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The endowment effect, discounting and the environment

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  • Dietz, Simon
  • Venmans, Frank
Abstract
There is a considerable body of evidence showing that our preferences exhibit both reference dependence and loss aversion, a.k.a. the endowment effect. In this paper, we consider the implications of the endowment effect for discounting, with a special focus on discounting future improvements in the environment. We show that the endowment effect modifies the discount rate via (i) an instantaneous endowment effect and (ii) a reference-updating effect. Moreover we show that these two effects often combine to dampen the preference to smooth consumption over time. What this implies for discounting future environmental benefits may then depend critically on whether environmental quality is merely a factor of production of material consumption, or whether it is an amenity. On an increasing path of material consumption, dampened consumption smoothing implies a lower discount rate. But on a declining path of environmental quality and where we derive utility directly from environmental quality, it implies a higher discount rate. On non-monotonic paths, loss aversion specifically can give rise to substantial discontinuities in the discount rate.

Suggested Citation

  • Dietz, Simon & Venmans, Frank, 2019. "The endowment effect, discounting and the environment," LSE Research Online Documents on Economics 100110, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:100110
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    File URL: http://eprints.lse.ac.uk/100110/
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    Cited by:

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    2. Rick Van der Ploeg, 2020. "Discounting And Climate Policy," OxCarre Working Papers 244, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    3. Karaarslan, Can, 2022. "Social policy, psychology and climate mitigation," Working Papers for Marketing & Management 64, Offenburg University, Department of Media and Information.
    4. Dominika Czyz & Karolina Safarzynska, 2023. "Catastrophic Damages and the Optimal Carbon Tax Under Loss Aversion," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 85(2), pages 303-340, June.
    5. Ben Groom & Frank Venmans, 2024. "The Social Value of Temporary Carbon Removals and Delayed Emissions," NBER Chapters, in: Environmental and Energy Policy and the Economy, volume 6, National Bureau of Economic Research, Inc.
    6. Zhu, Xueqin & Smulders, Sjak & de Zeeuw, Aart, 2019. "Discounting in the presence of scarce ecosystem services," Journal of Environmental Economics and Management, Elsevier, vol. 98(C).
    7. Venmans, Frank & Groom, Ben, 2021. "Social discounting, inequality aversion, and the environment," Journal of Environmental Economics and Management, Elsevier, vol. 109(C).

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    More about this item

    Keywords

    discounting; endowment effect; environmental discount rate; loss aversion; reference dependence; relative prices;
    All these keywords.

    JEL classification:

    • D00 - Microeconomics - - General - - - General
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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