The concept of subjective value is that each individual has their own preferences for objects or actions. This concept is applied by economists to understand behavior and operates "behind the scenes" of observed behavior. That is, preferences are part of a theoretical structure to explain behavior that is latent and are assumed to model the observed behavior. Thus it is common for economists to make statements such as "the individual is assumed to behave as if he or she has subjective preferences and values for this outcome" and then test the implications of that assumption. It is not the case that one can directly observe subjective preferences or subjective value. Instead, auxiliary assumptions are needed to infer subjective preferences or value.
The justification for subjective value is primarily a priori. It is easy to just imagine that people have different preferences for the same goods or actions; for example, one person likes red wine with most food, and another likes beer with most food.
What leads to the assumption of subjective value is that people seem to make different consumption decisions, even when the circumstances are otherwise the same. Imagine people deciding between two types of cars but having the same incomes and facing the same car prices. If we observe people choosing different cars or one person not buying a car at all, how do we explain this outcome? We could claim that there are some unobserved differences in people’s constraints—for example, one person might live close to good public transport. Should one always ascribe differences in behavior to differences in subjective value or, instead, assume constraints that are specific to the decision maker but not observable to others? The answer to this question is one of the practical considerations that comes up repeatedly in theoretical and empirical work in economics (e.g., Stigler and Becker 1977; Becker 1993).
The concept of subjective value has direct implications for the manner in which we determine what valuations people have. This is the area of subjective value elicitation. It also has implications for how we design policy. The concept of consumer sovereignty flows naturally from thinking about subjective value: We value what is a good wine by seeing what people are willing to pay for it. But there are two concerns with the notion of consumer sovereignty that flows from thinking of values as subjects. First, what if those values are "constructed" by others, such as marketing, or the addiction that comes from some drugs? Second, it is possible, and indeed likely in some settings, that subjective value is not based on a complete processing of all of the relevant information about the consequences of actions. Hence society may want to adopt valuations that differ from those that individuals would adopt.
WHY ELICIT SUBJECTIVE VALUES?
Economists are interested in eliciting subjective values at the level of the individual because market values do not provide the information needed to measure consumer surplus, value new products, or value goods that have no market. Why do we need to elicit values? The prices observed on a market reflect, on a good competitive day, the equilibrium of marginal valuations and costs. They do not quantitatively reflect the infra-marginal or extra-marginal values, other than in a severely censored sense. We know that infra-marginal values are weakly higher and extra-marginal values are weakly lower, but beyond that one must rely on functional forms for utility or demand to extrapolate. For policy purposes this is generally insufficient to undertake cost-benefit calculations.
When producers are contemplating a new product or innovation, they have to make some judgment about the value that will be placed on it. New drugs, and the research and development underlying them, provide an important example. Unless one can heroically tie the new product to existing products in terms of shared characteristics and somehow elicit values on those characteristics, there is no way to know what price the market will bear. Value elicitation experiments can help fill that void, complementing traditional marketing techniques (see Hoffman et al. 1993).
Many goods and services effectively have no market, either because they exhibit characteristics of public goods or because it is impossible to credibly deliver them on an individual basis. These nonmarket goods have traditionally been valued using surveys, where people are asked to state a valuation "contingent on a market existing for the good." The problem is that these surveys are hypothetical, in terms of the deliverability of the good and the economic consequences of the response, and this understandably generates controversy about their reliability (Harrison 2006).
It does not follow that subjective values are those that society should use for decisions that have public consequences. For example, when public goods are being provided, the subjective value that is elicited may entail "free riding," which occurs when one person rationally understates his or her private valuation for the good in the expectation that others, in aggregate, will be willing to pay it. In this case subjective values will understate true values, and society would end up with too little investment in public goods if it relied on consumer sovereignty. We are interested in understanding when the subjective values we elicit are biased in relation to true subjective values. In such settings we may adjust the elicited subjective values in some way.
A related example might be the subjective values that an addict would place on some drug. Even if we elicit the value reliably, it is not obvious that we should use that value when deciding on policy on the drug. In this case society may take a longer-term perspective on the subjective value of the drug, even its subjective value to the addict (e.g., Becker and Murphy 1988). Or it might consider the effects of the addict’s consumption of the drug on others, such as the addict’s family or society as a whole. Consumer sovereignty should not be abandoned lightly, because it constrains politicians and bureaucrats from asserting value in the absence of any "market test."
