The endowment effect, discounting and the environment

Simon Dietz and Frank Venmans

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: discounting; endowment effect; environmental discount rate; loss aversion; reference dependence; relative prices (search for similar items in EconPapers)
JEL-codes: D00 D61 H43 Q51 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2019-02-12
New Economics Papers: this item is included in nep-env and nep-upt
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Citations: View citations in EconPapers (7)

Published in Journal of Environmental Economics and Management, 12, February, 2019, 97, pp. 67-91. ISSN: 0095-0696

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Journal Article: The endowment effect, discounting and the environment (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:100110

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