3 The preferred method of estimating this change in utility is to simulate the market in order to estimate people's 'willingness to pay' (WTP) or 'willingness to accept' (WTA) a project's outputs or outcomes. Willingness to pay is the maximum amount of money an individual is willing to give up in order to receive a good. WTA is the minimum amount of money they would need to be compensated to forego or give up a good. The amount consumers are willing to pay depends to a large extent on the levels of income available to them, so valuations are usually obtained by averaging across income groups.
4 The market based approaches consist of 'Revealed Preference' approaches and 'Stated Preference' approaches.1
5 Revealed preference techniques involve inferring the implicit price placed on a good by consumers by examining their behaviour in a similar or related market. Hedonic pricing is an example of this approach. For example, the relationship between house prices and levels of environmental amenity, such as peace and quiet, may be analysed in order to assign a monetary value to the environmental benefit. Another example is the travel cost method, which involves estimating the costs people incur in order to consume a non-market good such as a recreational site.
6 Stated preference techniques use specially constructed questionnaires which describe a hypothetical choice within a hypothetical market in order to elicit estimates of the willingness to pay (WTP) for, or willingness to accept (WTA), a particular outcome. When using stated preferences the main choice is between contingent valuation and choice modelling (CM). Contingent valuation studies elicit WTP or WTA via direct questions such as 'What is the maximum amount you would be prepared to pay every year to receive good x?' (the 'open-ended' format) or 'Which of the amounts listed below best describes your maximum willingness to pay every year to receive good x?' (the 'payment card' format). CM studies, on the other hand, elicit values by presenting respondents with a series of alternatives and then asking which is most preferred. They are often used in order to value specific attributes of a good, rather than the good as a whole.
7 The technique chosen will depend on the individual circumstances, and should be judged on a case-by-case basis. As a general rule, revealed preference methods are fairly reliable, and should be used where the relevant information can be inferred. However, they cannot estimate the value placed on an asset by people who make no direct use of it. In these circumstances, stated preference methods may be helpful. In some cases, it will be appropriate to use both techniques together to, for example, check the consistency of results.
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1 More detail on the practical application of both stated preference and revealed preferences approaches can be found in the Green Book discussion paper Fujiwara and Campbell (2011), Valuation Techniques for Cost Benefit Analysis: Stated Preference, Revealed Preference and Subjective Well-Being Approaches', available on the HMT website: http://www.hm-treasury.gov.uk/d/green_book_valuationtechniques_250711.pdf. There is also more guidance on Stated Preference techniques specifically from the old DTLR, David Pearce and Ece Özdemiroglu et al. (2002), 'Economic Valuation with Stated Preference Techniques: Summary Guide', available on the DCLG website: http://www.communities.gov.uk/documents/corporate/pdf/146871.pdf