WTP or WTA - Is that the Question?
Reflections on the Difference between
“Willingness To Pay” and “Willingness to Accept”
by
Michael Ahlheima
Wolfgang Buchholzb
a
BTU Cottbus, Department of Economics, P.O. Box 10 13 44, D-03013 Cottbus, Germany, e-mail: ahlheim@umwelt.tu-cottbus.de
b
University of Regensburg, Department of Economics, D-93040 Regensburg, Germany, e-mail: wolfgang.buchholz@wiwi.uni-regensburg.de
WTP or WTA - Is that the Question?
- Reflections on the Difference between "Willingness To Pay" and "Willingness To Accept" -
1
Introduction
During the last ten years there has been growing interest in the contingent valuation method
(CVM) as an instrument for assessing the preferences for environmental quality. The CVM is
an interview technique used to estimate the value people attach to certain environmental
goods. In principle, there are two main fields of application for the CVM. One is the economic
valuation of environmental projects, i. e. of projects meant to improve environmental quality.
The second important field of application for the CVM is damage assessment after environmental accidents, i. e. after incidents that deteriorate environmental quality. In the United
States, as a consequence of the Comprehensive Environmental Response, Compensation and
Liability Act (CERCLA) of 1980, it is possible for the government to act as a trustee of the
nation's natural resources. This position enables the government to sue any person or firm for
compensation that is deemed responsible for contaminating the environment. In 1989 the US
Department of the Interior was directed by a federal court of appeals to demand compensation
not only for lost use values but also for destroyed non-use or passive-use values of environmental goods.1 As an appropriate technique for damage assessment the court recommended
the CVM. The inclusion of non-use values in the amount of compensation payments meant a
considerable increase in the financial risk of potential polluters. It is therefore not astonishing
that after this judicial decision a mighty alliance of firms bearing environmental risks was
formed with the objective to fight the acknowledgement of the CVM in the judicial proceedings following environmental accidents. The main policy of this group was to sponsor a great
number of research projects which were all meant to shake the confidence in the validity and
reliability of the CVM. A rather acrimonious debate followed between advocates and opponents of the CVM in the economics literature. A good impression of this controversy can be
obtained from Hausman (1993), Portney (1994), Hanemann (1994) and Diamond / Hausman
(1993 and 1994).
One of the many points of criticism raised in this debate refers to the choice of the correct
elicitation format. In principle, there are two possibilities: one can ask for people's willingness
to pay (WTP) for an improvement of environmental quality or one can ask for their willing1
Cf. State of Ohio versus United States Department of Interior, 880 F. 2d 432 (D. C. Circuit, 1989). By nonuse values of environmental goods we mean values which are independent of an active (and empirically observable) use of the respective goods. Typical kinds of non-use values are existence values, option values or
bequest values. While this conforms to the definition common in the economics literature there has been some
controversy about broader definitions of existence values recently (cf. Aldred, 1994, and Attfield, 1998). For
more details with respect to the relationship between use and nonuse values see e. g. Mitchell / Carson (1989,
p. 67 ff.) or Shechter / Freeman (1994).
2
ness to accept (WTA) compensation for renouncing this improvement. Critics of the CVM
hold that both measures should lead to nearly the same amount of money which can be interpreted as the value. The fact that most practical CVM surveys exhibit a rather substantial divergence between WTP and WTA is taken as evidence that the CVM "is a flawed measuring
instrument" (Diamond, 1996a, p. 65).
