The Contingent Valuation Method as a policy instrument

Seminar Paper 2008 17 Pages

Business economics - Business Management, Corporate Governance


Table of Contents

I. Introduction
1. General Theory of market failure
2. Asymmetric information within the Arts
3. Uncertainty and Adverse selection within the Arts
4. Public goods: Positive extern effects
5. Welfare Economics: Why and when should the government intervene?

II. The Contingent Valuation Method
1. What does the Contingent Valuation Method show
2. What are the weaknesses of CVM
3. What can CVM contribute to decision makers of public policy to overcome the particular reasons of Market failure within the Arts?

III. Conclusion
Contingent Valuation Method and “The New Political Economy”

IV. Literature Overview

I. Introduction

When David Throsby undertook his first application of a Contingent Valuation Method to the Arts in 1983 he did it to discuss the assumption that the arts were a case of market failure. But what makes the Arts to an example of market failure and how far could this particular method of research be used to overcome it? Throughout this essay I will shortly summarize some of those aspects of market failure that can be applied to art markets emphasising the necessity to know the collective willingness to pay and willingness to accept of parties involved in a particular market. On that general basis I shall discuss the Contingent Valuation Method (CVM) under the perspective of its usefulness to a policy decision maker, who is trying to prevent market failure from developing into governmental failure. I will point out, that CVM can provide a collective willingness to pay or willingness to accept as one of the main indicators for a failure within markets of the Arts in general. It is understood that applying the whole theory of market failure to the arts surely would go beyond the scope of this very essay. I therefore will concentrate on those aspects of market failure theory that may show the strengths and limitations of CVM and that may have an impact on public cultural policy.

I. 1. General theory of market failure

There are plenty of theories about what would lead to a market failure or what would ensure something that could be called an Optimum Optimorum within a particular market. One of the most important categories for that optimum is that there is a complete and free transparency according to preferences of consumers, property rights, price and quality and also internalised external effects. (Fritsch/Wein/Ewers 2005) Under those conditions a market of complete competition would arise, where all parties that are involved in any exchange process would develop a certain individual or collective willingness to pay and willingness to accept maximising their consumer surplus and producer surplus as it is shown in picture II.1.

illustration not visible in this excerpt

Picture I.1

Consumer surplus is defined as the savings between one consumer’s willingness to pay and the market price. But indirectly also the willingness to accept a certain amount of X, paying a given price.

Producer surplus (on a short time point of view) is defined as the added up difference between the Marginal Revenues (or the current market price) and the Marginal Costs that would arise if the production or the supply expanded. A surplus that also can be defined as the difference of one’s producer’s willingness to accept a price that would more or less cover the production costs and the price that was accepted by the consumer.

(Fritsch/Wein/Ewers 2005)

This short summary is to show - aside of all the other categories necessary for an efficient market - how important it might be to know at least one’s willingness to pay and one’s willingness to accept in order to intervene in a market where not all conditions leading to an optimum optimorum or a market of complete competition are fulfilled. A market that is about to fail.

I. 2. Asymmetric information within the Arts

All our decisions, preferences and needs are influenced or even let by information. Especially when we have to act under the pressure of monetary constraints we depend on information about necessity, usefulness, quality and price of our needs and the intentions and property rights of those who are about to give us what we are seeking for, because those information would directly influence our willingness to pay and our willingness to accept. According to common neoclassical theory an art market is optimal when any party involved was enabled to access those information completely, in time (without delay) and free of charge. But is it?

Despite of that utopia art markets are most often struggled by the fact that neither the supply side nor the demand side would be able to know or to provide all information required to make a proper choice. Moreover, the kind of information required may also change along with one’s preferences and experiences throughout time - and with it one’s willingness to pay and to accept. Due to the ignorance towards quality, utility and price-worthiness, asymmetric information would lead to uncertainties among all parties involved in one art-market’s transactions and without intervention - either by the market itself or by the government - asymmetric information will induce an art market most unstable and unpredictable.

I. 3. Adverse selection within the Arts

Those uncertainties would also lead to an adverse selection of any artistic good. Since the supply side would know the quality and utility of one artistic good setting up a particular willingness to accept in order to maximize the own producer-surplus. So does the demand site without having the information the supply side has developing then a particular willingness to pay in order to maximise the own utility and consumer surplus. A willingness to pay, however, that is bound to the average levels of quality the demand site experienced on the market. Thus the supply side offering a quality above average would hardly accept the demand-side’s willingness to pay and probably disappear from the market, neither being able to proof its quality to the demand side nor being able to anticipate the prospective willingness to pay or willingness to accept towards any future artistic invention. Once these suppliers are removed from the market, the demand side will experience a further decrease in quality of those goods and services they were seeking for. This development may continue until all different levels of quality are forced out of the market leaving a collapsed market behind, where only those product-qualities and utilities are traded nobody would demand or pay a price for. (A market for lemons as Akerlov would say) The perspective of asymmetric information may therefore show the crucial role, information about the development of a collective willingness to pay and willingness to accept may have as an indicator for:

- High information costs
- High searching and screening costs
- Lacks of Certificates, guarantees, publicly known quality standards and signalling activities
- Insufficient vertical integration (Principal-Agent theory)
- Inflexible allocation and exchange of information about price, quality and utility leading to uncertainties in general.




Title: The Contingent Valuation Method as a policy instrument