Willingness to Accept, Willingness to Pay and the Income Effect

Abstract

The disparity between willingness to pay and willingness to accept in experimental and survey settings remains a troubling anomaly. Willingness-to-accept is almost always higher than WTP, often substantially higher. Our interest lies with the neoclassical explanation of Hanemann, who demonstrates that for exogenous quantity changes, the difference between WTP and WTA depends ratio of the ordinary income elasticity of demand for the good to the Allen-Uzawa elasticity of substitution between the good and a composite commodity. When the elasticity of substitution is low, this ratio will be large. The ratio WTA/WTP will then also be large. We use a result of Sugden to formulate the WTA/WTP ratio as a function of the income effect on WTP. We find that the WTA/WTP ratios provided by our comprehensive literature search imply income elasticities and income effects that are implausibly high; much higher than income effects found in the literature; and much higher than income elasticities estimated in the set of studies from which the WTA/WTP results are drawn. Based on the evidence, it is difficult to accept the idea that the observed ratios of WTA/WTP, garnered from a remarkably large and diverse set of studies, are consistent with a standard neoclassical model. Substitution among goods seems an inadequate explanation for the divergence between WTA and WTP.

Keywords: Willingness to Accept, Willingness to Pay, Income Effect, Elasticity of Substitution

JEL Classification: D1, D4, H0, H6