Why The Choice Of Wtp Or Wta Makes A Difference

The traditional decision is to use the WTP for gains and the WTA for losses. The correct motivation for this lies in the recognition of the economic significance of psychological ownership, and the pattern of legal rights. Gains and losses are psychological; they represent changes from some psychological reference point. In many cases, this point is determined by legal ownership. Ownership implies a right to have what one owns measured by the willingness to sell it - that is, by the WTA. In other cases, a person may feel a moral entitlement based on reasonable expectations that may engender psychological ownership, even where legal ownership is lacking.

Until recently, it was thought that the choice between WTP and WTA made little difference, aside from exceptional cases, and that the source of the difference was solely income effects (Willig 1976, p. 589). Now it is recognized that the choice can make a great difference (see Levy and Friedman 1994 and Coursey, Hovis and Schulze 1987, pp. 679-690). Researchers have demonstrated repeatedly that WTA questionnaires generate values from three to nineteen times greater than those elicited by WTP questionnaires (Levy and Friedman 1994, pp. 493, 495, n. 6; see also Coursey, Hovis and Schulze 1987). These differences are not found just in questionnaires, but also in experiments using a wide array of methods, and they are found, as well, in many cases of real decisions (see, for example, Knetsch 1997). Nor are these differences only empirically driven; they are based on the psychology of valuation.

There are three reasons for the difference: income effects; substitution possibilities; and loss aversion, or the endowment effect, as it is sometimes called. The latter two reasons have been appreciated only in recent years.

Income Effects

The income effect arises from the fact that the value of additional income relative to some good is less when you have more income. Suppose an indigent wins a Mercedes in a contest, and that the rest of the indigent's assets, combined, are worth $5. The indigent's WTP for the car is (at most) $5, since that is his total wealth, not counting the car.9 The indigent's WTA is almost certainly more than $5, and presumably would be equal to the market value of a new Mercedes. This is an example of the most extreme form of income effect - a buying constraint.

However, income effects can exist without buying constraints. Suppose Al has $1,000 of disposable income, and owns a new coat, for which his WTA is $1,000. If Bob offered to buy the coat for $1,000, Al would accept, by definition. However, if Al's coat was stolen, and he later found it for sale in a pawnshop for $1,000, undamaged, he might not buy it. When Al loses his coat, his perspective changes. He is $1,000 poorer, and proportionately less willing to spend his money on expensive coats. Al might prefer to buy a $500 coat, and spend his other $500 on other things.

Figure 3.1 below shows the operation of income effects, in creating a divergence between the WTP and the WTA. U0 and U1 are indifference curves that represent two goods that are perfect substitutes for each other. Let us call them fame and money. Income is shown on the vertical axis, and fame on the horizontal axis. U1 has a steeper slope than U0 at every quantity of fame, indicating that fame is more valuable at a higher level of income. The initial level of income is at I0 at point A on the indifference curve U0, so that the initial amount of fame is q0. The consumer gains more fame in moving to position q1. To gain fame as presented by position q1, the consumer is willing to give up in income (I0 - Ia) to arrive at point C, which is just as satisfying a position as point A, the initial point. This difference in income I0 - Ia is the WTP. The WTA is shown by also beginning with income I0, but at point B on

Figure 3.1 The income effect

indifference curve U1 representing a higher level of satisfaction corresponding with having greater fame available. The consumer would be willing to accept less available fame if he gained income sufficient to put him at point D, a point that is equally satisfying as B. This income is Ib - I0, and is the WTA. The WTA will exceed the WTP, since U1 is steeper than U0.

Both the WTP and the WTA measure the effect of a change.10 The WTA presumes greater wealth than the WTP does; the greater wealth consists of possessing, in a psychological sense, the very good in question. This greater wealth means that the money measure of a positive change is larger for a normal good than when the same person has lower wealth. Whether or not the higher measure (which includes the greater wealth) is the better measure depends on whether that person possesses psychological ownership of the good being considered. The WTA measures the change from the perspective of one who claims the good.

Substitution Possibilities

Recently, Hanneman (1991, pp. 635f) showed that the poorer the substitutes for the good, the greater the divergence between the WTP and the WTA. Put another way, the more unique the good, the greater the divergence. The substantial divergence between WTP and WTA for environmental goods arises, in part, from the fact that many of these goods have no close substitutes. In general then, the divergence between the WTA and the WTP can be any positive value for normal goods.11

This can be shown by the following diagram. In Figure 3.2 the initial income is I0. The WTP for a move from position A on U1 to position C also on U1 leaves the consumer with less income, but more time. The consumer is indifferent about income, since the loss of income does not affect his welfare. Starting from position A, the consumer moving to position C would be willing to pay either zero, or at most, I0 - Ia, because any income greater than Ia is worthless to the consumer without more time. This is the WTP. Starting at position A', the consumer would be willing to pay zero. The reader needs to realize the strangeness of the situation here. Because the loss of income is the loss of a worthless good, we can say that the WTP for income is either zero, or at most I0 - Ia. A consumer who begins at position B, also with income I0, but on the higher indifference curve U2, will be unwilling to accept any amount of money in exchange for giving up time, since additional money is of no value to him without additional time. His WTA for time is infinite.12 Since the WTP is finite and the WTA is infinite, the difference is also infinite.

The substitution effect does not, however, operate independently from the existence of the income effect. In Figure 3.2, the income effect is positive,

Money WTA (infinite)

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