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 (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: 2 nd vs 9 th 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): Price increases (losses, sensitive): (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 saving A: Shorten distance B: Replace failed bridge, eliminate detour Shorter Indifferent Replace Univ. 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 Loss Before WTP Now WTA Now to Future CV for Future Accept Future Change Gain Loss After WTA Now to WTP Now to Future EV Forego Future Avoid Future Change 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: WTP $ WTP WTP WTP WTP 2.38 Increase: 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 Change State Measure Positive Negative Before WTP to WTA to Accept Change CV Decrease Increase Risk in Risk After WTA to Forego WTP to Avoid Change 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 WTA to forego reduced risk of ref WTA to accept increased risk WTP to avoid increased risk of ref (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.”