PROCEDURES FOR MEASURING SUBJECTIVE VALUES
Direct methods for value elicitation include auctions, auction-like procedures, and "multiple price lists." Sealed-bid auctions require the individual to state a valuation for the product in a private manner and then award the product following certain rules. For single-object auctions, the second-price (or Vickrey) auction awards the product to the highest bidder but sets the price equal to the highest rejected bid. It is easy to show, to students of economics at least, that the bidder has a dominant strategy to bid his or her true value: Any bid higher or lower can only end up hurting the bidder in expectation. But these incentives are not obvious to inexperienced subjects.
A real-time counterpart of the second-price auction is the English (ascending bid) auction, in which an auctioneer starts the price out low and then bidders increase the price to become the winner of the product. Bidders seem to realize the dominant strategy property of the English auction more quickly than in comparable second-price sealed-bid auctions, no doubt due to the real-time feedback on the opportunity costs of deviations from that strategy (see Rutstrom 1998; Harstad 2000). Familiarity with the institution is also surely a factor in the superior performance of the English auction: First encounters with the second-price auction rules lead many noneconomists to assume that there must be some "trick."
Related schemes collapse the logic of the second-price auction into an auction-like procedure due to Gordon Becker, Morris DeGroot, and Jacob Marschak (1964). The basic idea is to endow the subject with the product and to ask for a "selling price." The subject is told that a "buying price" will be picked at random and that if the buying price that is picked exceeds the stated selling price, the product will be sold at that price and the subject will receive that buying price. If the buying price is equal to or lower than the selling price, the subject keeps the lottery and plays it out. Again it is relatively transparent to economists that this auction procedure provides a formal incentive for the subject to truthfully reveal the certainty equivalent of the lottery. One must ensure that the buyout range exceeds the highest price that the subject would reasonably state, but this is not normally a major problem. One must also ensure that the subject realizes that the choice of a buying price does not depend on the stated selling price; a surprising number of respondents appear not to understand this independence, even if they are told that a physical randomizing device is being used.
Multiple price lists present individuals with an ordered menu of prices at which they may choose to buy the product or not. In this manner the list resembles a menu, akin to the price comparison Web sites available online for many products. For any given price, the choice is a simple "take it or leave it" posted offer, familiar from retail markets. The set of responses for the entire list is incentivized by picking one at random for implementation, so the subject can readily see that misrepresentation can only hurt for the usual revealed preference reasons. Refinements to the intervals of prices can be implemented to improve the accuracy of the values elicited (see Andersen et al. 2006). These methods have been used widely to elicit risk preferences and discount rates as well as values for products (see Holt and Laury 2002; Harrison et al. 2002; Andersen et al. 2007).
Indirect methods work by presenting individuals with simple choices and using a latent structural model to infer valuations. The canonical example comes from the theory of revealed preference and confronts the decision maker with a series of purchase opportunities from a budget line and asks them to pick one. By varying the budget lines one can "trap" latent indifference curves and place nonpara-metric or parametric bounds on valuations. The same methods extend naturally to variations in the nonprice characteristics of products and merge with the marketing literature on "conjoint choice" (e.g., Louviere et al. 2000; Lusk and Schroeder 2004). Access to scanner data from the massive volume of retail transactions made every day promises rich characterizations of underlying utility functions, particularly when merged with experimental methods that introduce exogenous variation in characteristics in order to statistically condition and "enrich" the data (Hensher et al. 1999). One of the attractions of indirect methods is that one can employ choice tasks that are familiar to the subject, such as binary "take it or leave it" choices or rank orderings. The lack of precision in that type of qualitative data requires some latent structure before one can infer values, but behavioral responses are much easier to explain and motivate for respondents.
One major advantage of undertaking structural estimation of a latent choice model is that valuations can be elicited in a more fundamental manner, explicitly recognizing the decision process underlying a stated valuation. A structural model can control for risk attitudes when choices are being made in a stochastic setting, which is almost always the case in practical settings. Thus one can hope to tease apart the underlying deterministic valuation from the assessment of risk. Likewise nonstandard models of choice posit a myriad of alternative factors that might confound inference about valuation: Respondents might distort preferences from their true values, they might exhibit loss aversion in certain frames, and they might bring their own homegrown reference points or aspiration levels to the valuation task. Only with a structural model can one hope to identify these potential confounds to the valuation process. Quite apart from wanting to identify the primitives of the underlying valuation free of confounds, normative applications will often require that some of these distortions be corrected for. That is only possible if one has a complete structural model of the valuation process.
A structural model also provides an antidote to claims that valuations are so contextual as to be an unreliable will-o’-the-wisp. If someone is concerned about framing, endowment effects, loss aversion, preference distortions, social preferences, and any number of related behavioral notions, it is impossible to generate a scientific dialogue without being able to write out a structural model and jointly estimate it.
