Answer to Question #10707 in Economics of Enterprise for Harry Williams

Question #10707
Use specific examples, evaluate the difficulty of accurately eliciting people’s preferences for public goods
Expert's answer
We'll evaluate the difficulty of accurately eliciting people’s preferences for public goods on the example of such
important source of misery as terrorism.
Terrorism has large social costs. It is undisputed that fear, grief and mourning, as well as the negative economic consequences of
terrorist activities, reduce people’s welfare. Security, or the absence of terrorism, is a fundamental public good and one of the primary justifications for the existence of the
state. Its provision competes with other public goods, and agents want to know
its valuation relative to private goods and other public services. When the
costs imposed on people by terrorist activities are known, the government can be
expected to make better decisions on how many resources should be allocated to
deal with terrorism. This holds even if the government is not viewed as a social-welfare maximizing agent, but is seen to act in a setting characterized
by political competition. However, it is commonplace that individuals have no
incentive to disclose their true demand for non-excludable goods; it is
advantageous to understate demand when it positively affects contribution
requirements and to overstate demand otherwise.
Therefore, some economists are very pessimistic as to whether it is possible to assess people’s preferences for public goods and bads. In contrast to this negative view, a vast literature exists, reflecting
extensive research and considerable progress in valuing public goods in monetary
terms. Essentially, two avenues have been pursued: revealed reference methods (examples are the hedonic method or the defense expenditure approach) on the one hand and stated preference methods (especially the contingent valuation method) on the other hand. However, despite their
ingenuity, these approaches have serious flaws, especially in the context of
Life Satisfaction Approach (LSA) as a potentially effective complementary method to value the psychic costs of terrorism. The LSA
correlates the degree of public goods or public bads with individuals’ reported
subjective well-being and evaluates them directly in terms of life satisfaction,
as well as relative to the effect of income on life satisfaction. This approach
obviates some of the major difficulties inherent in both the revealed preference
and stated preference methods. As it is not based on observed behavior, the
underlying assumptions are less restrictive and non-use values can — to a
certain extent — be measured. Furthermore, individuals are not asked to value
the public good directly, but to evaluate their general life satisfaction. This
is presumably a cognitively less emanding task, does not evoke answers
considered desirable by the persons asked, and there is no reason to expect
strategic behavior.

The LSA as a promising approach for the valuation of important non-monetary costs of conflicts but also for the valuation of public
goods and bads in general. In addition to any overall valuation, net
distributional consequences of the provision of some public good can be studied.
Studies can show, for example, people living in urban areas rather than rural
areas suffer more from terrorism. While overall valuations can provide valuable information for cost-benefit analyses, findings for differential effects can help to derstand
the intensity of support for the provision of some public goods in the political

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