Willingness to pay

Willingness to pay

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Encyclopedia
In economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, the willingness to pay (WTP) is the maximum amount a person would be willing to pay, sacrifice or exchange in order to receive a good
Good (economics and accounting)
In economics, a good is something that is intended to satisfy some wants or needs of a consumer and thus has economic utility. It is normally used in the plural form—goods—to denote tangible commodities such as products and materials....

 or to avoid something undesired, such as pollution. This term stands in contrast to willingness to accept
Willingness to accept
Willingness to accept is the amount that а person is willing to accept to abandon a good or to put up with something negative, such as pollution. It is the minimum monetary amount required for sale of a good or acquisition of something undesirable to be accepted by an individual...

 payment (WTA), which is the minimum amount an individual is willing to receive to give up a good or to accept something undesirable.

Several methods have been developed to measure consumer willingness to pay. These methods can be differentiated whether they measure consumers' hypothetical or actual willingness to pay and whether they measure consumer willingness to pay directly or indirectly.

Choice modelling
Choice Modelling
Choice modelling attempts to model the decision process of an individual or segment in a particular context. Choice modelling may also be used to estimate non-market environmental benefits and costs....

 techniques may be used to estimate the value of the WTP through a choice experiment.

Unlike WTA, WTP is constrained by an individual's wealth. For example, the willingness to pay to stop the ending of one's own life can only be as high as one's wealth, while the willingness to accept payment to accept the ending of one's life would be an extremely high number, perhaps approaching infinity.

Formal definition


Let u(w, x) be an individual's utility function, where w is the person's wealth and x is a variable that takes the value one in the presence of a good and takes the value zero in the absence of that good. The utility function is assumed to be increasing in both wealth and x. Also, define w0 as the person's initial wealth. Then the "willingness to pay", denoted WTP, is defined by


Thus WTP is the amount of payment which, combined with the presence of the good, gives the person the same level of utility as would occur if there were no payment and no acquisition of the good.

The concept extends readily to a context of uncertain outcomes, in which case the utility function above is replaced by the expected value of a von Neumann-Morgenstern utility function
Expected utility hypothesis
In economics, game theory, and decision theory the expected utility hypothesis is a theory of utility in which "betting preferences" of people with regard to uncertain outcomes are represented by a function of the payouts , the probabilities of occurrence, risk aversion, and the different utility...

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