In this paper we first try to retrace the discussion on the difference between WTP and WTA in
the economics literature and then we diagrammatically describe the dependence of this difference on income and substitution effects as shown mathematically by Hanemann (1991). We
make transparent that the size of the WTA-WTP-difference is mainly affected by substitution
effects so that, particularly for environmental goods, seemingly anomalous phenomena can
well be explained in the framework of standard utility theory. We argue in a further step that
within the framework of ordinal utility theory the absolute values of WTA and WTP, as well
as the difference between these values are of no importance at all. In an ordinal world the only
fact that counts is the sign of a welfare change. The problem of comparing absolute values
arises only if we want to add up individual WTPs or WTAs according to the Hicks-Kaldor
criterion, which means leaving the grounds of ordinal utility theory. Aggregation of individual
values, which is crucial for cost-benefit analysis, implies the use of arbitrary political value
judgements. Using aggregate WTPs or WTAs thus implies leaving the world of pure economic science and entering the world of applied policy. Here, not only abstract considerations
whether WTA or WTP is more appropriate for principal reasons matter, but also the choice of
the welfare measure (WTP or WTA) should depend on the specific political and socioeconomic framework of the project in question. This will be explained in more detail below.
The paper is organised as follows: In section 2 the main principles and concepts of welfare
measurement like the Hicksian compensating and equivalent variation and their relation to
WTP and WTA are elaborated. Then the main explanations for the WTP-WTA difference
given in the economics literature are scrutinised. Section 3 presents a diagrammatic analysis
of the relation between the WTP-WTA difference on the one hand and income and substitution effects of changes in environmental quality on the other. This implies a graphical illustration of Hanemann's (1991) analysis. In section 4 we present the main conclusions from our
analysis with respect to the design of practical CVM surveys.
2
WTP versus WTA - The state of the art
Hicksian measures of individual welfare
It is well known that the concepts of WTP and WTA are derived from the Hicksian welfare
measures of the compensating variation (CV) and the equivalent variation (EV). For a household consuming a vector x of market goods with prices p (assumed to be constant here) and a
scalar Q representing environmental quality the Hicksian compensating variation can be defined as
3
(1) CV = e(p,Q1,U1) - e(p,Q1,U0),
where e(p,Q,U) is the household's expenditure function. The superscripts 0 and 1 indicate the
situation before and after the environmental change to be valued, and U is the utility level
attained by the household in the respective situations. From the definition of the expenditure
function it follows that the CV according to (1) is equal to the difference between the effective
household income in the new situation on the one hand and the fictitious income the household would need to attain its initial utility level U0 with new environmental quality Q1 on the
other hand. Therefore, the CV equals the maximum amount of money the household could
give up in situation 1 (i. e. after the change in environmental quality Q) without being worse
off than in the initial situation 0. If this amount is positive, the CV can be interpreted as the
household's maximum willingness to pay (WTP) for the project in question. If it is negative,
the CV equals the smallest sum that could compensate the household for the respective utility
loss. In this case the CV represents the household's minimum "willingness to accept" (WTA).
In other words, the CV equals the amount of money that could compensate the household (in a
positive or a negative sense) for the utility change implied by the project in question.
The Hicksian equivalent variation EV on the other hand is given by the minimum amount of
money a household would require in situation 0 (i. e. without a change in environmental quality) to attain the same utility level as in situation 1 (i. e. after the change in environmental
quality has taken place):
(2) EV = e(p,Q0,U1) - e(p,Q0,U0)
If this amount is positive, the EV can be interpreted as the minimum amount of money that
could compensate the household for renouncing the environmental change in question (i. e. its
minimum willingness to accept (WTA) compensation for going without that change). If it is
negative, the EV equals the household's maximum WTP to prevent this (utility decreasing)
change. In this case the EV equals the amount of money that is equivalent (from a utility point
of view) to the environmental change in question. The relationship between the Hicksian
measures of CV and EV on the one hand and the concepts of WTP and WTA on the other is
illustrated in fig. 1.2
2
For cases like this where only the quantities of (rationed) goods are changed the variation measures CV and
EV are often referred to as "compensating surplus" and "equivalent surplus" according to Hicks (1943). But
since for such cases the Hicksian variation measures and the surplus measures are identical we do not make
this distinction here.
