Week 3 -- Added Value

All right. Added Value is in the homework. So we should put something up about that here.

Added Value is what we’d use when deciding how big of a group to form. In real life, this is sort of like… planning a trip to Tasmania, for instance. Say one of your ‘friends’ is miserable, mean to everyone, and will make everyone slightly upset during the trip. You wouldn’t invite him, would you? Probably not. In English, his added value would be negative. That’s sort of what we’re talking about, but not completely… This is one of those concepts that doesn’t quite make common sense.

In economics, the added value of a person is the value of the group’s payoff with him minus (the value of the group’s payoff without him + the value of the individual’s payoff). In other words, just like in WTP / WTS, our ‘group’ payoff includes everyone in our possible transaction. Here, it even includes the guy we’re not inviting to come out with us.

Here’s the example: Your mean friend would LOVE to come to Tasmania, and if he were to come with you, his happiness from the trip would be really high. Furthermore, if he was home by himself, he’d be absolutely miserable. You and your friends mind him, but not THAT much, so the group’s happiness is higher with him going to Tasmania. After all, if he were at home, the ‘group’ would be worse off, largely because your mean friend hates being home by himself and he counts as part of the group. Notice again that the group is defined as every person involved in the possible transaction.

Again, this will become a crucial concept in a few weeks when we’re talking about multilateral negotiation.