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WTP or WTA: A Means of Determining the Appropriate Welfare Measure of Positive and Negative Changes When Preferences are Reference Dependent

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Abstract

Many positive and negative changes are valued by people relative to a neutral reference state, which may, or often may not, be the status quo. Positive changes can then be either gains and the monetary value of the increase in welfare best assessed with the WTP measure, or reductions of losses, and like losses, the change in welfare more accurately assessed with the WTA measure. A means to discriminate between gains and reductions of losses is presented here, along with the results of tests of its efficacy, and a demonstration of its application to VSL estimates–with findings suggesting likely widespread biases of present practice of using WTP to assess the value of essentially all changes.

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Notes

  1. A series of published reviews by analysts in various applied fields, with the notable exception of behavioural finance, are mostly of the view, for example, that “topics investigated in behavioural economics research are of interest and may warrant further study, but there is little in current findings that should be taken into account in any practical analysis” (Gillingham and Palmer 2014, p. 28). The Kim, Kling, and Zhao review (2015), is one of few that includes consideration of the role of reference dependence in the choice of measure issue. They also recognize the problem of determining the appropriate choice of measure to use in specific cases, that is addressed here, in suggesting, “… this approach poses practical problems, as an agreement on reference environmental levels may be hard to reach” (p. 181).

  2. The recent report of the results of the major study “putting a value on injuries” resulting from the massive BP Deepwater oil spill in the Gulf of Mexico in 2010, provides an illustrative example of what seems to be the continuing general practice of using the WTP measure to assess the monetary value of losses rather than the usually more applicable WTA measure. The report was authored by 20 mostly well-known economists (including 5 Fellows of the Association of Resource and Environmental Economics) “under the guidance” of the U.S. National Oceanic and Atmospheric Administration, and published in Science (Bishop, et al., (2017). After a design process of “development, testing and refinement” extending over more than three years, a contingent valuation personal interview survey was carried out with over 3600 respondents. These respondents were, however, not asked to “put a value on the injuries” resulting from the Deepwater spill. They were instead asked to indicate how much they would be willing to pay for “a proposed program for preventing a similar accident in the future”. This manipulation of the framing of the valuation altered what was to be valued from being considered as a loss, which it clearly was, to being treated as a gain of preventing another spill which was said to otherwise be certain “to take place in the next 15 years”.

  3. A shopkeeper does not lament the loss of a pair of shoes in a sales transaction as this is the point of the enterprise. However, the same shopkeeper, like many enterprises, may well exhibit loss aversion or valuation disparities with respect to other aspects of their operation, such as acquiring or disposing of physical assets or changing personnel in key positions.

  4. Hanemann (1991) called attention to the assumptions of standard theory in explaining the role of substitutes in determining WTA vs. WTP disparities. However, he also noted that “the concept of loss aversion”, which is the interest here, “is a different phenomenon” (p. 645).

  5. Market observations from natural experiments are, essentially, close parallels of the observations used in most traditional empirical studies of demand and supply functions, estimations of various kinds of elasticities, and the fodder for most marketing studies.

  6. Bukszar (in preparation) provides the results of further more stringent within-subject tests of elite golfers’ behaviours in playing all of their shots, rather than just their play on the greens, and also finds statistically significant evidence of loss aversion–complementing the earlier Pope and Schweitzer (2011) results.

  7. These 79 Thai undergraduate students were part of 331 Thai undergraduate students recruited from undergraduate economics courses at Khon Kaen University. This group of students was recruited to take part in one of two survey experiments – 79 were randomly assigned to this experiment, and the remaining 252 took part in a test of the influence of a chance to break-even from a previous loss, reported in Sect. 3.3.

  8. Double translations were used in this, and all of the following survey tests, in which the original English version was translated into Thai (and Vietnamese in the cases of those done in Vietnam), and then translated back to English by another person, and compared to the original English version to ensure the accuracy of the translation.

    In tests of conclusions reached on the basis of responses to different kinds of survey commonly used to solicit responses to questions such as those used in these tests, classroom surveys of undergraduate students in China and Vietnam were no more inconsistent with results from four other kinds of survey, and were even marginally more consistent (Nguyen, Knetsch, and Zong, in preparation).