4
CV
EV
increase in environmental quality
(∆U > 0)
decrease in environmental quality
(∆U < 0)
WTP
WTA
(CV > 0)
(CV < 0)
- case 1 -
- case 3 -
WTA
WTP
(EV > 0)
(EV < 0)
- case 2 -
- case 4 -
- fig. 1 -
In the following we shall concentrate on cases 1 and 2, i. e. on the WTP and WTA for an increase in environmental quality which correspond to the Hicksian CV and EV, respectively.
Cases 3 and 4 can be treated analogously. The EV and CV for an improvement of environmental quality from Q0 to Q1 are illustrated in fig. 2, where the market goods are treated as a
single Hicksian composite commodity (with quantity X) which is also used as a numéraire
with p = 1. Environmental quality Q is assumed to be a collective consumption good supplied
free of charge so that the household's lump-sum income I is spent completely on the market
good. The household's budget constraint is then a parallel to the Q-axis.
5
X
.
.


EV = WTA 


I= X

CV = WTP 

D
A
.
.
C
B
Q
0
Q
U
1
U
0
Q
1
- fig. 2 -
The maximum amount of money the household could dispense with after the increase of environmental quality from Q0 to Q1 without being worse off than in the initial situation 0, i. e. its
WTP, is represented by BC in fig. 2. Its WTA to forgo this environmental improvement
equals AD in fig. 2, i. e. if it were given this amount of money without increasing environmental quality it could attain the same utility level U1 as after that environmental change.
From fig. 2, it becomes apparent that CV and EV measure the vertical distance between the
two indifference curves U0 and U1 for different values of Q. This simple and obvious fact has
two important consequences for our problem here.
First: Within the framework of ordinal utility theory both measures are equivalent with respect
to the comparison of two states of the world (situations 0 and 1), since both always have the
same sign for the same change in utility3, i. e.
>
(3) CV = 0
<
>
⇔ U1 = U0
<
>
⇔ EV = 0 .
<
The fact that they differ in absolute value for the same project is of no importance at all, since
differences between utility levels are (like utility functions themselves) only defined up to a
strictly monotone transformation. The only thing that counts is the sign of these differences.
Therefore, questions like "WTP and WTA: How much can they differ?" (title of Hanemann
1991) are completely irrelevant for the measurement of individual welfare. They gain impor-
3
This follows immediately from definitions (1) and (2) and from the fact that the expenditure function is
strictly increasing in the utility level U.
6
tance only in the context of adding up individual utility levels, a procedure that contradicts the
principles of ordinal utility theory, as will be discussed below.
Second: The fact that the vertical distance between two indifference curves varies along one
of the commodity axes (here along the Q-axis) is not astonishing at all since this is the "normal" case. Only very special preference orderings (like e. g. quasi-linear preferences where the
Engel curves are parallels to the X-axis) do not show this phenomenon. Therefore, the whole
debate on the difference between the absolute values of WTP and WTA is irrelevant from an
ordinalist point of view. Further, the result of many practical CVM surveys that the WTA is
greater than the WTP becomes also plausible from the simple fact that the WTP is restricted
by a household's budget constraint while there is no upper bound for its WTA.
Psychological aspects
A psychological line of reasoning to explain the disparity between WTP and WTA is followed, among others, by Kahneman / Tversky (1979), Knetsch (1994 and 1995), Boyce et al.
(1992), Shogren et al. (1994), Morrison (1997) and Shogren / Hayes (1997). The general idea
underlying these papers is that from a psychological point of view the typical WTP-situation,
where people bid for an environmental improvement, is not symmetric to the typical WTAsituation, where they have already attained that improvement (or are promised to get it) and
are now asked for the amount of money that could compensate them for its loss. It is suspected that people have a strong psychological affinity to the status quo such that they are
rather unwilling to accept a change for the worse and, therefore, demand high compensation
payments for any deterioration of their actual situation while, in the WTP-situation, they are
willing to pay only a comparatively modest sum for an equivalent improvement: "Losses appear to matter much more than gains to most people, and valuation of goods depends, to a
large degree, on the reference position and the direction of change from this point." (Knetsch,
1995, p. 140). This so-called endowment effect (Morrison, 1997, Shogren / Hayes, 1997)
leads to asymmetric reaction curves with respect to the two directions of leaving the status
quo where the WTP for improvements is much lower than the WTA compensation for decreases in utility.4 The foundations of this idea can already be found in the so-called 'prospect
theory' of Kahneman and Tversky (1979).
