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Willingness-to-Pay, Compensating Variation, and the Cost of Commitment

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  • Zhao, Jinhua
  • Kling, Catherine

Abstract

Hicksian welfare theory is static in nature, but many decisions are made in a dynamic environment. We present a dynamic model of an agent's decision to purchase or sell a good under the realistic conditions of uncertainty, irreversibility, and learning over time. Her willingness to pay (WTP) contains both the intrinsic value of the good as in Hicksian theory plus a commitment cost associated with delaying to obtain more information. The Hicksian equivalence between WTP/Willingness to accept (WTA) and compensating and equivalent variations no longer holds. The WTP and WTA divergence may arise and observed WTP values are not always appropriate for welfare analysis.

Suggested Citation

  • Zhao, Jinhua & Kling, Catherine, 2004. "Willingness-to-Pay, Compensating Variation, and the Cost of Commitment," ISU General Staff Papers 200401010800001272, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:200401010800001272
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    JEL classification:

    • D60 - Microeconomics - - Welfare Economics - - - General
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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