101-13_07 - Econ 101 Lecture 13 Markets allocate scarce...

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Econ 101 Lecture 13 Markets allocate scarce goods and services on the basis of willingness to pay. Similarly, cost-benefit analysis resolves public decisions on the basis of willingness to pay. Is that a good thing to do? Doesn’t willingness-to-pay unfairly disadvantage those who don’t have much money? Example 13.1. A public radio station currently offers all-music programming. A proposal has been introduced to switch the station’s format to all talk. All community residents are neutral with respect to this proposal except for the following three: A rich resident (R), who favors the proposal; and two poor residents (P 1 and P 2 ), who oppose it. Each of these three feels equally strongly about the issue. But because R is wealthy, he is willing to pay $1000 to see the switch enacted, while P 1 and P 2 are willing to pay only $100 each to prevent it. Should the switch be made? Cost-benefit analysis says to make the switch, because the benefit ($1000) exceeds the cost ($200). Is willingness to pay (WTP) the right basis for making such decisions? Many social critics say no, that WTP gives unfair decision weight to the preferences of the wealthy. Recent Presidential executive orders in the US, for example, have directed agencies to temper cost-benefit calculations with “distributional concerns.” These orders militate against making the format switch. Yet both rich and poor would benefit if we resolved all such cases on the basis of pure, unweighted willingness to pay, using the tax and transfer system to compensate those who would be hurt in the process. For instance , raise R’s taxes by $500, reduce those of P 1 and P 2 by $250 each. Compared to the status quo, R has net gain of $500,while P 1 and P 2 each reap a net gain of $150. Example 13.2. City Lights Antiques has a 1905 Stickley grandfather clock on display in its showroom. Susan, a fourth grade teacher and an aficionado of early 20 th century grandfather clocks, would LOVE to own it. Malcolm, a personal injury lawyer, has no particular interest in clocks—from that period or any other. But he happened to see the Stickley as he walked by and thought it might look nice in his office waiting room. Susan, a single mother of two who earns $28,000/yr, is willing to pay up to $5000 for the clock. Malcolm earns $950,000/yr and is willing to pay $10,000 for it. Who “should” get the clock? The attraction of willingness to pay Yes, Susan would enjoy the clock more than Malcolm would. But because of her relatively low income, she also values other things that money can buy more highly than Malcolm does. If she were given the clock, her best option would be to sell it to Malcolm. Suppose Malcolm buys it from her for $8000. Since the clock was worth “only” $5000 to her, Susan can now buy goods and services that are worth $3000 more to her than
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This note was uploaded on 03/27/2008 for the course ECON 1110 taught by Professor Wissink during the Spring '06 term at Cornell University (Engineering School).

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101-13_07 - Econ 101 Lecture 13 Markets allocate scarce...

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