It is important to note that this endowment effect must not always be taken literally but may
also occur in a figurative sense. This refers to situations where people have not attained an
actual property right to a certain environmental good but think they have a moral right to it.
As an example for this moral endowment effect Boyce et al. (1992) compare the case where
American citizens are asked for their WTA compensation from the Japanese for the final extinction of the blue whales by Japanese whalers with another scenario where the Americans
are asked for their WTP to keep the Japanese from exterminating the whales. It is obvious that
the aggregated WTP to save the whales will be much smaller than the WTA compensation for
their extinction since the American public thinks it has a moral right to the survival of the
whales. The Japanese whalers are the "bad guys" in this scenario so that bribing them to keep
4
See e. g. Bateman / Turner (1993, p. 144).
7
them from this outrage against nature is out of the question for many people outside Japan.
This example shows that the difference between WTA and WTP for environmental values
may often depend on the allocation of "moral property rights". It becomes very large if people
reject the property rights implied by the WTA format, as is often the case. Boyce et al., detected this effect also in an experimental survey performed by themselves and conclude: "It is
our belief that the disparity between WTA and WTP for environmental goods may in great
part be due to the intrinsic "moral" values captured by such commodities" (Boyce et al. 1992,
p. 1371).
Another psychological explanation for the large differences between WTP and WTA found in
CVM studies is the so-called "cautious consumer hypothesis" (cf. e. g. Mitchell / Carson,
1989). This hypothesis holds that households do not have the time or opportunity to collect
enough information on the environmental good in question to optimise their decision so that
there always remains a rest of uncertainty with respect to its "true" value. To be on the safe
side households state a lower WTP and a higher WTA for the respective good in this situation
than they would if they were to value it under conditions of perfect certainty. Though this hypothesis seems to be quite plausible at first sight it is highly unlikely that the differences between WTP and WTA found in empirical studies can be explained solely by consumer cautiousness.
Analytical aspects
There have been several attempts to clarify the relation between the absolute values of WTP
and WTA by using the analytical tools of neo-classical household theory. In his seminal paper
Robert Willig (1976) showed that the difference between the Hicksian equivalent and compensation variation for changes in commodity prices depends crucially on the income elasticities of the commodities whose prices change. Randall and Stoll (1980) extended Willig's
analysis to the case of quantity changes. This aspect is important for cost-benefit analyses of
environmental projects because such projects change the quantities (or quality) of goods
which are not traded in markets so that Willig's analysis is not directly applicable. Randall and
Stoll derive limits for the difference between the Hicksian CV and the EV (i. e. between WTP
and WTA) for quantity changes where these limits depend decisively on the "price flexibility
of income" for these goods (Randall and Stoll, 1980, p. 453). The price flexibility of income
can be interpreted as the income elasticity of shadow or virtual price functions for the environmental goods in question.5 This study gave rise to the interpretation of the difference between the WTP and WTA for an environmental change as some sort of "income effect". The
crucial importance of the work done by Randall and Stoll lies in the fact that these elasticities
were estimated empirically in several CVM surveys and their values were always rather small.
According to Randall and Stoll the difference between WTP and WTA should then also be
small. Unfortunately, they were found to be quite large in most CVM studies. This induced
the critics of the CVM to question its consistency with neoclassical consumer theory in general and its ability to measure consumer preferences (see e. g. Diamond, 1996a, p. 66).
5
For public goods which are supplied for free virtual prices and shadow prices can be treated as being identical.
