kf007 - EfficiencyandExchange KafuWong UniversityofHongKong...

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1 Ka-fu Wong University of Hong Kong Efficiency and Exchange
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2 Is it unfair 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?
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3 Example 7.1. A public radio station currently offers all-music  programming.  A proposal has been introduced  to switch the station’s format to all talk.
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4 Example 7.1. All community residents are neutral with respect to this  proposal except for the following three: A rich resident (R), who  favors the proposal… P1 P2 ..and two poor residents (P1 and  P2), who oppose it.
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5 Example 7.1. 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 P1 and P2 are willing to  pay only $100 each to prevent it. Should the switch be made?
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6 Example 7.1. 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.
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7 Example 7.1. In the US, recent Presidential executive orders, 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 P1 and P2  by $250 each. Compared to the status quo, R has net gain of $500,while P1 and  P2 each reap a net gain of $150.
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8 Decision based on unweighted WTP Persons Favor switch WTP Weight R 1 1000 1 P1 -1 100 1 P2 -1 100 1 Aggregate  unweighted  WTP = 1000 – 100 – 100 = 800 >0.   Thus, based on pure unweighted WTP, the station should switch to all talk. Persons Favor switch WTP Weight R 1 1000 0.01 P1 -1 100 0.9 P2 -1 100 0.09 Aggregate  weighted  WTP = 0.01*1000 – 0.9*100 – 0.09*100 = - 89 <0.   Thus, based on weighted WTP (with this particular weight), the station should not  switch to all talk.
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Example 7.2. City Lights Antiques has 
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kf007 - EfficiencyandExchange KafuWong UniversityofHongKong...

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