Chapter 26: Willingness to Pay Theory
The threshold approach that we have just covered is an appropriate method when we have little information available on which to base our evaluation of an intervention. The WTP approach is particularly useful when we have access to the most information. It is the method that is considered to be best practice in CBA because it is the approach that fits in best with standard microeconomic principles. Values in the presence of competitive markets are determined by demand and supply, and demand is based on willingness to pay. The mechanics of using marginal benefit and marginal cost curves to make cost–benefit evaluations were illustrated in Chapters 7 and 8. Here we explain in greater detail what lies behind the construction of the MB curve. For simplicity we will stick with the simple case where costs per unit are constant. COMPETITIVE MARKETS AND CBA Competitive markets allocate resources according to demand and supply. That is, at the point where demand and supply intersect the equilibrium price and quantity are determined. Demand reflects MB and supply MC. In this way the market functions just like a cost–benefit mechanism. To see this, look at the market for condoms that is shown in Figure 26.1 (based on Brent, 2009c). The market relates to a condom marketing program in Tanzania, so the prices are expressed in Tanzanian shillings (TZSH). The quantity (number of packs of condoms) that the market would authorize would be 12 at a price of 290 TZSH. This outcome corresponds...
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