Jack L. Knetsch

6 September 2008

“A core set of economic assumptions should be used in calculating benefits and costs”.

(Arrow, et al., 1996)

“Any measurement technique … should be consistent with standard economic theory of individual preferences and measurement of welfare changes”.

(Freeman, 1993)

“The value of these types of events is that it’s national, it creates a larger impact by spreading out the new wealth.”

Construction of new stadium $105 million Staging expenses 18 million Associated spending 45 million $168 million

Opting-In vs. Opting-Out

New employee enrollment in pension plan: Information, but opt-in 25% enroll Automatic unless opt-out 80% enroll

Organ donation concent: U.S. (Opt-in) < 20% Europe (Opt-out) > 80%

Measures of Economic Values

“Economic value of something is how much someone is willing to pay for it or, if he has it already, how much money he demands to part with it”. (Posner, 1986)

“… we shall normally expect the results to be so close together that it would not matter which we choose”. (Henderson, 1941)

Value of Gain and Loss

50 percent Chance to Win $20

Means

Maximum Price to Gain $ 5.60

Minimum Price to Lose 11.02

(Kachelmeier and Shehata, 1992)

Choice Between Goods

Final Outcome Mug Chocolate Choice of Good (N=55) 56% 44%

Initial Endowment: Mug (N=76) 89% 11% Chocolate (N=87) 10% 90%

Continuing Questioning and Reporting of Contrary Results

“Disparity disappears with repeated trials” Failure of Vickrey auction: 2nd vs 9th price

“Inexperience explains disparity” Reference state of dealers vs. visitors

“Experimental procedures responsible” Demonstrations manipulate reference, change gain/loss to choice: of course, no disparity

Natural Experiments

Investors reluctant to realize losses: Sell “winners” and keep “losers” Shares sold return 3.4% more than those kept (Odean, 1998)Price elasticity of eggs: Price decreases (gains, insensitive): -0.45 Price increases (losses, sensitive): -1.10 (Putler, 1992)

Standard Value Function

Value

Quantity

Value of Gains and Losses from Reference State

Value

R Quantity

“We suffer more … when we fall from a better to a worse situation, than we ever enjoy when we rise from a worse to a better”.

(Adam Smith, The Theory of Moral Sentiments, 1759)

Choice of Project

Two Transportation Projects, A and B: Equal: cost, beneficiaries, time savingA: Shorten distanceB: Replace failed bridge, eliminate detour Shorter Indifferent ReplaceUniv. Students 18% 13% 69%Econ Students 19% 21% 60%Sing. Civil Serv. 13% 22% 65%Int’l Experts 10% 20% 70%

Loss vs. Foregone Gain

Changing pension plan savings from payments from current earnings (a loss) to foregoing a portion of future wages (a foregone gain):

Savings rate from 3.5 percent of earnings, to 15.6 percent in three years. (Thaler and Benartzi, 2007)

Value of Gains and Losses from Reference State

Reference State and Measures of the Value of Positive and Negative Changes

Reference Basis of Valuation Measure State Measure Positive Negative

Before Compensating WTP to WTA to Change Variation Improve Accept Loss

After Equivalent WTA Forego WTP Avoid Change Variation Superior Ref Inferior Ref

Time Preferences / Discount Rates

“The discount rate should be based … on how individuals trade off current for future consumption”.

(Arrow, et al., 1996)

Time Peferences and Reference Effect

Value of Change in Delivery of Prize Speed-up delivery $14 Delay delivery 30

Trade Current Days for 11 Future Days Holiday Give up current days for future gain: 5.4 days Gain current days for future loss: 11.7 days

The Reference State and Measures of the Value of Future Gains and Losses

Ref Basis of Valuation of State Measure Future Gain Future LossBefore WTP Now WTA Now toFuture CV for Future Accept FutureChange Gain Loss

After WTA Now to WTP Now to Future EV Forego Future Avoid FutureChange Superior Ref Inferior Ref

Risk Aversion and Risk Seeking (A) 80% Chance of +$100 20% Chance of 0 or (B) Certain +$80

(C) 80% Chance of -$100 20% Chance of 0 or (D) Certain -$80

Changes in Insecticide Risks Risk Change (Initial Level 15/10,000) Inhalation Child Poisoning Money Value Decrease: -15 0 WTP $2.69 0 -15 WTP 4.28 -15 -15 WTP 8.09 -5 -5 WTP 1.84 -10 -10 WTP 2.38 Increase: +1 +1 WTA 3.38 (65% Refuse Purchase) (Viscusi, et al., 1987)

Reference State and Measures of the Value of Positive and Negative

Changes in Risk of Harm

Ref Basis of Valuation of Risk ChangeState Measure Positive NegativeBefore WTP to WTA to Accept Change CV Decrease Increase Risk in Risk

After WTA to Forego WTP to AvoidChange EV Decreased Risks Increased

Risk to Superior Ref to Inferior Ref

Survey Values of Changed Risks of Having Bicycle Stolen

Mean Median WTP to reduce risk 20.19 12 WTA to forego reduced risk of ref 46.29 35 WTA to accept increased risk 41.59 30 WTP to avoid increased risk of ref 16.53 10 (Knetsch, Tang, Zong, 2008)

Herbert Simon, 1986

“I think the textbooks are a scandal … I don’t know of any other science that purports to be talking about real world phenomena, where statements are regularly made that are blatantly contrary to fact.”