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The implications of hyperbolic discounting for project evaluation


  • Cropper, Maureen
  • Laibson, David


The neoclassical theory of project evaluation is based on models in which agents discount the future at a constant exponential rate. But there is strong empirical evidence that people discount the future hyperbolically, applying larger annual discount rates to near-term returns than to returns in the distant future. This has led some policymakers to argue that, in evaluating programs with benefits spread over decades (such as subway systems and abatement of greenhouse gases), a low long-term discount rate should be used. In fact, some economists have suggested that higher discount rates be applied in the present and lower rates in the future. The authors demonstrate that this is incorrect. The problem with hyperbolic discounting is that it leads to time-inconsistent plans -- a person who discounts the future hyperbolically will not carry out the consumption plans he makes today. The authors note that if social decisionmakers were to use people's 1998 hyperbolic rates of time preferences, plans made in 1998 would not be followed -- because the low discount rate applied to returns in, say, 2020, will become a high discount rate as the year 2020 approaches. Since it makes sense to analyze only plans that will actually be followed, the authors characterize the equilibrium of an intertemporal game played by an individual who discounts the future hyperbolically. Along an equilibrium consumption path, the individual will behave as though he were discounting the future at a constant exponential rate. The individual's consumption path is, however, Pareto inferior: He would be better off if he could force himself to consume less and save more. This provides a rationale for government subsidization of interest rates or, equivalently, lowering the required rate of return on investment projects. Although hyperbolic discounting provides a rationale for lowering the required rate of return on investment projects, it does not provide justification for those who seek to treat environmental projects differently from other investment projects.

Suggested Citation

  • Cropper, Maureen & Laibson, David, 1998. "The implications of hyperbolic discounting for project evaluation," Policy Research Working Paper Series 1943, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1943

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    References listed on IDEAS

    1. R. H. Strotz, 1955. "Myopia and Inconsistency in Dynamic Utility Maximization," Review of Economic Studies, Oxford University Press, vol. 23(3), pages 165-180.
    2. Cropper, Maureen L & Aydede, Sema K & Portney, Paul R, 1994. "Preferences for Life Saving Programs: How the Public Discounts Time and Age," Journal of Risk and Uncertainty, Springer, vol. 8(3), pages 243-265, May.
    3. George Loewenstein & Drazen Prelec, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, Oxford University Press, vol. 107(2), pages 573-597.
    4. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
    5. David I. Laibson, 1996. "Hyperbolic Discount Functions, Undersaving, and Savings Policy," NBER Working Papers 5635, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Winkler, Ralph, 2009. "Now or Never: Environmental Protection under Hyperbolic Discounting," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-22.
    2. Yuri Biondi, 2009. "Capital budgeting under relational contracting: optimal ranking and duration criteria for schemes of concession, project-financing and public-private partnership," Post-Print hal-00404305, HAL.
    3. Gonzalo Edwards, 2003. "The effect of a constant or a declining discount rate on optimal investment timing," Applied Economics Letters, Taylor & Francis Journals, vol. 10(10), pages 657-659.
    4. Stavins, Robert, 2004. "Environmental Economics," Working Paper Series rwp04-051, Harvard University, John F. Kennedy School of Government.
    5. Romano, Eduardo & Thornsbury, Suzanne, 2007. "Economic Evaluation of SPS Regulations: Where Can Progress be Made?," Staff Papers 36946, Michigan State University, Department of Agricultural, Food, and Resource Economics.
    6. Schilizzi, Steven, 2003. "Deciding with long-term environmental impacts: what role for discounting?," 2003 Conference (47th), February 12-14, 2003, Fremantle, Australia 58206, Australian Agricultural and Resource Economics Society.
    7. Kim, Sooil & Haab, Timothy C., 2003. "Temporal Insensitivity Of Pvwtp And Implied Discount Rates In Cvm," 2003 Annual meeting, July 27-30, Montreal, Canada 21921, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    8. Pindyck, Robert S., 2012. "Uncertain outcomes and climate change policy," Journal of Environmental Economics and Management, Elsevier, vol. 63(3), pages 289-303.
    9. Karp, Larry, 2007. "Non-constant discounting in continuous time," Journal of Economic Theory, Elsevier, vol. 132(1), pages 557-568, January.
    10. Karp, Larry S. & Tsur, Yacov, 2007. "Climate Policy When The Distant Future Matters: Catastrophic Events With Hyperbolic Discounting," Discussion Papers 7181, Hebrew University of Jerusalem, Department of Agricultural Economics and Management.
    11. Martin L. Weitzman, 2001. "Gamma Discounting," American Economic Review, American Economic Association, vol. 91(1), pages 260-271, March.
    12. Ben Groom & Cameron Hepburn & Phoebe Koundouri & David Pearce, 2005. "Declining Discount Rates: The Long and the Short of it," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 32(4), pages 445-493, December.
    13. W. Viscusi & Joel Huber & Jason Bell, 2008. "Estimating discount rates for environmental quality from utility-based choice experiments," Journal of Risk and Uncertainty, Springer, vol. 37(2), pages 199-220, December.
    14. Cameron Hepburn, 2003. "Hyperbolic Discounting and Resource Collapse," Economics Series Working Papers 159, University of Oxford, Department of Economics.
    15. W. Kip Viscusi & Joel Huber, 2006. "Hyperbolic Discounting of Public Goods," NBER Working Papers 11935, National Bureau of Economic Research, Inc.
    16. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
    17. J.K. Horowitz, 2002. "Preferences in the Future," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 21(3), pages 241-258, March.
    18. María A. García-Valiñas, 2004. "Environmental federalism: a proposal of decentralization," ERSA conference papers ersa04p492, European Regional Science Association.
    19. Gonzalo Edwards, 2002. "La Tasa de Descuento en Proyectos de Largo Plazo," Documentos de Trabajo 231, Instituto de Economia. Pontificia Universidad Católica de Chile..
    20. Heal, Geoffrey, 2005. "Intertemporal Welfare Economics and the Environment," Handbook of Environmental Economics,in: K. G. Mäler & J. R. Vincent (ed.), Handbook of Environmental Economics, edition 1, volume 3, chapter 21, pages 1105-1145 Elsevier.
    21. Kim, Soo-Il & Haab, Timothy C., 2009. "Temporal insensitivity of willingness to pay and implied discount rates," Resource and Energy Economics, Elsevier, vol. 31(2), pages 89-102, May.


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