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On the Relation between Dual-Rate Discounting and Substitutability

  • Kögel, Tomas

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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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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  1. Gollier, Christian, 2009. "Ecological Discounting," IDEI Working Papers 524, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Neumayer, Eric, 1999. "Global warming: discounting is not the issue, but substitutability is," Energy Policy, Elsevier, vol. 27(1), pages 33-43, January.
  3. 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.
  4. 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.
  5. 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.
  6. Thomas Sterner & U. Martin Persson, 2008. "An Even Sterner Review: Introducing Relative Prices into the Discounting Debate," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 2(1), pages 61-76, Winter.
  7. Roger Guesnerie, 2004. "Calcul économique et développement durable," DELTA Working Papers 2004-02, DELTA (Ecole normale supérieure).
  8. 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.
  9. 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.
  10. 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.
  11. 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.
  12. Traeger, Christian P., 2008. "Sustainability, Limited Substitutability and Non-Constant Social Discount Rates," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt10d7d7n4, Department of Agricultural & Resource Economics, UC Berkeley.
  13. Weitzman Martin L., 1994. "On the Environmental Discount Rate," Journal of Environmental Economics and Management, Elsevier, vol. 26(2), pages 200-209, March.
  14. 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.
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