8
As a reaction to this development Hanemann (1991) showed in a household consumption
model with one environmental good that the price flexibility of income ξ can be expressed by
the ratio of the income elasticity of the Marshallian demand function for this good η and the
Allen-Uzawa elasticity of substitution σ between the environmental good and a Hicksian
composite commodity representing the market goods, i. e. ξ = η/σ. This result was generalised
for the case of many environmental goods by Flores and Carson (1997). Hanemann argued
that from his analysis it becomes obvious that the WTP-WTA difference is not only a question
of income effects but also of substitution possibilities between environmental and market
goods. It is, of course, plausible that the difference between WTP and WTA must be larger
when no substitute for the environmental good to be valued is available than in cases where it
can easily be replaced by other goods. There may be no finite WTA for the loss of your life
but your WTP for its rescue is limited to a finite amount by your income. The result that the
difference between WTP and WTA becomes larger when possibilities of substitution become
smaller was also confirmed by a series of experiments by Shogren et al. (1994). Two extreme
examples of preference orderings with differences of zero and infinity between WTP and
WTA according to the degree of substitutability are given in fig. 3.
- fig. 3 -
While Hanemann's theoretical considerations explain the large differences between WTP and
WTA found in most CVM surveys, they give no explanation for the fact that the price flexibilities of income ξ and their variation over the relevant range as estimated in these studies
were rather small. According to Hanemann's formula (ξ = η/σ) a CVM survey for the valuation of an easily substitutable environmental good, which, therefore, produces a large difference between WTP and WTA, should also find high values for the respective price flexibility.
Unfortunately, in most empirical studies this was not the case.
It is most irritating in this context that while the price flexibility of income can be assessed
empirically by a CVM survey, this is not true for the income elasticities of the Marshallian
demand for environmental goods η and for the respective elasticities of substitution σ (cf. e. g.
Diamond, 1996b, p. 344). This deficiency makes it difficult to decide if the CVM is an inap-
9
propriate method to assess the correct values of WTP and WTA or if the data collected and/or
empirical methods used were insufficient to estimate the correct price flexibilities of income.
If it were possible to measure the degree of substitutability empirically instead of just guessing
it we would have an alternative tool for testing the validity of the CVM. Before we go further
into the question of how significant these findings are with respect to the practical use of the
CVM we illustrate the theoretical relations detected by Hanemann (1991) in a diagrammatic
analysis, which is much easier than the one presented by Morrison (1997). Since Hanemann’s
seminal contribution some confusion has arisen whether the substitution and the income effects are really separate determinants of the WTA-WTP difference. By our simply diagrammatic analysis we want to clarify this issue.
3
A diagrammatic analysis
For a deeper analysis of the WTA-WTP difference consider Figure 4, which has similarly
been used by Hanemann (1991), but only for heuristic purposes. In this diagram we plot the
Hicksian pseudo demand curves Qi(p) := Q(p,Ui) for i = 0,1 which correspond to the utility
levels U0 and U1 of Figure 2. The shadow price of the public good measured in units of the
private numéraire good is denoted by p. Then Qi(p) describes the demand for the environmental good for a given price p if individual income is adjusted so that the representative individual has utility Ui in his household optimum. Consider now the corresponding inverse
demand functions p0(Q) and p1(Q) which indicate the marginal rate of substitution between
the public and the private good on the indifference curves U0 and U1. When xi(Q) describes
the indifference curve for the utility level Ui (i = 0,1) as a function of Q, we have.
(4)
p i ( Q ) = - x ′i ( Q )
(i = 0,1)
for every Q.
10
- fig. 4 -
WTA and WTP can then be expressed as
(5)
WTA = x1 ( Q 0 ) − x 0 ( Q 0 ) and WTP = x1 ( Q1 ) − x 0 ( Q1 ) .
Turning to integral representation gives (cf. Cornes 1992, p. 213)
Q1
(6)
x i ( Q ) − x i ( Q ) = − ∫ p i ( Q )dQ
1
0
Q0
for both i = 0,1 so that we obtain
Q1
(7)
WTA − WTP = ∫ ( p1 ( Q ) − p 0 ( Q ))dQ .
