1. 1 Civil Systems Planning Benefit/Cost Analysis Scott Matthews Courses: 12-706 and 73-359 Lecture 12 - 10/7/2002

2. Lecture 12: 10/8/0112-706 and 73-3592 Social Discount Rate  Discounting rooted in consumer preference  We tend to prefer current, rather than future, consumption  Marginal rate of time preference (MRTP)  Face opportunity cost (of foregone interest) when we spend not save  Marginal rate of investment return

3. Lecture 12: 10/8/0112-706 and 73-3593 Intergenerational effects  We have tended to discuss only short term investment analyses (e.g. 5 yrs)  What about effects in distant future?  Called intergenerational effects  Economists agree that discounting should be done for public projects  Do not agree on positive discount rate

4. Lecture 12: 10/8/0112-706 and 73-3594 An example  Someone offers you choice of $1000 now and $1200 in one year  If you have no preference (indifferent) then your MRTP is 20%

5. Lecture 12: 10/8/0112-706 and 73-3595 Discounting handout  How much do/should we care about people born after we die?  Higher the discount rate, the less future values will count compared to today  Ethically, no one’s interests should count more than another’s  Implies there is no justification for discounting across long time periods  Called ‘equal standing’

6. Lecture 12: 10/8/0112-706 and 73-3596 Climate Change  Discussions ongoing about how best to manage global CO2 emissions to limit effects of global change  Should we sacrifice short-run economic growth to do something to improve environment and leave resources for the future?  Really asking 2 separate questions!

7. Lecture 12: 10/8/0112-706 and 73-3597 Two Questions  What duty do we have to make sacrifices for future generations?  If we sacrifice, what is the optimal policy to maximize benefit?  So we should compare global change proposals with alternatives  Perhaps higher R&D spending on science or medicing would have higher benefits!

8. Lecture 12: 10/8/0112-706 and 73-3598 Hume’s Law  Thus discounting issues are normative vs. positive battles  Hume noted that facts alone cannot tell us what we should do  Any recommendation embodies ethics and judgment  E.g. focusing on ‘highest NPV’ implies net benefits is only goal for society

9. Lecture 12: 10/8/0112-706 and 73-3599 Some evidence  Cropper et al surveyed 3000 homes  Asked about saving lives in the future  Found a 4% discount rate for lives 100 years per now  Equal standing does not imply different generations have equal claims to present resources!  Harsanyi says only do so if their marginal gain is higher than our loss

10. Lecture 12: 10/8/0112-706 and 73-35910 More evidence  If future generations will be better off than us anyway  Then we might have no reason to make additional sacrifices  There might be ‘special standing’ in addition to ‘equal standing’  Immediate relatives vs. distant relatives  Different discount rates over time  Why do we care so much about future and ignore some present needs (poverty)