Disparities in empirical welfare measures: the effects of time and information

Jay Roger Corrigan

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: In a static setting, willingness to pay (WTP) for an increase in quantity or quality is simply equal to the compensating variation, a Hicksian welfare measure. Likewise, willingness to accept compensation in exchange (WTA) for a decrease in quantity or quality is equal to the equivalent variation. However, in a dynamic setting characterized by uncertainty, limited delay or reversal, and the potential for learning, these stated preference measures may also contain option values. Zhao and Kling (Economics Letters , 2001) use real options theory to explain the relationship between learning, irreversibility, and value formulation in a dynamic setting. In this dissertation, I discuss the design and results of two empirical tests of whether stated preference value measures are affected by dynamic aspects of the market environment, and whether those effects, if they exist, are consistent with Zhao and Kling's predictions.;The first test incorporates the dynamic nature of the value formulation process into a contingent valuation study designed to measure the value local residents place on a north-central Iowa lake. My results show that WTP is highly sensitive to the potential for future learning. Respondents offered the opportunity to delay their purchasing decisions until more information became available were willing to pay significantly less for improved water quality than those facing a now-or-never decision. These results suggest that welfare analysts should take care to accurately represent the potential for future learning.;The second test also deals with the effects of learning and irreversibility on stated preference measures, but this time in an experimental economic setting. I test whether part of the disparity observed between WTA and WTP in the experimental economic literature can be explained by the presence of real options. To do this, I have performed a series of experimental treatments designed to analyze the effect subjects' perceptions regarding the relative difficulty of reversal and delay have on their valuation of a private good. While I find some evidence that subjects do take into account dynamic considerations, I cannot show that WTA and WTP are affected in a manner consistent with Zhao and Kling's theory.

Date: 2002-01-01
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