Methods of Measuring Externalities

There is the presence of positive and negative externalities associated with every economic activity undertaken in our society. However, these externalities are frequently ignored because of difficulties of measurement. Economists use a bid rent concept to describe the relationships between land value, socioeconomic activities, and working place or commercial location. The bid rent is the maximum willingness to pay (WTP) by the household for a piece of land for a given level utility. In a competitive land market, households are assumed to compete for residential locations through a bidding process. This competitive process continues until an urban equilibrium occurs. In this case, no household has an incentive to change its location. Externalities arise when activities of one group’s residential affect the well-being of another group. Residential externalities result when the members of one residential area may feel that their well-being is adversely affected by the members of another residential area. Measuring the value of externalities in economic activity is extremely complex, almost always controversial. The innovative idea is to measure the incidence and intensity of externalities of activities. The incidence measures the coverage of negative externalities and the intensity specifies a degree of negative externalities. The methods are provided to estimate WTP for the reduction of negative externalities and to estimate the actual cost paid due to negative externalities. The study suggested that the bidding game (BG) method to increase the precision of WTP estimates relative to other methods. Possible solutions to the starting point bias are provided. Both qualitative and quantitative approaches require to improving the validity and reliability in WTP studies.