Efficiency (shadow) prices

Efficiency (shadow) prices

Suitability for the forest ecosystem services to be valued:
Services that are traded in domestic or international markets and it may also be calculated for non-marketed goods
Description of the method:
The market price does not necessarily mean the “proper” price and/or reflect the true economic efficiency price. There are market and policy failures that can distort market prices. Market failures refer to the inability of market prices, under certain conditions, to reflect accurately the value of environmental goods or services. Policy failures concern instances where government policies have unintended effects, or sometimes even side-effects or cause resource-use behaviour inappropriate from a societal perspective.
In financial analysis, no account is taken of any of these failures that distort market prices. Therefore, it is advisable to look at their economic value in order for their value to society as a whole to be reflected, as in the case, for example, of alternative forest land uses. To do so, the market price is adjusted. There are various methods for correcting market and policy distortions. A variant of the market price-based method uses shadow prices (market prices adjusted for transfer payments, market imperfections and policy distortions). Shadow prices may also incorporate distribution weights, where equality concerns are made explicit.
Benefits of the method:
Reflect the true economic value (opportunity cost) to society as a whole
Especially useful when there are significant distortions on market prices (considering that prices often reflect the effects of subsidies given to foresters/farmers or of trade policies)
Limitations of method:
Derivation of shadow price is complex and may require substantial data
Decision-makers may not accept what they might consider to be artificial prices
Market prices are often more readily accepted by decision makers than artificial values derived by the analyst
Market prices are generally easy to observe, both at a single point and over time
Market prices reflect the decision of many buyers, whereas calculating shadow prices often relies on the objectivity of judgement of the analyst
The procedures for calculating shadow prices are rather imperfect and therefore estimates can, in certain cases, introduce larger discrepancies than even the simple use of imperfect market prices
Each case should be analysed within the context in which the valuation is being made, and should take into account the data and resource constraints. There cannot be a simple blueprint for every case