Teaching consumer surplus with the Becker-DeGroot-Marschak method in an environmental and resource economics course

The other day in my intro environmental and natural resource economics class we used the BDM method to elicit willingness to pay (WTP) values for an App State travel tumbler (I paid $26 with a faculty discount at the university bookstore). I explained the BDM with these slides [Download BDM] and each student had a “payment card” for revealing their WTP [Download BDM-WTP]. The average WTP was $6.23 (n=26). I entered the WTP values into Excel, sorted them from highest to lowest and plotted them along with the randomly chosen price ($7). At this price, 12 of 26 students would have purchased the tumbler and enjoyed a consumer surplus of $45 (CS = WTP – price).

As a preview of what we are going to do later in the semester, I simulated a dichotomous choice stated preference exercise. For each WTP value I randomly chose a price that ranged from $2 to $14 (average = $5.69) and simulated whether the consumer would purchase the tumbler or not. Fifty percent of the consumers would purchase the product. I then estimated a linear probability model: Pr(purchase=1) = 0.711 – 0.0372 x Price. Plotting this line and calculating the consumer surplus area of the triangle yields a CS estimate of $6.81 — very close to the actual CS average. I told them that this valuation approach is called the dichotomous choice WTP survey approach and is used in E&R economics (and marketing) to estimate WTP values for environmental amenities and consumer goods.

I randomly chose one of the student’s WTP sheets and the WTP was less than $7. Then I chose another and the WTP was $15. This student paid me $7 and is, apparently, enjoying $8 of consumer surplus. 

I think I’ve convinced many of the students in this class that consumer surplus is equivalent to getting a “good deal”. Now the trick is to convince them that WTP measures the value of nonmarket goods … too be continued.