In
economics
Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and intera ...
, willingness to accept (WTA) is the minimum monetary amount that а person is willing to accept to sell a
good
In most contexts, the concept of good denotes the conduct that should be preferred when posed with a choice between possible actions. Good is generally considered to be the opposite of evil and is of interest in the study of ethics, morality, ph ...
or
service
Service may refer to:
Activities
* Administrative service, a required part of the workload of university faculty
* Civil service, the body of employees of a government
* Community service, volunteer service for the benefit of a community or a pu ...
, or to bear a
negative externality
In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either co ...
, such as pollution.
This is in contrast to ''
willingness to pay
In behavioral economics, willingness to pay (WTP) is the maximum price at or below which a consumer will definitely buy one unit of a product.Varian, Hal R. (1992), Microeconomic Analysis, Vol. 3. New York: W.W. Norton. This corresponds to the st ...
'' (''WTP''), which is the maximum amount of money a
consumer
A consumer is a person or a group who intends to order, or uses purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. T ...
(a ''buyer'') is willing to sacrifice to
purchase
Purchasing is the process a business or organization uses to acquire goods or services to accomplish its goals. Although there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between ...
a good/service or avoid something undesirable.
The
price of any transaction will thus be any point between a buyer's willingness to pay and a seller's willingness to accept; the net difference is the ''
economic surplus
In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus (after Alfred Marshall), is either of two related quantities:
* Consumer surplus, or consumers' surplus, is the monetary gain ...
''.
Several methods exist to measure consumer willingness to accept payment. These methods can be differentiated by whether they measure consumers' hypothetical or actual willingness to accept, and whether they measure it directly or indirectly.
Choice modelling Choice modelling attempts to model the decision process of an individual or segment via revealed preferences or stated preferences made in a particular context or contexts. Typically, it attempts to use discrete choices (A over B; B over A, B & C) ...
techniques may be used to estimate the value of WTA through a choice experiment.
Contingent Value techniques are also common and directly ask respondents what they would be willing to accept for different hypothetical scenarios.
Formal definition
Let be an individual's
utility function
As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosopher ...
, where is the person's wealth and is a
dummy variable that takes the value 1 in the presence of an undesired feature and takes the value 0 in the absence of that feature. The utility function is assumed to be increasing in wealth and decreasing in . Also, define as the person's initial wealth. Then the ''willingness to accept'' is defined by
:
That is, the willingness to accept payment in order to put up with the adverse change equates the pre-change
utility
As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosopher ...
(on the right side) with the post-change utility, including compensation.
In contrast, the ''willingness to pay'' is defined by
:
That is, the willingness to pay to avoid the adverse change equates the post-change utility, diminished by the presence of the adverse change (on the right side), with utility without the adverse change but with payment having been made to avoid it.
The concept extends readily to a context of uncertain outcomes, in which case the utility function above is replaced by the expected value of a von Neumann-Morgenstern utility function (See
expected utility hypothesis The expected utility hypothesis is a popular concept in economics that serves as a reference guide for decisions when the payoff is uncertain. The theory recommends which option rational individuals should choose in a complex situation, based on the ...
).
Standard theory versus experimental results
The standard assumptions of economic theory imply that with the absence of income effects, there is no difference between WTA and WTP.
Thus
indifference curve
In economics, an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is ''indifferent''. That is, any combinations of two products indicated by the curve will provide the c ...
s are drawn without reference to current endowments. This leads to the wide acceptance of the ''
Coase theorem
In law and economics, the Coase theorem () describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low trans ...
'' assertion that, subject to income effects, the allocation of resources will be independent of the assignment of property rights when costless trades are possible. This is to say, the allocation of property rights does not influence the way externalities are internalized by the market. However, many experiments, such as that by
Daniel Kahneman
Daniel Kahneman (; he, דניאל כהנמן; born March 5, 1934) is an Israeli-American psychologist and economist notable for his work on the psychology of judgment and decision-making, as well as behavioral economics, for which he was award ...
, Jack L. Knetsch and
Richard Thaler
Richard H. Thaler (; born September 12, 1945) is an American economist and the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business. In 2015, Thaler was pr ...
showed that measures of WTA greatly exceed measures of WTPF.
Theories have been formed based on these experiments which aim to explain the disparity between WTA and WTP.
Income effect
The
income effect
The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption as measured by their pref ...
has been used by multiple studies to explain the disparity between WTA and WTP.
They argue that due to income constraints, there is a maximum price people are able to pay, whereas there is no bounds on what people are willing to accept.
For example, the willingness to pay to stop the ending of one's own life can only be as high as one's wealth, while the willingness to accept compensation to accept the loss of one's life would be an extremely high number (or maybe infinite, meaning that there would be no finite acceptable payment amount).
Endowment effect
The
endowment effect
In psychology and behavioral economics, the endowment effect (also known as divestiture aversion and related to the mere ownership effect in social psychology) is the finding that people are more likely to retain an object they own than acquire th ...
argues that ownership results in
loss aversion
Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. The principle is prominent in the domain of economics. What distinguishes loss aversion from risk aversion is that the utility of a monetary payoff depends o ...
as people attach value to owned objects, resulting in a higher WTA of a good or service than WTP. The greater the degree of loss aversion, the greater the gap between WTA and WTP.
