Evaluating Willingness to Pay

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Evaluating Willingness to Pay
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Evaluation

• Process of measuring the benefits derived from
  the use of a resource in monetary terms

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Opportunity cost method

• Among a group of alternative uses of a resource,
  the value of the chosen use is at least equal to
  the benefits that would have been derived from
  the next best alternative.

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Willingness to Pay method

• In an economy based on monetary exchange, the
  individual's willingness to pay a amount tells
  us that the amount paid is worth the sacrifice of
  the other things that could have been purchased
  with the money.

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Total v. Marginal WTP

• Total WTP is the total amount an individual would
  be willing to pay for a particular quantity
• area under the demand curve
• Marginal WTP is what an individual is WTP for
  additional units
• Illustrated by a curve

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About WTP

• Marginal WTP diminishes with quantity (Law of
  demand)
• An individuals marginal WTP may exceed market
  price (consumer surplus)
• If an individuals marginal WTP is less than
  market price, individual will not buy

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About WTP for skiing

• How much is the first day of ski trip worth? The
  second? The fifth?
• Great day for skiing! Same price! Who benefits?
• Why doesnt everyone ski? What if the price goes
  down?

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Total v. Marginal WTP for skiing

• What was that ski trip worth? gt total
  willingness to pay
• What was the first day worth? The fifth day? gt
  marginal willingness to pay

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Marginal WTP curve

• Downward sloping
• Price elasticity
• measures how responsive consumers are to price
  change
• Percentage change in quantity demanded /
  Percentage change in price
• ?Qd / ?price

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Price elasticity example

• If Ed .6 a 10 change in price brings about a
  6 change in quantity demanded.
• If Ed 1.4, a 10 change in price brings about a
  14 change in quantity demanded.
• Whenever
• Ed lt 1 demand is inelastic
• Ed gt1 demand is elastic

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Elasticity and Total Revenue

• What happens to total revenue when price
  decreases?
• Lower price ? producers get less for each unit
  sold ? total revenue declines
• Lower price ? increases quantity demanded ? total
  revenue increases
• Overall impact of lower price on total revenue
  depends on the net result of these opposite
  effects
• If demand is inelastic, a firm that raises it
  price will find that total revenue increases
• If demand is elastic, a firm that raises its
  price will find that total revenue decreases

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Total WTP area under MWTP curve

• Pricequantity consumer surplus for a
  particular quantity
• Pricequantity total revenue, observed in
  market place
• Consumer surplus area above price below MWTP
  curve, unobserved

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Inframarginal WTP for a large change in quantity
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Increase in marginal WTP for a quantity

• additional area under the new curve for a
  particular quantity

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Aggregating WTP among buyers

• Market value depends on the values of all buyers
• Add quantity at each price for each buyer

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Solved problem 1 movement along WTP with a
change in price

• Quantity (acres) 20 - .04Price per acre
• Find quantity for prices from 500 to 0
• Plot marginal WTP
• Find consumer surplus and total willingness to
  pay for 4 acres
• Find total willingness to pay for 2 additional
  acres

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Marginal WTP equation and table
Quantity (acres) 20 - .04Price per acre
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Marginal WTP curve
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Total WTP area under curve

• total revenue rectangle consumer surplus
  triangle
• 4400 0.54100
• 1600 200
• 1800

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Find total willingness to pay for 2 additional
acres

• Area under MWTP from Q4 to Q6
• Divide into two areas rectangle and triangle
• (6-4)350 0.5(6-4)(400-350)
• 750

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Solved problem 2 - shift in entire WTP function

• New Quantity (acres) 20 - .04Price per acre
• Find the increase in the Total WTP for a quantity
  of Q4 with the increase in the MWTP.

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Increase in marginal WTP for a quantity
additional area under the new curve
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Increase in total WTP increase in area under
new curve

• area of triangle area of triangle
• .51004 .51004
• 400

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Solved problem 3 Aggregating WTP among buyers
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Solved problem 3 Aggregating WTP among buyers