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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.

Suggested Citation

  • Kögel, Tomas, 2009. "On the Relation between Dual-Rate Discounting and Substitutability," Economics Discussion Papers 2009-10, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:7489
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    References listed on IDEAS

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    1. 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.
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    3. Gollier, Christian, 2010. "Ecological discounting," Journal of Economic Theory, Elsevier, vol. 145(2), pages 812-829, March.
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    6. Traeger, Christian P., 2011. "Sustainability, limited substitutability, and non-constant social discount rates," Journal of Environmental Economics and Management, Elsevier, vol. 62(2), pages 215-228, September.
    7. Neumayer, Eric, 1999. "Global warming: discounting is not the issue, but substitutability is," Energy Policy, Elsevier, vol. 27(1), pages 33-43, January.
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    More about this item

    Keywords

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

    JEL classification:

    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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