Theoretical Demonstration of the Willingness to Pay ( WTP ) – Willingness to Accept ( WTA ) Gap Using Multiple Reference Points

The WTP-WTA gap refers to the often observed difference between the price an individual states he is willing to sell an item (WTA), and the price he states he is willing to pay for the same item (WTP). A common explanation for the gap is the so-called endowment effect, first proposed by Thaler (1980). In the literature the endowment effect is explained very simply by appealing to the concept of loss aversion -the proposition in Kahneman and Tversky’s (1979) prospect theory that losses are felt more strongly than gains. We extend the explanation of the endowment effect by considering a multiple reference point framework, and then provide the theoretical derivation of the prospect theory equations supporting it. In so doing we are able to demonstrate how subjects’ attempts to maximize these prospect values naturally lead to WTAs that exceed WTPs. Theoretical Demonstration of the Willingness to Pay (WTP) – Willingness to Accept (WTA) Gap Using Multiple Reference Points