Willingness-To-Pay, Compensating Variation, and the Cost of Commitment

Hicksian welfare theory is static in nature, but many decisions are made in a dynamic environment. We present a dynamic model of an agent's decision to purchase or sell a good under the realistic conditions of uncertainty, irreversibility, and learning over time. Her willingness to pay (WTP) contains both the intrinsic value of the good as in Hicksian theory plus a commitment cost associated with delaying to obtain more information. The Hicksian equivalence between WTP/Willingness to accept (WTA) and compensating and equivalent variations no longer holds. The WTP and WTA divergence may arise and observed WTP values are not always appropriate for welfare analysis.