Economic valuation and the demand curve

Most valuation techniques in natural resources and biodiversity involve elicitation of

willingness to pay (WTP). WTP has a formal relationship to the notion of a demand curve.

Figure 5 shows the usual depiction of a demand curve for an individual. The horizontal axis

measures the total number of units that can be bought and the vertical axis measures the price per

unit. Points on the individual’s demand curve show, for each quantity purchased, how much that

individual is willing to pay for that last (or marginal) unit.

For example, the individual is WTP £10 for the first ten units, £8 for the second ten units,

£6 for the third ten units and so on. The total WTP for three units is £(10+8+6) x 10 =£240.

Hence marginal WTP is given by points on the demand curve and total WTP is given by the area

under the demand curve.

Suppose the market price settles at £6 per unit, then we see that total expenditure is

30x£6 = £180 and this is less than total WTP of £240. The difference between total WTP and

actual expenditure, i.e. £240 – £180 = £60, is the consumer’s surplus. Consumer surplus is

therefore a measure of the net benefit to the consumer of buying 30 units at the market price

since he/she pays out £180 but ‘gets back’ £240 in the form of well-being as measured by WTP.

The £240 in this case is a measure of the gross change in well-being (or welfare, or utility) from

buying 30 units, and the £60, the consumer surplus, is a measure of the net change in well-being

(welfare or utility).

A basic formula, then, is:

Total WTP = Market Price + Consumer’s Surplus