The Dynamic Formation of Willingness to Pay: An Empirical Specification and Test
In a static setting, willingness to pay for an environmental improvement is equal to compensating variation. However, in a dynamic setting characterized by uncertainty, irreversibility, and the potential for learning, willingness to pay may also contain an option value. In this paper, we incorporate the dynamic nature of the value formulation process into a study using a contingent valuation method, designed to measure the value local residents assign to a north-central Iowa lake. Our results show that willingness to pay is highly sensitive to the potential for future learning. Respondents offered the opportunity to delay their purchasing decisions until more information became available were willing to pay significantly less for improved water quality than those who faced a now-or-never decision. The results suggest that welfare analysts should take care to accurately represent the potential for future learning.