Q0
Therefore, the WTA-WTP difference is measured by the area A'B'C'D' in Figure 4. If we make
the plausible assumption that the environmental good is (weakly) normal, Hicksian demand
for the public good (weakly) increases with utility for any public good price p. The inverse
demand function p1(Q) then cannot lie below p0(Q), which implies
(8)
WTA ≥ WTP .
Our considerations above show that normality is decisive for the well-known inequality (8).
This also holds true for the following result, which is the cornerstone of the analysis in this
paper,
(9)
p1 ( Q1 ) ≤ p 0 ( Q 0 ) .
11
For a proof note that in Figure 4 C' can never lie above A', or equivalently, in Figure 2 the
indifference curve U0 in A has to be steeper than the indifference curve U1 in C. But this easily follows as - by normality - the income expansion path passing through A will intersect U1
in a point left of C and U1, of course, is convex.
Obviously, the size of the WTA-WTP difference, which is the focus of our analysis, depends
on the vertical distance between the two Hicksian demand curves under consideration. Let ε
denote the maximal vertical distance between p0(Q) and p1(Q) in the range between Q0 and
Q1. From (7) we then get the following estimate:
(10) WTA - WTP ≤ ε(Q1 - Q0) .
The difference between p0(Q) and p1(Q) describes how the shadow price of the environmental
good changes for a given Q when utility increases from U0 to U1. In a certain way, ε provides
some kind of a Hicksian variant of the ‘price flexibility of income’, which is at the heart of
Randall/Stoll’s (1980) analysis. As was explained above the 'price flexibility of income' is
defined as the income elasticity of the household's shadow price function which can be represented by the vertical distance between the p0(Q) and p1(Q) functions.
But, as will be shown now, the size of ε can be expressed by the vertical distance of both demand curves as well as by their slopes. It is just this which lies behind the complicated calculations by Hanemann (1991). These geometrical properties of the Hicksian pseudo demand
curves, however, can be interpreted in a straightforward way.
The horizontal distance Q1(p) - Q0(p) between the two Hicksian demand functions is equivalent to the Hicksian income effect, i. e. it describes how, for any given price p, public good
demand changes if utility increases from U0 to U1. Let d denote the maximum horizontal distance in the range between the new and the old marginal shadow price of the environmental
good. Then, as Hicksian demand is falling with convex indifference curves, from (9) we especially obtain
(11) d ≤ Q1 − Q 0 .
Furthermore, define µ as the maximum value which the absolute value pi'(Q) of the two
pseudo Hicksian demand curves has in the relevant range. This will allow us to consider the
impact of substitution effects on the WTA-WTP divergence. For an interpretation note that
pi'(Q) is the positively signed reciprocal value of Qi'(p), i. e. the slope of a Hicksian pseudo
demand curve, so that a small value of pi'(Q) indicates that public good demand is rather
elastic if the public good price varies. Then, the possibility to substitute away from the public
good is high which is also reflected in the elasticity of substitution. We will in particular consider how the WTA-WTP difference varies if µ decreases, i. e. if the environmental good can
be more easily substituted by the numéraire good.
Under the normality assumption, there is a simple estimate for the vertical distance of the two
Hicksian pseudo demand curves:
12
(12) ε ≤ µd .
~
Just look at Figure 5 where for any Q lying between Q0 and Q1 it can be seen that
( )
( )
~
~
(13) p1 Q − p 0 Q ≤ FH = tan α ⋅ FG ≤ µd
as FG ≤ d by definition of d.
- fig. 5 -
Combining inequalities (10) and (12) we obtain an upper-bound for the WTA-WTP divergence which has the same message as Hanemann’s central formula
(14) WTA − WTP ≤ µd(Q1 − Q 0 ) .
Here, the substitution and the income effect seem to be two quite independent determinants of
the WTA-WTP divergence connected with an increase in environmental quality. But there is
an asymmetry which might explain why the discussion in the literature is not so much transparent.
