q 0 qi Time

Figure 3.2 Pure substitution effect: divergence between WTA and WTA can be infinite since a parallel shift in a budget line to the right will increase the amount of time purchased.

Suppose, instead, that there is no positive income effect, as in figure 3.3. In this case, the indifference curve, U2, will have its vertical axis lying on U1, but its horizontal axis lying above the horizontal axis, on U1. Here, an increase in income (a shift to the right on the budget line, which is not shown) will not increase the purchase of time. In this situation, the WTA will be the same as the WTP, and no divergence exists.

The WTP for a move from A or A' to C would be either zero, or, at most, I0 - Ia, as before. The WTA for a move from B to A will be zero, or, at most, /0-/a, for a move from C to A'. There is no divergence between the WTP and WTA. That is, some income effect is necessary for the substitution effect to drive the wedge between WTP and WTA.

Loss Aversion or the Endowment Effect

The essence of the endowment effect is found in an asymmetrical value function.13 This function reflects the consequences of living in a state in which individuals value losses more highly than they value gains. Empirically, individuals appear to place a significantly higher value on a unit of a good that they already have, and might lose or have to give up, than they

Ui and U2

0 0

Post a comment