular diseaseEmphysema
CancerOther serious chronic disease

Q5
Age of father: ____ . if deceased at what age ?
Age of mother:_____ . if deceased at what age ?
Q6 Do you think you are in:
. good health for your age
. average health for your age
. poor health for your age
Q7 Do you practice any (sports) physical
activity?
. several times a week
. once a week
. less than once a week
. never

Q8 Are you ?
. a smoker
. an occasional smoker
. a non-smoker
non-
. a former smoker
Q9 Do you live with a smoker ?
. yes
. no

II. THE EFFECTS OF AIR
POLLUTION ON LIFE
EXPECTANCY
Reducing life expectancy is another
major effect of air pollution on health
and this is the one that we will
concentrate on for the remainder of
the questionnaire.
Life expectancy is the number of years
you can expect to live, depending on
how old you are now. For example a
baby girl born today has a life
expectancy of 83 years, and a baby boy
has a life expectancy of 76 years. Of
course it is an average calculated for
the whole population.

Age Men Women
Birth 75 80
20 55 60
30 45 50
40 36 41
50 27 31
60 19 23
70 12 15
For someone of your age, you can
expect to live another ......... years

Your life expectancy actually depends on several
factors, which are:
1. biological (genetic)
2. social (if you live in a city, in the mountains,
your lifestyle, your standard of living)
3. behavioural factors ( you are a smoker, a
non-
non-smoker, you exercise, you eat healthy)
4. medical (you have high blood pressure,
diabetes, kidney failure)
5. environmental ( you live in a highly polluted
neighbourhood or not very polluted
neighbourhood)

We will only focus on environmental
factors, but remember the other
factors also play a role on your life
expectancy.
There have been significant scientific
advances in the past ten years and
today we can better estimate the
effects of air pollution on the health
status of individuals.
What are the effects of air pollution on
your life expectancy?
The daily inhalation of air pollutants
gradually damages the body and
accelerates the aging process.

Individuals (of all ages) who are
already more vulnerable because they
suffer from respiratory or
cardiovascular illnesses are more
sensitive to air pollution because it
aggravates their symptoms.
An improvement in air quality would
lead to an increase in the life
expectancy of the general population.
To obtain this benefit all sectors of the
economy will have to respect new
reduced pollutant emission levels.

III. POLICIES TO DECREASE
AIR POLLUTION
Let us consider two possible policies for the coming
decades that the European Union could implement
and its benefits in terms of life expectancy:
implement and its benefits in terms of life
expectancy:
Policy I, will impose a 3% reduction per year in the
emission of air pollutants for 20 years:
(which means a total reduction of 60% by 2025)
Afterwards the emission of air pollutants will be
maintained at this lower level whatever the economic
growth
The benefit in terms of life expectancy would be an
average increase of:
6 months

Policy II, will impose a 1,5% reduction per year in
the emission of air pollutants for 20 years:
(which means a total reduction of 30% by 2025)
Afterwards the emission of air pollutants will be
maintained at this lower level whatever the economic
growth
The benefit in terms of life expectancy would be an
average increase of:
3 months
* These policies do not concern the emission of
greenhouse gases but only the pollutants with direct
health effects such as fine particulates and sulphur
dioxides.
Stricter limits on emissions will be imposed on all
member countries of the UE and will be closely
monitored and enforced by the European
Commission.

This gain in life expectancy comes from an
improved health status which will slow down
your ageing process and consequently increase
your life expectancy by an average of 6(3)
months.
This is an average gain calculated for the whole
population; some individuals could gain more
than the average 6(3) months predicted while
other individuals less vulnerable to air pollution
could gain less than the average 6(3) months
predicted.
The current the level of knowledge does not
allow to predict more precisely what could be
your individual gain in life expectancy.

(“We know that many factors are
at play, including the
environmental factor. Specialists
believe that there is a genetic
predisposition could significantly
change the risk perhaps by a
factor of three, but this is still an
area of research” Doctor Aubier,
Chief of Respiratory illnesses at
Hopital Bichat in Paris, France)

Individuals potentially more
vulnerable to air pollution:
• children
• the elderly
• pregnant women
• cardiac patients
• those with respiratory illnesses
• asthma sufferers
• those with chronic bronchitis
• those who through work have to be
in contact with chemicals

To better explain what an average gain of 6 (3)
months means, here is an illustration to give
you an example
Show the graph
The graph shows very schematically the ability
of the body to survive as a function of age. If air
pollution is reduced, there is less damage to the
body. Thus, people are more able to fight off the
effects of illness and are more likely to survive
longer, as shown by the blue line. They age less
rapidly than with the current level of pollution.
This is particularly noticeable above
age 50, although it has some effect already
earlier.

The black line represents the situation we have today with
current levels of air pollution. The blue line shows what
would happen if we reduce air pollution (although the gain
is exaggerated to make it more clearly visible on the
graph). The average LE gain is about 6 months if the air
pollution is decreased by 60%.
The benefit begins as soon as pollution is reduced and
reaches gradually the full level, as suggested by the arrows
in the graph.
Note that the gain is not just a few months at the end of life
when people tend to be in poor health. To emphasize this
fact, the dashed horizontal line has been added to the graph
corresponding to a state of “good health”. The age where
the black and the blue curves intersect this line could be
called “healthy life expectancy”, at this state of good
health. The gain of “healthy life expectancy” is about the
same as the LE gain, 3 or 6 months, respectively, that we
are talking about in the questionnaire.
Are the benefits of these policies clear to you? If you have
any question please ask.

