Willingness-to-Pay, Compensating Variation, and the Cost of Commitment
Jinhua Zhao, Catherine L. Kling
August 2000 [00-WP 251]
Zhao, J. and C.L. Kling. 2000. "Willingness-to-Pay, Compensating Variation, and the Cost of Commitment." Working paper 00-WP 251. Center for Agricultural and Rural Development, Iowa State University.
The authors present a dynamic model of an agent's decision to purchase or sell a good under the following conditions: uncertainty, irreversibility, and learning over time. As the authors show, an agent's willingness-to-pay (WTP) is influenced by both the intrinsic value of the good and the commitment cost associated with delaying the decision until more information is available. Consequently, the standard Hicksian equivalence between WTP and compensating and equivalent variation no longer holds. This finding has important practical implications because it implies that observed WTP values are not always appropriate for welfare analysis.