3 - Value theory

Summary

Introduction

For auction markets to be useful in understanding demand for new products, services, or technologies, we assume people have an economic value, v_i, for the good or service up for auction. This value can be positive, negative, or zero, but the assumption is that a value does exist. We now discuss exactly what we mean by the idea of economic value and how it is derived from a utility theoretic framework.

This chapter discusses the economic concepts of willingness to pay (WTP) and willingness to accept (WTA), which are the values that are elicited in an auction. The chapter lays the foundation for how to interpret a person's value using the benchmark model of rational individual decision making characterized in neoclassical economics. The chapter first considers how to derive WTP and WTA for the case when the quality of a good is known with certainty. Valuation measures are then derived for the case of uncertainty, where a person attaches probabilities to whether a good possesses particular levels of quality. For uncertain quality, we start by discussing the expected utility model, and then we consider a few non-expected utility models. The last part of this chapter considers how to derive WTP and WTA in a dynamic setting when people have the ability to delay their decision to buy or sell. Later in the book, in Chapter 9, we extend our discussion to include some of the findings from behavioral economics and psychology.