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Working Out the Willingness to Accept and Willingness to Pay Gap Using Economics, Psychology, and Happiness Approaches to Valuation

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Abstract

The gap between willingness to accept and willingness to pay is an outcome of incomplete valuation procedure. The solution then is a complete valuation procedure. One approach presented in this paper focuses on the income and substitution effects as the missing items to the valuation procedure. Another approach deals with the hedonic contents of the income, the good, and the setting of the good as the missing items to the valuation procedure. This paper submits a third approach that uses (evaluative) happiness as a proxy of utility while taking account of the hallmarks of the other two valuation procedures: the setting of the good under consideration and the income and substitution effects.

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Notes

  1. Kahneman and Tversky (1979) and Thaler (1980) assume a “utility” function with an asymmetric sigmoid form. They examine psychological utility when a good is given to or taken away from a person. Their findings indicate that U Y is not constant when money is accepted or it is paid. To verify, hold psychological utility constant across for the alternative states of acceptance or payment of money then check out the slopes. Notice that U Y for a gain of money (i.e., WTA) is less than U Y for a loss of an equal amount of money (i.e., WTP).

  2. The “setting” is a specific type of endowment. The “endowment effect,” on the other hand, is associated with ownership, possession, entitlement, or claim. The “reference effect” is contingent to an endowment. Studies that look into the endowment effect draw attention to the individual’s perception of the setting in explaining the WTA-WTP gap and not on the income and/or the good itself.

  3. WTP became the choice of valuation over WTA on the presumption that WTA is a “flawed” procedure. See also Mitchell and Carson (1999) on using WTP. Knetsch (1990) and Gregory and Brown (1999) note that using WTP when WTA is appropriate implies two things: first, the good is undervalued; and, second, allocative efficiency is effectively abandoned.

  4. The paper does not discuss the debates concerning the measurement of SWB itself. Readers may wish to check Andrews and Robinson (1991) for a review of measures. Psychology recognizes the reliability and validity of SWB measures, but economics is more hesitant to do so. Frey and Stutzer (2002), Frey (2008), Krueger and Schkade (2008), and Oswald and Wu (2010) are recent papers in economics that accept the reliability and validity of SWB measures. A related issue with SWB concerns its cardinality. Psychology, in this case, takes the cardinality of SWB for granted, but economics is hesitant to do so. Ng (1997, 2003), and van Praag and Ferrer-i-Carbonell (2008), among others, treat SWB as a cardinal measure. The mounting evidence not only from psychology but also from the biological and related sciences suggests that SWB measures are viable proxies for utility (c.f., Kahneman and Sugden 2005; Di Tella and MacCulloch 2006).

  5. The effect of Z or that of both Y and Z on another external variable like health can be examined as well. In such case, the utility function takes the form, respectively, U = F[[Y(Z), Z(Y)] + W(Z)] or U = F[[Y(Z), Z(Y)] + W(Y, Z)], where W is the “health” function.

  6. An important issue here is whether the fickleness, even fleeting, nature of emotions bring instability in the valuation procedure. If so, the results are deemed spurious. It is not straightforward to what extent Eq. 2 is resolved with Eq. 4 since there are no real indirect income effects. In addition, other aspects like personality are excluded in the consideration (see, e.g., Georgantzís and Navarro-Martinez 2010; Boyce and Wood 2011; Boyce et al. 2013).

