Revealed Preferences

‘Revealed’ Preference Methods

In contrast to 'stated' or 'expressed' preferences (read more about stated preferences), revealed preferences are not collected by asking individuals for their opinions or views. They are instead collected through direct observation of actual responses to complement or substitute goods. This provides an indirect estimate of the value of a cost or benefit using surrogate market goods and commodities. Valuing the impacts of projects using revealed preferences can be conducted using the following methods:

(1) Market Analogy Method

This method of using revealed or observed preferences is associated mainly with the provision of public goods. When a public good is provided it is often done so either for free, or at a price lower than the true market value. If this value was used in project appraisal it would not give an accurate value to the benefits associated with the provision of such a public good. To address this problem the equivalent good or service provided in the private sector market can be used to provide a more accurate valuation of the public good.

(2) Trade-Off Method

One method of applying a value to a good or commodity is to use opportunity cost – i.e. the value of what an individual would have to give up to obtain something – as a proxy for a good or commodity which has no market value. Two notable examples of the use of the trade-off method for calculating value are, (1) the trade-off between time and wages to provide a value for someone’s time, and (2) the trade-off between risk of fatality and wages to value life. The latter example is dealt with separately. This section now uses the example of valuing time.

To obtain a valuation of an individual’s time we can use the wage rate. This provides a value for an individual’s time assuming that the social value of an additional hour of an individual’s time is equal to the wage rate of that individual. Ceteris Paribas the value of an hour of leisure to an individual is equal to their wage rate, so that if they are paid £35 per hour worked, an hour of their leisure time is valued at £35.

There are a number of limitations to this method of valuing time. These are:

Assumes productive time. The time saved may not be used productively, so even though time savings are made it may not be appropriate to apply a value equal to the wage rate to this time.
The wage rate may not be an appropriate shadow price. Using the wage rate assumes that working hours are flexible. In reality hours worked per week are relatively rigid in most occupations and as such an individual cannot simply increase or decrease their hours as they benefit from time savings on travel or other activities.
Wages ignore benefits. Benefits form part of the compensation package for a worker and as such should be included.
Ignores multi-tasking. This method does not acknowledge that individuals can work while travelling, on a train for example, or while waiting at a train station.
Taxes. Individuals consider their income as their after-tax wage rate plus benefits. As such this may offer a more appropriate valuation of time.
Variations in the value of time. Individuals will value different aspects of their time use differently. An individual may consider the value of train travel time saved to be worth less than time saved on a congested road. Time spent travelling by train may be enjoyed by the individual if they travel through interesting surroundings or may be able to be used to conduct work activity. In comparison time waiting in traffic on a congested road is likely to be lost to any other activity, and may be considered frustrating and stress inducing.

(3) Intermediate Good Method

The intermediate good method is used to estimate the value for the benefit of a project based on its value added to a downstream activity. This method is often used to provide a value for education, but can also be used to provide values for benefits from other goods. For example, consider the 2018 Football World Cup bid. The UK is planning to enter a bid and wishes to estimate the benefits to the local economy of holding some of the football matches in Nottingham. The team of researchers can gather data on average business revenues (shop, restaurants, bars etc.) in Nottingham during an average period, and compare these to average revenues when large sporting (or other) events are held in the city. The difference between the two provides an estimate for the income that will be generated by holding a World Cup match in Nottingham.

The annual benefit of a project can be expressed as:

Annual Benefit = Income (with project) – Income (without project)

(4) Asset Valuation Method

The asset valuation method uses changes in the value of assets to estimate the benefits or costs of a project. The size of a price increase can be used to estimate the benefit of a project, and similarly the size of a price decrease can be used to measure the costs of a project or negative externality.

This method is often used to value differences in housing. For example, data can be collected on average prices of houses with a large garden, or close access to a country park. These can be compared against houses without those attributes, to obtain an estimate of the value of having a large garden or local access to a country park.

(5) Replacement Cost Method

This method of assigning a value to a benefit involves observing the cost of replacing or restoring a damaged asset. If the cost of replacing or restoring an asset is known, then this can be used as a value for the benefit of not needing to replace or restore the asset if damage to it can be avoided.

For example, if air pollution causes damage to a town hall which costs £100,000 to rectify, reducing air pollution, and therefore damage to the town hall, can be estimated to have saved £100,000, or as such provided a net benefit for this amount.

(6) Preventative or Defensive Expenditure Method

The preventative or defensive expenditure method estimates the value of a cost by observing the value of the costs incurred in attempting to mitigate or prevent the effects of a negative externality.

For example, using this measure we could estimate the cost of noise pollution from a road by observing the expenditure of individuals living close to the road on double-glazing to block out noise pollution. If we wish to estimate the benefits of introducing boarding on the sides of the road to block out the noise, we could do so by looking at the changes in expenditure on double-glazing by households located close to the road over time.

The limitation of this method is that some actions may be taken for a number of reasons, and not solely in order to mitigate a negative externality. For example, individuals may invest in double-glazing to reduce energy bills, or in order to make their home more attractive to potential buyers.

(7) Delphi Method

This method of data collection involves evaluation of costs or benefits through consensus. The Delphi method involves the consultation of a number of experts. These experts will independently provide values for costs and benefits. They will then be given the opportunity to re-evaluate their responses after viewing the responses given by other experts. Through successive rounds of re-evaluation eventual consensus will be achieved.