Title: Losing the environment: the endowment effect and environmental discounting
Abstract: It has recently been shown that, when discounting future improvements in the environment, relative prices matter. However, we argue relative prices are not the whole story. Not only is the environment a consumption good in its own right, with a corresponding environmental discount rate that depends on relative scarcity, it also matters that we tend to be losing it. That is, there is a considerable body of evidence from behavioural economics and stated-preference valuation showing that we are loss-averse, even in riskless choice settings. Therefore in this paper we introduce reference dependence and loss aversion – the endowment effect – to a model where welfare depends on consumption of a produced good and of environmental quality. We show that the endowment effect modifies the discount rate by introducing (i) an instantaneous endowment effect and (ii) a reference-level effect. Moreover we show that, when environmental quality is strictly decreasing, these two effects mostly combine to dampen our usual preference to smooth consumption over time – perhaps surprisingly, the endowment effect increases the environmental discount rate on these paths. In addition, on non-monotonic paths the endowment effect can give rise to substantial discontinuities in the discount rate.
Publication Year: 2016
Publication Date: 2016-04-01
Language: en
Type: preprint
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