How Our Brains Impede Pricing the Ecosystem

3p is proud to partner with the Presidio Graduate School’s Macroeconomics course on a blogging series about “the economics of sustainability.” This post is part of that series. To follow along, please click here.

By Bart Agapinan

Can a quirk of human psychology undermine our ability to set a fair price for ecosystem services? To try to answer that, let's start with a trivia question, and try to guess without visiting Wikipedia first. The question is, “What percentage of African countries are members of the United Nations?” Do you think it is more or less than ten percent? Go ahead and think of a number, and remember it for later on.

In most of our economic transactions we don't pay the full price for the value of what we're getting. This is in part because of externalities – side effects of economic transactions that affect parties not directly related to the exchange. Externalities can be positive – like immunizations that protect people who didn't even get a shot – or they can be negative, like the air pollution produced by a coal-fired power plant. Many negative externalities can exist because the ecosystem provides services that absorb the negative effects of economic production for free. If prices of goods and services include the cost of negative externalities, how much more would we have to pay? How do we compare a given good with an alternative that has a higher price but fewer negative externalities? Answering these questions requires us to decide how much we should value the ecosystem services we get, but don't pay for.

One way to price natural services (when a market for those services don't already exist) is to use a technique called Contingent Valuation. Contingent Valuation is a survey method in which respondents are asked a series of three types of questions. The first type is a set of attitudinal and behavioral questions toward the ecosystem service. The second type of question asks how much they would be willing and able pay for that service. Finally, the third type of question is about the survey respondents themselves, such as their socioeconomic background or their ability to use the ecosystem service in question.

One criticism of Contingent Valuation is that what people say they will do and what they actually do are not always consistent. For example, if I were to ask you how much you would be willing to donate to fight climate change, how much would you say? After reading this post, how many people do you think will go to 350.org and donate? This is not to pick on TriplePundit readers; the gap between intention and action is sometimes referred to as procrastination. Sound familiar?

Another criticism of Contingent Valuation is that answers can be biased because of a psychological effect called anchoring. Remember the question above about the percentage of African countries in the UN? In 1974, psychologists Amos Tversky and Daniel Kahneman posed this question to participants in a study, but first had them spin a wheel with the numbers 1 through 100 on it. The wheel had been rigged to always land on either 10 or 65. People for whom the wheel landed on 10 on average said they thought the answer was about twenty-five percent. If the wheel landed on 65, the guesses were about forty-five percent. Seeing the number on the wheel “anchored” that number in people’s minds and influenced their answer even though that number had nothing to do with the question.

The above criticisms highlight the difficulties when asking people to accurately report how much they would pay for ecosystem services. So what's the best way to make sure the prices we pay properly reflect all of the negative externalities our economic activity creates? As with any question in economics, the answer is "it depends." One way to figure out how much something should cost is to create a market for it. This is what the California Air Resources Board is trying to do with the new cap and trade program for greenhouse gas emissions. While the cap-and-trade market will be regulated to make sure prices don't increase too much for energy consumers, the market will be able to set a price on carbon emissions as companies buy and sell emission credits. Setting a market price on greenhouse gas emissions will not only reward companies who reduce their carbon footprint, but it will also cause companies to think twice about increasing emissions, since they will have to pay to do so.

Oh, and the percentage of African countries that are members of the UN? It's actually about seventy-six percent. How much are you willing to spend for those ecosystem services again?

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Bart Agapinan is an MBA candidate at Presidio Graduate School in San Francisco. Bart works as an Engineering Program Manager at Apple Inc., with interests in technology, design, and whatever random things come across his Twitter feed. He can be reached at bart.agapinan@presidioedu.org.

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Image credit: Matt Kieffer