Value of Information and Averting Behavior: The Case of Toxic Water Contamination

Little theoretical work has been done previously on the welfare valuation of changes in price and quality when consumers are imperfectly informed. The presence of imperfect information is particularly important in the analysis of averting behaviors. We develop a theoretical welfare measure, called quasi-compensating variation, as a natural extension of compensating variation (CV). We show that this welfare measure offers not only a money metric of the "value of information", but also a means to appropriately evaluate the welfare effects of various policies when consumers are imperfectly informed of water contamination. With a numerical example and our decomposition results (Propositions 2 and 3), we demonstrate that (i) the value of information could potentially account for a large portion of the total welfare gains when regulators simultaneously disseminate accurate information and improve drinking water quality, (ii) the willingness to pay to avoid toxic contamination is strictly larger for imperfectly informed than perfectly informed consumers, and (iii) the distribution of imperfect information among consumers affects the relative performance of the two compelling policy alternatives, "self-protection" and "pollution control".