โ Scribed by Don L. Coursey
No coin nor oath required. For personal study only.
Consumer's surplus and the Hicksian measures of compensating and equivalent variation have a long history in empirical economic analysis. However, at both the theoretical and the empirical level, economists, psychologists, and public choice theorists have not been able to reach a significant consensus regarding the usefulness of these measures.
Economic theorists have only recently dissected the differences which exist between alternative welfare measures in a systematic and transparent fashion. In Willig (1976), Hausman (1981), and Takayama (1984), the role of income in determining the correct, theoretical measurements of compensating and equivalent variations was exposed.
During this same period of time, theoretical results obtained by the psychologists Kahneman and Tversky (1979) indicated that the fundamental structure of preferences upon which the theoretical economic results are based is flawed. The so-called prospect theory of decision developed by these authors indicated that measured of welfare based upon payment will differ from measures of welfare based upon compensation because of the fact that individuals will value losses at a greater marginal rate than gains. This difference was then predicted to dominate any income effect important in the economist's model.
Finally, this period recorded the emergence of many demand revealing processes which provide individuals with appropriate incentives to accurately reveal their preferences. As summarized in Coursey and Schulze (1986), one interpretation of the literature on incentive compatibility suggests a set of well defined guidelines for improving both the accuracy and validity of compensating and equivalent variation measures.
These differences in professional preferences regarding what is important in improving the accuracy of economic welfare measurements led John Prepared as a response to the comment by Gregory and Furby entitled 'Auctions, Experiments, and Valuation.' Human subject payments made while conducting the experiments discussed in this paper were supported by the Bugas Fund at the University of Wyoming.
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