Cost benefit analysis Lecture 8 Valuations from observed behaviour · Some approaches to obtain monetary estimates: 1. Revealed preference methods Market alternatives Hedonic prices Trade-off method Travel cost method 2. Stated preference methods Contingent valuation Value of life · Putting a financial value on life (even implicitly) is unavoidable - Spending on safety, health improvements - Regulations (compliance cost) · Could consider the individuals as financial value of outputs or net outputs (e.g. gross wage, net wage)? . Issue about valuing those who do not work Resources are limited. Life is a collection of time. Form of earnings in life = value of life. Which wages to use? Benefits? Higher wages males than females - life worth more? Some people out of the labour market - zero value? = problems Purchasing behaviour that improves health - trade off Valuing life · Very few situations where individuals directly trade money for their lives . But many situations when individuals pay to avoid (usually small) fatality risks (e.g. buying a car with safety features, installing a smoke alarm, choosing jobs with different fatality risks) . This information can be used to help derive the value of a statistical life Value putting on life - maximum paid towards insurance and health. Consumers behaviour - related market. Valuation on statistical life. Cost involved to reduce the number of deaths by one. Cost involved to lower average deaths. Statistical life · Denote by opi (i = 1, · · · , n) = change in probability of (homogeneous) death for each of n individuals associated with a particular project · mi = individuals' marginal rate of substitution of wealth for probability of death · Then aggregate willingness to pay = V = - Ei mi Spi reduction in chances of death Mi : willingness to pay.
Valuing life 1 · If Ôpi = n. then the value of avoiding one statistical life is mi v =- 27 i n · Relevant to decisions involving small changes in risk probabilities · Basic approach - if people are prepared to pay £500 to eliminate a fatality risk of 1/10,000, estimated VSL = £5 million · How do you find out what people are prepared to pay? · Observe behaviour in a number of different markets, including cars (people pay extra for safety features), purchases of safety devices such as smoke alarms, and the labour market (idea of compensating wage differential) . In the labour market can also use the hedonic price approach; the difference in pay between two otherwise identical jobs with different associated fatality risks will reflect individuals' willingness to pay to avoid risk Trade off - higher risk jobs and wages. Estimating the value of life (Viscusi (1993)) · Simple labour market model · Individual worker faces a wage-offer curve (W (p)) and chooses a job with a particular fatality risk p to maximise expected utility: EU = (1-p)U(W (p)) + pV (W (p)) - p = risk of death in employment - U =