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The external effects described above cannot be valued directly from market data, because there are no “prices” for the resources associated with the external effects (such as clean air, or clean water). Hence indirect methods have to be adopted. Values have to be inferred from individuals’ decisions in related markets, or from directly eliciting the WTP for the environmental good through questionnaires. Values of environmental goods are broadly divided into use values and non-use values. The former comprises those values that result from some direct or indirect use to which the environment is put. Non-use values arise when individuals have a WTP for an environmental resource even when they make no use of it, or never will make any use of it, see Perman et al. (1999) for a discussion of this distinction.
The following methods have been developed and used in valuing environmental (and other) externalities. Further details can be found in several books (Hanley et al., 1997; Bateman and Willis, 1999; Markandya et al., 2000).
Impact pathway analysis measures the losses of goods and services affected by environmental impacts which are themselves (or their substitutes) priced in the market. To identify these losses, the effects of an action are traced from the release of pollutants and their dispersion in the ambient environment through to their impacts on natural resources and on humans. Based on the changes of market prices of these goods and services caused by the environmental impacts, demand schedules and the respective consumer surplus, measures can be estimated to reflect the welfare losses. This method has been used extensively to value the impacts of air pollution generated by electricity generation and transport (ExternE, 1995; 1997; 1999). Its main limitations are (a) the physical data on the linkages are not always quantified and those that are can be highly uncertain, (b) market prices are not available for all impacts, and (c) the more sophisticated analysis of price changes requires a level of modelling that is not always possible.
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