ECON361 Chapter Notes - Chapter 8: Pareto Efficiency, Adverse Selection, Moral Hazard
8 Aug 2016
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Purpose: to develop option price as the conceptually correct measure of wtp in circumstances in which individuals face uncertainty. The expected social surplus measure is usually different from the option price measure of benefits. Consensus among economists is that the conceptually correct way to value the benefits of a policy in circumstances involving risk is to sum the ex-ante amounts people affected by a policy would be willing to pay to obtain it. Option price is the maximum amount an individual would pay for a policy prior to knowing which contingency will occur (if the probability of each contingency is known). The sum of the option price of all individuals equals the aggregate benefit of the policy. Relation of option price to expected surplus (es) and option value (ov) Option value is the difference between option price and expected surplus: the maximum amount beyond expected benefits that individuals are willing to pay to reduce risk.
