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On the Relation between Dual-Rate Discounting and Substitutability

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  • Kögel, Tomas

Abstract

To justify substantial emission reductions, recent literature on cost-benefit analysis of climate change suggests discounting environment consumption with an environmental discount rate instead of a consumption discount rate that is usually used in cost-benefit analysis. The present study clarifies that whether or not this dual-rate discounting approach succeeds in justifying substantial emission reductions depends on whether or not environment and goods consumption are substitutes in the Hicks-Allen sense and in the Edgeworth-Pareto sense (substitutes in the Hicks-Allen sense implies the Hicksian goods demand to be increasing in the relative price of environmental goods, while substitutes in the Edgeworth-Pareto sense implies the marginal utility of goods consumption to be decreasing in environment consumption). Moreover, a low intratemporal elasticity of substitution between environment and goods consumption within a period contributes to a low environmental discount rate in comparison to the consumption discount rate, while a low intertemporal elasticity of substitution between composite consumption of different periods contributes to declining discount rates over time. --

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2009-10.

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Date of creation: 2009
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Handle: RePEc:zbw:ifwedp:7489

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Keywords: Discounting; dual-rate discounting; environmental discount rate; cost-benefit analysis; climate change;

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  1. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
  2. GOLLIER Christian, 2008. "Ecological Discounting," LERNA Working Papers 08.18.262, LERNA, University of Toulouse.
  3. Neumayer, Eric, 1999. "Global warming: discounting is not the issue, but substitutability is," Energy Policy, Elsevier, vol. 27(1), pages 33-43, January.
  4. J.K. Horowitz, 2002. "Preferences in the Future," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 21(3), pages 241-258, March.
  5. Gerlagh, Reyer & van der Zwaan, B. C. C., 2002. "Long-Term Substitutability between Environmental and Man-Made Goods," Journal of Environmental Economics and Management, Elsevier, vol. 44(2), pages 329-345, September.
  6. Traeger, Christian P, 2007. "Sustainability, limited substitutability and non-constant social discount rates," CUDARE Working Paper Series 1045, University of California at Berkeley, Department of Agricultural and Resource Economics and Policy.
  7. Fisher, Anthony C & Krutilla, John V, 1975. "Resource Conservation, Environmental Preservation, and the Rate of Discount," The Quarterly Journal of Economics, MIT Press, vol. 89(3), pages 358-70, August.
  8. Roger Guesnerie, 2004. "Calcul économique et développement durable," DELTA Working Papers 2004-02, DELTA (Ecole normale supérieure).
  9. Weitzman Martin L., 1994. "On the Environmental Discount Rate," Journal of Environmental Economics and Management, Elsevier, vol. 26(2), pages 200-209, March.
  10. Robert A. Amano & Tony Wirjanto, 1997. "Government Expenditures and the Permanent-Income Model," Working Papers 98002, University of Waterloo, Department of Economics, revised Nov 1997.
  11. Ben Groom & Cameron Hepburn & Phoebe Koundouri & David Pearce, 2005. "Declining Discount Rates: The Long and the Short of it," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 32(4), pages 445-493, December.
  12. Sterner, Thomas & Persson, U. Martin, 2007. "An Even Sterner Review: Introducing Relative Prices into the Discounting Debate," Discussion Papers dp-07-37, Resources For the Future.
  13. Martin L. Weitzman, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 703-724, September.
  14. Weikard, Hans-Peter & Zhu, Xueqin, 2005. "Discounting and environmental quality: When should dual rates be used?," Economic Modelling, Elsevier, vol. 22(5), pages 868-878, September.
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