  7. Putting the economics and psychology of valuation together obtains a utility function of the form U = H[Y(Z), Z(Y), E(Y, Z), Q(Z)], where Y and Z are assumed endogenous to each other and the three elements of hedonic content are assumed not trivial. Thus, \( \frac{\partial U/\partial Z}{\partial U/\partial Y}=\frac{H_Z+{H}_Y\frac{ dY}{ dZ}+{H}_Z\frac{ dQ}{ dZ}+{H}_E\frac{\partial E}{\partial Z}+{H}_E\frac{\partial E}{\partial Y}\kern.2em \frac{ dY}{ dZ}}{H_Y+{H}_Z+{H}_E\frac{\partial E}{\partial Y}+{H}_E\frac{\partial E}{\partial Z}\kern.2em \frac{ dZ}{ dY}} \) is the valuation of Z. Given the nature of emotion, \( \left({H}_E\frac{\partial E}{\partial Z}+{H}_E\frac{\partial E}{\partial Y}\frac{ dY}{ dZ}\right) \) and \( \left({H}_E\frac{\partial E}{\partial Y}+{H}_E\frac{\partial E}{\partial Z}\frac{ dZ}{ dY}\right) \) might introduce instability and volatility to the valuation procedure.

  8. Stated or declared SWB is some transformation of the underlying well-being (SWB*) provided the former is highly correlated with the latter. Algebraically, SWB = h[U(·)], where U(·) is SWB*. It implies SWB 2   > SWB 1 iff U 2 (·) > U 1 (·). For various reasons (e.g., cognitive biases, cultural predispositions, etc.), SWB* − SWB = e, where e is an error term. Presumably, e does not come from a change in the valence of life circumstances but rather from the errors of “interpretation. If e ~ N(0, σ e 2 ), then a sufficiently large set of data compensates for the discrepancy to approximate SWB ≡ SWB*. That SWB ↔ SWB* is possible when individual are more informed about their situation and well-being.

  9. The extant literature discusses three types of happiness: emotional happiness, evaluative (or judgment) happiness, and eudaimonic happiness. Part of the problem in using “happiness” is confusion on the type of happiness used in the analysis. This paper suggests that evaluative happiness is the more appropriate proxy for subjective well-being in the valuation procedure.

  10. Frey and Stutzer (2010) argue that cardinality is not required to perform the SWB approach to valuation. Studies in psychology assume that self-reports are cardinal and interpersonally comparable but applications in economics assume that self-reports are ordinal and interpersonally comparable.

  11. Emotion is excluded in the expression because it can lead to exaggerated valuations. This problem is associated with focusing illusion, immune neglect, focalism, miswanting, projection bias, or visceral effect (Gilbert et al. 1998; Schkade and Kahneman 1998; Loewenstein 1996; Wilson et al. 2000; Loewenstein et al. 2003), other hedonic matters like existence value (Boyce et al. 1992; Kahneman and Knetsch 1992), and other biases (Gilovich et al. 2002).

  12. Suppose H Y   > 0 and \( {H}_Z\frac{ dQ}{ dZ}>0 \). The receipt of money means \( \left({H}_{Y_{WTA}}>0\right)\downarrow \) and \( \left({H}_Z\frac{ dZ}{ dY}\right)>0\uparrow \), whereas the payment of money means \( \left({H}_{Y_{WTP}}>0\right)\uparrow \) and \( \left({H}_Z\frac{ dZ}{ dY}\right)<0\downarrow \). Let \( \frac{ dZ}{ dY}>0 \). The indirect income effect depends on H Z (Eqs. 3a and 3b). Notice that \( \frac{H_Z+{H}_Z\frac{ dQ}{ dZ}}{H_{Y_{WTA}}+{H}_Z\frac{ dZ}{ dY}}=\frac{H_Z+{H}_Z\frac{ dQ}{ dZ}}{H_{Y_{WTP}}+{H}_Z\frac{ dZ}{ dY}} \) resolves Eq. 2. The outcome is the same if \( \frac{ dZ}{ dY}<0 \).

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  1. Department of Economics, Ateneo de Manila University, Quezon City, 1108, Philippines

    Edsel L. Beja Jr.

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Beja, E.L. Working Out the Willingness to Accept and Willingness to Pay Gap Using Economics, Psychology, and Happiness Approaches to Valuation. Applied Research Quality Life 9, 819–829 (2014). https://doi.org/10.1007/s11482-013-9271-5

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