Estimates economic values for ecosystem products or services that contribute to the production of commercially marketed goods.

1. Overview
2. Why Use the Productivity Method?
3. Application of the Productivity Method
4. Summary of the Productivity Method
5. Applying the Productivity Method
6. Advantages of the Productivity Method
7. Issues and Limitations of the Productivity Method

Overview

The productivity method, also referred to as the net factor income or derived value method, is used to estimate the economic value of ecosystem products or services that contribute to the production of commercially marketed goods.  It is applied in cases where the products or services of an ecosystem are used, along with other inputs, to produce a marketed good.

For example, water quality affects the productivity of irrigated agricultural crops, or the costs of purifying municipal drinking water.  Thus, the economic benefits of improved water quality can be measured by the increased revenues from greater agricultural productivity, or the decreased costs of providing clean drinking water.

This section continues with some example applications of the productivity method, followed by a more complete technical description of the method and its advantages and limitations.
 

Hypothetical Situation
A reservoir that provides water for a city¡¦s drinking water system is being polluted by agricultural runoff.  Agency staff want to determine the economic benefits of measures to eliminate the runoff.

Why Use the Productivity Method?
The productivity method was selected because this is a straightforward case where environmental quality directly affects the cost of producing a marketed good¡¦municipal drinking water. This example is one of the simplest cases, where cleaner water is a direct substitute for other production inputs, such as water purification chemicals and filtration.
Thus, the benefits of improved water quality can be easily related to reduced water purification costs.

Application of the Productivity Method

Step 1:
The first step is to specify the production function for purified drinking water.  This is the functional relationship between the inputs¡¦water of a particular quality from the reservoir, chemicals, and filtration, and the output¡¦pure drinking water.

Step 2:
The second step is to estimate how the cost of purification changes when reservoir water quality changes, using the production function estimated in the first step.  The researcher would calculate the quantities of purification chemicals and filters needed for different levels of reservoir water quality, by plugging different levels of water quality into the production function.  These quantities would then be multiplied by their costs.

Step 3:
The final step is to estimate the economic benefits of protecting the reservoir from runoff, in terms of reduced purification costs.  For example, if all runoff is eliminated, the reservoir water will need very little treatment and the purification costs for drinking water will be minimal.  This can be compared to the cost of purifying water where runoff is not controlled.  The difference in purification costs is an estimate of the benefits of eliminating runoff.  Similarly, the benefits for different levels of runoff reduction can be estimated.  This step requires information about the projected success of actions to reduce runoff, in terms of the decrease in runoff and the resulting changes in reservoir water quality.
 

How Can the Results be Used?
The results of the analysis can be used to compare the benefits of achieving different levels of water quality in the reservoir with the cost of programs to reduce or eliminate the polluting runoff, and thus improve water quality.
 

Case Study Example of the Productivity Method¡¦ Values of Wetlands in the Peconic Estuary, Long Island

The Situation
The Peconic Estuary includes many productive wetlands of different types, including eelgrass, saltmarsh, and intertidal mudflats.  Development and resulting water quality degradation have reduced the quantity of these wetlands, and may continue to do so in the future.

The Challenge
The Peconic Estuary Program is considering various management actions for the Estuary and surrounding land areas.  In order to assess some of the values that may result from these management actions, a productivity study for wetlands was conducted.

The Analysis
The study focused on valuing marginal changes in acres of wetlands, in terms of their contribution to the production of crabs, scallops, clams, birds, and waterfowl.  It was assumed that wetlands provide both food chain and habitat support for these species.  First, the productivity of different wetlands types in terms of food chain production was estimated and linked to production of the different species of fish.  Second, the expected yields of fish and birds per acre of habitat was estimated.  Finally, the quantities of expected fish and bird production were valued using commercial values for the fish, viewing values for birds, and hunting values for waterfowl.

The Results
The study results estimated that an acre of eelgrass is worth $1065 per year, an acre of saltmarsh is worth $338 per year, and an acre of intertidal mudflat is worth $68 per year, in terms of increased productivity of crabs, scallops, clams, birds, and waterfowl.  Based on the results of this study, managers can calculate the economic value, for productivity services, of preserving or restoring wetlands in the Estuary.  These values do not capture the full value of the wetlands, because they only address values in production of commercially and recreationally valuable species.  Thus, they are an understatement of the total economic value for the wetlands, which might include other services, such as erosion and storm protection or aesthetics. 
 

Summary of Productivity Methods

The net factor income, derived value, or productivity method is used to estimate the economic value of ecosystem products or services that contribute to the production of commercially marketed goods.  It is applied in cases where the products or services of an ecosystem are used, along with other inputs, to produce a marketed good.

For example, water quality affects the productivity of irrigated agricultural crops, or the costs of purifying municipal drinking water.  Thus, the economic benefits of improved water quality can be measured by the increased revenues from greater agricultural productivity, or the decreased costs of providing clean drinking water.

If a natural resource is a factor of production, then changes in the quantity or quality of the resource will result in changes in production costs, and/or productivity of other inputs.  This in turn may affect the price and/or quantity supplied of the final good.  It may also affect the economic returns to other inputs. 

Two types of benefits (or costs) may be important.  First, if the quality or price to consumers of the final good changes, there will be changes in consumer surplus .  Second, if productivity or production cost changes, there will be changes in producer surplus .  Thus, the economic benefits from improvements in the resource can be estimated using changes in observable market data. 
 

Applying the Productivity Method

To apply the productivity method, data must be collected regarding how changes in the quantity or quality of the natural resource affect:

• costs of production for the final good
• supply and demand for the final good
• supply and demand for other factors of production

This information is used to link the effects of changes in the quantity or quality of the resource to changes in consumer surplus and/or producer surplus, and thus to estimate the economic benefits.

The method is most easily applied in two specific cases:

1. Cases where the resource in question is a perfect substitute for other inputs. For example, increased water quality in a reservoir means that less chlorine is needed for treating the water.  In this case, an increase in quantity or quality of the resource will result in decreased costs for the other inputs. Thus, in this example, the benefits of increased water quality can be directly measured by the decreased chlorination costs.
2. Cases where only producers of the final good benefit from changes in quantity or quality of the resource. Consumers are not affected. For example, improved quality of irrigation water may lead to greater agricultural productivity¡¦more crops are produced on the same amount of land.  If the market price of the crops to consumers does not change, benefits can be estimated from changes in producer surplus resulting from increased income from the other inputs. Thus, in this example, the profits per acre will increase, and this increase can be used to estimate the benefits of improved irrigation water quality.

Advantages of the Productivity Method

• In general, the methodology is straightforward.
• Data requirements are limited, and the relevant data may be readily available, so the method can be relatively inexpensive to apply.

Issues and Limitations of the Productivity Method

• The method is limited to valuing those resources that can be used as inputs in production of marketed goods. 
• When valuing an ecosystem, not all services will be related to the production of marketed goods.  Thus, the inferred value of that ecosystem may understate its true value to society.
• Information is needed on the scientific relationships between actions to improve quality or quantity of the resource and the actual outcomes of those actions.  In some cases, these relationships may not be well known or understood.
• If the changes in the natural resource affect the market price of the final good, or the prices of any other production inputs, the method becomes much more complicated and difficult to apply. 

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Method 3: Hedonic Pricing Method

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Dollar-Based  Ecosystem Valuation Methods