The endowment effect, discounting and the environment

Dietz, Simon ORCID: 0000-0001-5002-018X and Venmans, Frank ORCID: 0000-0002-4264-6606 (2019) The endowment effect, discounting and the environment. Journal of Environmental Economics and Management, 97. pp. 67-91. ISSN 0095-0696

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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.

Item Type:	Article
Additional Information:	© 2019 The Authors
Divisions:	Geography & Environment Grantham Research Institute
Subjects:	H Social Sciences > HB Economic Theory G Geography. Anthropology. Recreation > GF Human ecology. Anthropogeography H Social Sciences > HV Social pathology. Social and public welfare. Criminology
JEL classification:	D - Microeconomics > D0 - General > D00 - General D - Microeconomics > D6 - Welfare Economics > D61 - Allocative Efficiency; Cost-Benefit Analysis H - Public Economics > H4 - Publicly Provided Goods > H43 - Project Evaluation; Social Discount Rate Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q5 - Environmental Economics > Q51 - Valuation of Environmental Effects
Date Deposited:	19 Feb 2019 13:39
Last Modified:	17 Oct 2024 17:24
URI:	http://eprints.lse.ac.uk/id/eprint/100110

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