IV. THE COST FOR SOCIETY
If a policy for reducing air pollution is
implemented, all polluters (industries,
municipalities, households) will have
to respect stricter emission limits to
improve air quality. All sectors of the
economy will be affected and will need
to increase their efforts to reduce
pollution by such means as modifying
production processes and producing
less polluting cars, heating
systems etc…

This will increase the costs of industry, and as a
consequence there will be a general increase in the
cost of living. It would mean a cutback in your daily
consumption of goods and services and/or savings if
you can afford to save.
Show illustration on product price increase
To decide what financial cost will be imposed on the
economy it is necessary for you to express the value
you attribute to a gain in your life expectancy.
One way of communicating this value is to estimate
how much money, in terms of a higher cost of living,
you are willing to give up each month to obtain this
benefit. In other words, what financial effort are you
willing to make each month for this gain in life
expectancy?
Are these explications clear?
Don’t hesitate to ask questions

Q10 Are you willing to accept a higher cost of
living, therefore an increase in your daily
expenses, to gain an increase in your life
expectancy?
. yes
. no
If not, why?
Would you be willing to accept an increase in
the cost of living for any benefits of improved air
quality?
If yes
(Verbally give instructions of how to handle the
payment cards)

Q11 Average gain of 6 months
Please consider only your personal gain of life
expectancy: :
What is the maximum amount you are willing to
pay in the form of higher expenses to gain an
average of 6 months in your life expectancy?
The largest amount of your “Yes, I would pay”
cards:
____ per month (for the rest of my life)
____ per year (for the rest of my life)
Please take your time to answer, it is an
important question. If you have any question
please ask.

Q12 Average gain of 3 months
Please only consider your personal
gain of life expectancy:
What is the maximum amount you are
willing to pay in the form of higher
expenses to gain an average of 3
months in your life expectancy?
The largest amount of your “Yes, I
would pay” cards:
____ per month (for the rest of my
life)
____ per year (for the rest of my life)

To better understand your answers…
13. Do you think it is likely that a decrease in air
pollution will extend your life expectancy ?
. yes
. no
14. Does this questionnaire clearly illustrate
that the 6 months and 3 months gain in life
expectancy are averages based on the entire
French (insert your country here) population
and that this gain can be different for each one
of us?
. yes
. no

15. Did you think your personal gain of life
expectancy would be:
. close to the national average
. different from the national average
16. What reasons do you have to think that your gain
could be different than the national average?
for those whose willingness to pay is not proportional
to the gain:
17. Why did you indicate an increase in your
expenditures that is not proportional to your gain in
life expectancy?
18. How confident are you of the amount you stated
you were willing to pay to increase your life
expectancy an average of 6(3) months?
. yes I am sure
. no I am not sure

19. If you would like to change the amount you
stated, please do so now. If not, go to the next
question.
I would like to pay: ____ per month for an average of
5 months
I would like to pay: ____ per month for an average of
2 months
20. When you picked an amount, what did you think
about the most?
. only about your life expectancy
. cleaner air and its overall benefits on health (I will
breathe better, will be in better health)
. a bit of both
. other
__________________________________________
___

21. Did you think about the length
of time during which you will
have to pay ? (your whole life)

22. If you live in a 2 income household, when
stating your amount did you think about:
. Your own revenue
. Household revenue
23. If you are approaching retirement, what did
you think about when stating your amount?
. current income
. future retirement income (what amount per
month would you receive?______)
24. What expenses did you think about that you
would forgo when you were thinking of an
amount for your willingness to pay?

25. Do you have a complementary
(private) health insurance?
. yes
. no
26. Have you donated any money to
charities in the past year?
. yes
. no
27. Approximately how much?
______________

Demographics
How many people live in your
household? Including yourself:
___________
Number of children that live in your
household: __________
Age of the children:
_______________________________
______________
Do you rent or own your
house/apartment?

Education level:
. primary
. secondary
. superior
Your net revenue (per month):
. less than 1000 Euros
. 1001 Euros to 1500 Euros
. 1501 Euros to 2000Euros
. more than 6000 Euros

Household net revenue (per month):
. less than 1000 Euros
. 1501 Euros to 2000Euros
. more than 7000 Euros

TO BE FILLED BY THE
INTERVIEWER:
How cooperative have you found the person
interviewed to be?
12345
Not much Much
How much attention has the person interviewed
paid?
12345
Not much Much
Degree of comprehension
12345
Not much Much

During the interview did the person
think of another person or only of
him/herself ?
. Yes
. No
If yes did he/she mention some person
in particular ?
Duration of the interview
Address of the interview
Name of the interviewer
Interviewer comments

The usual effects are :
-Eye irritation, headaches
-Bronchitis, asthma, emphyzema
-Decrease in life expectancy due
to the body’s weakening by
air pollution

WTP Survey EU version
Lesson 2

Are you willing to accept the higher
cost of living?

When you picked an amount, what
did you think about the most?
1 only about your life expectancy
2 cleaner air and its overall benefits on health (I will
breathe better, will be in better health)
3 a bit of both
4 other

What expenses did you think about that you would forgo
when you were thinking of an amount for your willingness
to pay?

Distinguishing Externalities and Internalization

Distinguishing Externalities and Internalization

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