Abstract
In this study we investigate two reference dependence effects in a choice experiment. The first is the effect of the well-known distinction between gains and losses, the second is the effect of changing the reference value on willingness to pay (WTP) and willingness to accept (WTA). The latter has to our knowledge not been studied before. We hypothesize that there are differences between WTA and WTP, and that both value functions and their disparity are affected by the absolute value of the reference point. We test our hypotheses using a choice experiment with trade-offs between changes in flood probabilities and costs. The choice experiments elicit WTP and WTA, using two flood probability reference values, yielding four separate value functions. Our findings show that a substantial WTA–WTP disparity exists, and that this disparity increases when moving away from the reference point. Also, both WTA and WTP value functions are affected by the flood probability reference value, and the WTA–WTP disparity increases when the flood probability reference point increases. Both findings suggest that welfare effects caused by changes in public good provision depend not only on the direction of change (loss aversion), but also the reference value. Moreover, our results show that the latter effect is larger for losses than for gains. We introduce the concept of reference point updating as a possible explanation for these findings.
Highlights
The pervasive disparity between willingness to accept (WTA) and willingness to pay (WTP) for identical changes in goods and services implies that choosing appropriate welfare measures to assess the economic consequences of those changes is essential
Our prior expectations were that: (1) there is a disparity between WTP and WTA; (2) under risk aversion decreasing the flood probability reference value moves both the WTP and WTA value functions upward, for which we introduce the concept of reference point updating; (3) the WTA–WTP disparity increases as we increase the flood probability reference
To test these hypotheses we conducted four separate choice experiments using four split samples with similar socio-demographic characteristics living in the same case study area facing similar flood exposure levels, resulting in two WTP experiment with different flood probability reference values, and two WTA experiments with different flood probability reference values
Summary
The pervasive disparity between willingness to accept (WTA) and willingness to pay (WTP) for identical changes in goods and services implies that choosing appropriate welfare measures to assess the economic consequences of those changes is essential. This is especially true in the realm of public goods provision, where property rights are not always well defined and market prices to guide welfare analysis and decision making are often missing. Studies by Sudgen (1999) and Horowitz and McConnell (2003), among others, show that the observed differences cannot be reasonably explained by income and substitution effects only
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