First, WTA and WTP are equal if there is no income effect, i. e. d = 0, irrespective of the size
of the substitution effect as measured by µ. Just look at the extreme case of a quasi-linear utility function
(15) u(x,Q) = x + bϕ(Q)
13
for which with respect to the environmental good the income effect is zero. For this type of
utility function in Figure 2 all indifference curves only differ by a parallel shift along the xaxis. Consequently, in Figure 4 the inverse Hicksian pseudo demand curves p1(Q) and p2(Q)
always coincide in this case. The size of b, which is responsible for the slope of the Hicksian
demand curves, i. e. for the substitution effect, then plays no role with respect to the WTAWTP difference. It is not required here either that ϕ(Q) is a linear function. Thus, convexity of
the indifference curves alone will not create a positive WTA-WTP divergence as - following
Shogren et al. (1994) - has been suggested by Hanley/Shogren/White (1997, pp. 362-364).
In order to get a better understanding of the interplay between income and substitution effects,
inequality (14) is transformed into
(16) WTA − WTP ≤ µ(Q1 − Q 0 )
2
which is possible as d ≤ Q1 - Q0 according to (11). Note that for this step the normality assumption is crucial. In inequality (16) only the substitution effect appears. In particular, this
means that the WTA-WTP difference will inevitably vanish if perfect substitutability is approached, irrespective of how the income effect simultaneously might change. As inequality
(11) shows how the size of the Hicksian income effect is bounded it can be made explicit by
use of inequality (16) that an increasing income effect cannot compensate for declining substitution possibilities.
Isolating the substitution effect in this way might give a more precise argument for Hanemann’s (1991, p. 646) assertion ‘that the substitution effects could exert a far greater leverage
on the relation between WTP and WTA than the income effects’. In particular there is no reason to assume that in the standard utility theory the WTA-WTP difference should be small.
Look at Figure 5. If the upper Hicksian demand curve Q1 ( p ) is very steep, WTA will exceed
WTP by much. This means that decreasing the public good amount starting from Q1 will
cause a loss to individuals esteemed as considerable by them. This is nothing more than a description of some kind of endowment effect which seems to be typical for environmental
goods. The high preference for keeping an environmental good at a high level may well reflect
feelings of moral obligations for preserving nature. Only if one wants to measure non-use values by CVM ethical preferences have to be taken as an integral part of environmental preferences. That they may cause a rather untypical shape of indifference curves and Hicksian demand curves is neither a surprise nor does it constitute a real preference anomaly. The error of
the proponents of “WTP should be very similar to WTA” lies in the belief that preferences for
environmental goods should be as smooth as preferences for easily substitutable private
goods. This is obviously at odds with reality but having differently shaped preferences is not
necessarily at odds with neo-classical consumer theory. We do not have to take resort to endowment effects lying beyond neoclassics nor to Morrison’s opaque diagrams in order to
make this distinction clear.
14
4
Conclusions with respect to practical CVM surveys
From the previous sections the following points became apparent: (1) As measures of individual welfare changes WTP and WTA are both derived from the Hicksian measures of compensating and equivalent variation. Both measures are strictly monotone transformations of a
utility index. Since utility itself is not observable empirically we need welfare measures like
WTP or WTA for the practical assessment of utility changes because they are defined in observable (monetary) units. Within the framework of ordinal utility theory WTP and WTA are
equivalent measures of individual welfare change since they always have the same sign, and
the sign of a welfare change is all that matters in this context. (2) The absolute values of WTP
and WTA for an environmental good can differ considerably where the difference depends on
the possibilities of substitution and on the income elasticity of the Marshallian demand for the
environment. The divergence between the WTP and the WTA can alternatively be explained
by the so-called price flexibility of income, i. e. by the income elasticity of the virtual price
function for the environmental good in question. (3) Several practical CVM surveys found
large differences between WTP and WTA while the respective price flexibilities of income
were rather small. Since these results are contradictory from a theoretical point of view the
question arises what the consequences should be with respect to the practical use of the CVM.
