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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. (JEL D60, D83)
ABBREVIATIONS
CV: Compensating Variation
CVM: Contingent Valuation Method
EV: Equivalent Variation
QOV: Quasi-Option Value
WTA: Willingness to Accept
WTP: Willingness to Pay
I. INTRODUCTION
Hicksian welfare theory, which is static in nature, forms the basis of modern welfare analysis. This theory has provided a wealth of compelling principles with direct applicability for empirical welfare analysis (see, for example, Hoehn and Randall 1987; Bockstael and McConnell 1983; Randall and Stoll 1980). The equivalence of the maximum willingness to pay (WTP) for a good with the Hicksian concept of compensating (or equivalent) variation (CV or EV) is a central precept of this theory. This specific principle has provided the necessary theoretical basis for substantial literature in several areas of applied economics, including work on valuing public goods, experimental economics, and price discriminating monopoly, to name only a few.
Thus, researchers in search of the value of a public good have designed surveys eliciting consumers' maximum WTP to obtain. the public good. If the assumptions of the static Hicksian theory hold, this measure can be readily interpreted as the compensating variation, a theoretically defensible welfare measure that can be directly applied to cost-benefit analysis using stated preference methods (Mitchell and Carson 1989; Carson 1997; Smith 2000). Likewise, experimental economists elicit WTP or willingness to accept (WTA) based on actual transactions to test a variety of consumer theory hypotheses, including the empirical disparity between WTP and WTA (Horowitz and McConnell 2002; Horowitz et al. 1999; List forthcoming) and the equivalence between revealed and stated preference values (Cummings and Taylor 1999; List 2001).
However, many decisions in the real world...