A well-known example of this effect was documented by
Ziv Carmon
Ziv Carmon is the Dean of Research, Professor of Business Administration, and holder of The Alfred H. Heineken Chaired Professorship at INSEAD. An expert in human judgment and decision-making, he is best known for his research on placebo effects ...
and
Dan Ariely
Dan Ariely ( he, דן אריאלי; born April 29, 1967) is an Israeli-American professor and author. He serves as a James B. Duke Professor of psychology and behavioral economics at Duke University. Ariely is the founder of the research inst ...
, who found that willingness to accept for tickets to a major basketball game was more than 10 times larger than the willingness to pay. Showing that the endowment effect makes people value a good or service more if they possess it.
The endowment effect theory's conclusions about the relationship between WTA-WTP has recently come under criticism.
Plott and Zeiler argued that "...observed gaps
etween WTA and WTPare symptomatic of subjects' misconceptions about the nature of the experimental task" and that "the differences reported in the literature reflect differences in experimental controls for misconceptions as opposed to differences in the nature of the commodity."
As a consequence of this work, alternative theories regarding the endowment effect and WTA-WTP correlations have become more widespread, as it may be possible that some economic scholarship about the WTA-WTP gaps are a result of experimental design issues.
Evidence of the endowment effect is widespread in
contingent valuation
Contingent valuation is a survey-based economic technique for the valuation of non- market resources, such as environmental preservation or the impact of externalities like pollution. While these resources do give people utility, certain aspects ...
. Contingent valuation is a common method in identifying how consumers value various things like healthcare, safety and the environment. The WTA and WTP are very common methods for contingent valuation, where subjects are asked exactly how much money they would be willing to accept in order to received one less unit of the goods or conversely how much they would pay to receive additional unit of goods.
Mathematically that is, how much would it take for them to consume x rather than x+1 or how much would they pay to consume x+1 rather than x. Through this questioning, we are able to identify the value on the x+1st unit of the good.
Given prior acceptance and acknowledgment of the endowment effect, it comes at little surprise that the WTA and WTP return differing results. The WTA method makes the subjects sure that if they are losing any level of consumption, that they may want considerable sums of money in order to offset the loss of goods. The WTP on the other hand leads subjects to believe that losing money may not be worth the additional unit of the good. The disparity between these two valuation has been shown to be quite large on occasion. What we experience form these results is a systematic violation of procedural invariance, leading us to have answers that are largely dependant on the procedure used, this acts as a specific example of the larger
framing effect
In the social sciences, framing comprises a set of concepts and theoretical perspectives on how individuals, groups, and societies organize, perceive, and communicate about reality.
Framing can manifest in thought or interpersonal communicati ...
.
This has raised question about the fundamental valuation given by people. This stems from the endowment effects natural tendency to imply physical ownership of a good. The WTA (and WTP) measures then push for people to think about the potential ownership of goods and services and is seemingly enough to trigger an endowment effect and subsequently alter the reference point.
Hypothetical Bias
An article exploring the effects of WTA and WTP in the public health services sector concluded that hypothetical bias is higher with less information about a good or service and higher information costs. WTP as a result is lower with high hypothetical bias, resulting in a disparity between WTA and WTP.
Practical Applications
WTP and WTA are important factors for public policy. Many economic decisions are based upon the implicit assignment of property rights. When looking at a lake which is being polluted by a nearby factory, the WTA and WTP for treatment of an effluent treatment plant may have different consequences based upon how property rights are politically assigned. If lakeside residents have no property right to an effluent-free lake, then their willingness to pay to treat the lake's water supply would be considered. Conversely, if the lakeside residents are found to have a property right to a clean lake, then their willingness to accept compensation for a polluted lake would be considered.
See also
*
Becker-DeGroot-Marschak method
*
Gains from trade
In economics, gains from trade are the net benefits to economic agents from being allowed an increase in voluntary trading with each other. In technical terms, they are the increase of consumer surplus plus producer surplus from lower tariffs ...
*
Opportunity cost
In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effective it means if you chose one activity (for example ...
*
Property rights (economics)
Property rights are constructs in economics for determining how a resource or economic good is used and owned, which have developed over ancient and modern history, from Abrahamic law to Article 17 of the Universal Declaration of Human Rights. Re ...
*
Willingness to pay
In behavioral economics, willingness to pay (WTP) is the maximum price at or below which a consumer will definitely buy one unit of a product.Varian, Hal R. (1992), Microeconomic Analysis, Vol. 3. New York: W.W. Norton. This corresponds to the st ...
*
Willingness to recommend
Willingness to recommend is a metric related to customer satisfaction. When a customer is satisfied with a product, he or she might recommend it to friends, relatives and colleagues. This ''willingness to recommend'' can be a powerful marketing ad ...
Notes
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Microeconomics
Business economics