The judgement of notorious CVM critics like Peter Diamond and Jerry Hausman (1994, p. 62)
is rather clear-cut: "We belief that contingent valuation is a deeply flawed methodology for
measuring nonuse values, one that does not estimate what its proponents claim to be estimating." Practitioners of the CVM like Mitchell and Carson (1989) or the members of the socalled NOAA panel6 (1993) recommend to use always the WTP format for practical studies.
The reason is that WTP turned out to be smaller than WTA in most practical CVM surveys so
that the WTP is the "conservative choice" (NOAA 1993, p. 4612) and, therefore, should be
used to be on the safe side. Of course, in this recommendation there is a high degree of resignation with respect to the significance of CVM results.
Our point of view is much less resigned in this respect. From the preceding sections of this
paper it became clear that WTP and WTA are measures of individual welfare and that their
absolute values do not matter at all in the context of ordinal utility theory. In fact, large differences between WTP and WTA for environmental goods should be expected from a theoretical
point of view since substitutes for these goods are not easily available and the WTP-WTA
difference is negatively correlated with the substitution possibilities as was shown before. In
practical cost-benefit analyses it is customary to aggregate individual welfare changes by
adding up the individual WTPs or WTAs. According to the Hicks-Kaldor criterion a project is
recommended as socially advantageous if and only if the sum of the individual WTPs or
WTAs is positive. At this stage the absolute values of the individual measures are of crucial
importance for the outcome of the whole project evaluation. It is well-known that welfare
6
Cf. National Oceanic and Atmospheric Administration (1993). The NOAA panel which was presided by the
Nobel laureates Kenneth Arrow and Robert Solow recommended the CVM as a valuable instrument for the
judicial processes of damage assessment following accidents with environmental degradation and fixed a
number of guidelines for its use in this context.
15
judgements on the basis of the sum of individual welfare measures are not possible within the
framework of ordinal utility theory. It has been shown by several authors that this aggregation
procedure implies political value judgements by attaching implicit welfare weights to the different households or household groups (see e. g. Ebert, 1985, Blackorby / Donaldson, 1988 or
Pauwels, 1993). Further, the Hicks-Kaldor criterion is neither necessary nor sufficient for the
existence of potential Pareto improvements (cf. Ebert, 1985). This means that the use of aggregate WTPs or WTAs as a welfare criterion already implies leaving the world of "pure"
economic science and entering the world of applied policy. Accordingly, the decision on
which of these aggregate measures should be used to value a certain environmental change
should be made dependent on the specific political and socio-economic circumstances, since
this choice is a political decision, too. Therefore, WTP should be chosen if we want to implement an environmental improvement and WTA should be employed if we want to sue a polluter for environmental damage (i. e. if we want to compensate society for the loss of environmental quality).
Another important criterion should be the plausibility of the respective elicitation question to
"normal" people (i. e. to non-economists) in the specific context of the project to be valued. If
an environmental improvement is to be valued, the "natural" question is that for respondents'
WTP, while in the context of damage assessment after an environmental deterioration the psychologically adequate question would aim at their WTA compensation for the resulting decrease in utility. Using the WTP for all kinds of environmental changes as recommended by
the NOAA panel implies a systematic underestimation of environmental damages. Such a
policy stabilises the actual situation in which the use and abuse of nature is too inexpensive
from a social point of view. The distribution of property rights implied by assessing the WTP
for an improvement and the WTA for a deterioration of environmental quality appears plausible to most people so that there should be a good chance to obtain reliable answers.7 Additionally, these are the concepts that are relevant from a political point of view in the respective
cases, so that the resulting question formats are also adequate under socio-economic aspects.
From our considerations it follows that the question "WTP or WTA?" cannot and should not
be answered in general as is often claimed in the economics literature. Instead, the choice of
the adequate question format should be made dependent on the political and socio-economic
circumstances of the specific environmental change to valued.
5
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16
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