Discussion Paper

Discounting and Relative Prices: Assessing Future Environmental Damages

Apr 28, 2006 | Michael Hoel, Thomas Sterner

Abstract

Environmentalists are often upset at the effect of discounting costs of future environmentaldamage, e.g., due to climate change. An often-overlooked message is that we should discount costs butalso take into account the increase in the relative price of the ecosystem service endangered. The effect ofdiscounting would thus be counteracted, and if the rate of price rise of the item was fast enough, the effectmight even be reversed. The scarcity that leads to rising relative prices for the environmental good willalso have direct effects on the discount rate itself. The magnitude of these effects depends on properties ofthe economy’s technology and on social preferences. We develop a simple model of the economy thatillustrates how changes in crucial technology and preference parameters may affect both the discount rateand the rate of change of values of environmental goods. The combined effect of discounting and thechange of values of environmental goods is more likely to be low—or even negative—the lower thegrowth rate of environmental quality (or the larger its decline rate), and the lower the elasticity ofsubstitution between environmental quality and produced goods.