Using averting expenditures to estimate the demand for public goods: Combining objective and perceived quality
IRENE Institute of Economic Research Working Paper
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In response to the perceived quality of a public good, households may choose to incur averting expenditures as a substitute to its aggregate provision, thereby revealing an (inverse) demand function. When unobserved heterogeneity affects both perceived quality and averting behavior, identification of the demand function is plagued by a problem of endogeneity. In this paper, we propose the use of an auxiliary (first stage) model of perceived quality as a function of objective quality to recover unbiased and microconsistant estimates of marginal willingness to pay for the provision of the public good. The approach can be applied when people have well-formed perceptions of the quality of the good, a pre- requisite for the averting expenditures method, and when objective quality of provision is plausibly exogenous. We illustrate the approach with data on averting expenditures for two qualitative aspects of household tap water networks: water hardness and aesthetic quality in terms of taste and odor.
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