If the Large WTA-WTP Gap for Public Goods is Real (And There are Good Reasons to Think So) Conventional Welfare Measures are Simply Incorrect

Abstract

A robust finding in economics is that decision-makers often exhibit a much smaller dollar willingness to pay (WTP) for an item than the minimum amount that they claim to be willing to accept (WTA) to part with it. The spread between these two numbers is particularly large for public goods, raising serious public policy concerns regarding which number, if either, is appropriate for valuing such goods. A traditional utility maximizing model is presented here that predicts - as both measures are currently calculated - that WTA will exceed WTP, quite plausibly by a substantial amount for public goods. Moreover, it is shown here that current measures of WTA, and not WTP, are likely to be more appropriate for use in public policy decisions about increases in the supply of public goods. The central argument stems from a failure to properly value public goods by traditional methods. First, since households cannot individually purchase public goods by generating income, they will under-generate any income that would have been devoted to public goods. Second, since households will be expected to generate income to buy (possibly quite poor) private good substitutes for the public good, the costs of the public good can come from reduced expenditures on the private good substitutes. That is, conventional welfare analysis implicitly assumes an initially optimal combination of leisure, private goods, and public goods when an increment to public goods is being contemplated when the initial combination will be sub-optimal in general - it will involve some mix of too much leisure and too many private good substitutes for the under-supplied public good. Welfare measures for increments to a public good, as currently practiced, are simply incorrect, undervaluing public goods by a potentially large amount.