  9. A one-sample proportion test was used to determine the statistical significance of departures from the null hypothesis of the proportion of respondents choosing the certain outcome being 0.5 (of the proportions of certain and proportions of risky outcomes both being 0.5). The significance levels of 1% and 5%, are indicated by ***, and **, respectively, in this and in all of the following reporting of results.

  10. The exchange rate for the Thai Bhat was about 30 THB to USD 1.

  11. Interestingly, given the seeming pervasive findings of gender differences in risk preferences, no significant differences were found in this, or in any other of the tests carried out in this study.

  12. A one-sample proportion test was used to determine the statistical significance of departures from the null hypothesis of the proportion of respondents choosing the certain outcome being 0.5 (of the proportions of certain and proportions of risky outcomes both being 0.5). The significance levels of 1% and 5%, are indicated by ***, and **, respectively.

  13. However, the third test, involving a risky win exceeding the loss, was not statistically significant in the Thai survey. This much weaker risk effect may in part be due to this option offering both a mitigation of the loss and a gain–though there is no evidence of such an influence in the results of the same test carried out in Vietnam.

  14. These respondents were also paid 20,000 VND for their participation. A one-sample proportion test was also used to determine the statistical significance of departures from the null hypothesis of the proportion of respondents choosing the certain outcome being 0.5. The significance levels of 1% and 5%, are indicated by ***, and **, respectively.

  15. And, while these results strongly suggest the presence of reference dependent preferences in this case, which implies a likelihood of a disparity between the measures, this is not empirically demonstrated without a more direct test for this.

  16. The former presumed lack of evidence of any significant difference has long been a basic rationale for the present use of the WTP measure for the assessment of nearly all changes, in spite of the clear directives for the use of the WTA measure for those involving losses–a rationale now seriously undermined by the findings referred to earlier. Further reasons that have been put forward to justify the avoidance of using the WTA measure of assessing the monetary value of losses and the mitigation of losses may well also be undermined by further evidence and analysis (Knetsch 2020).

  17. For example, the protection of access to sunlight formally afforded in many jurisdictions by “the doctrine of ancient lights,” generally gave way to the increased desires to construct tall buildings in close proximity to one another in growing cities–though there has been a bit of recent revival of interest in its applicability, but now for the protection of investments in solar panels from shadows cast from subsequent constructions.

  18. These include the now very questionable conclusion of the Coase Theorem that in a transaction cost free environment, all entitlements will end the same regardless of initial assignment (for example, Kahneman, Knetsch, and Thaler 1990).

  19. An interesting example of this is provided by the rule of adverse possession, in effect in many jurisdictions, which gives a long-time user of a parcel of land the possibility of eventually asserting a successful claim of ownership over an owner who has effectively abandoned the land. Many of these cases involve mistakes over the location of land boundaries, and after passage of many years, as normally required by the rule, the user is likely to view a denial as a loss while the owner is then likely to view the “return” of the land as a gain, and the rule’s recognition of this asymmetry in valuations leads to what is then very likely to be the more efficient outcome (Cohen and Knetsch 1992).

  20. It seems quite likely that the WTA measure of the loss due to oil spills, such as the BP spill noted above, that provides the more useful guidance for determining the justification for costly safeguards to prevent future spills or if future drilling is justified or not, rather than what appears to be an understated assessment based on the WTP measure.

  21. As illustrated by the choice of the WTP measure to assess the monetary value of the damages resulting from the BP oil spill noted earlier.

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Acknowledgements

This research was in part supported by the Vietnam National Foundation for Science and Technology Development (Grant #502.01-2016.15); by the Can Tho University Improvement project VN14=P6 supported by a Japanese ODA loan, and in part by the Faculty of Economics, Khon Kaen University. The research and this report have benefited from the assistance, comments, and suggestions of Ed Bukszar, Graham Loomes, Qiyan Ong, Walter Theseira, and Trinh Cong Duc; and from further comments of the editor and two anonymous reviewers.

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Correspondence to Phumsith Mahasuweerachai.

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Nguyen, K.T., Knetsch, J.L. & Mahasuweerachai, P. WTP or WTA: A Means of Determining the Appropriate Welfare Measure of Positive and Negative Changes When Preferences are Reference Dependent. Environ Resource Econ 78, 615–633 (2021). https://doi.org/10.1007/s10640-021-00546-0

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