Lecture 5 Flashcards
discount rate
a value that tells us how much future dollars are worth in today’s terms
Formula for net present value (NPV)
(Benefits_t - costs_t) / (1+r)^t
Implication of increasing discount rate
as this increases, we put less weight on the future
How to choose discount rate
Option 1: take the market interest rate
Option 2: social discounting (
Reasons to discount the future
Time preferences (impatience)
growth/inequality
ramsey discounting
r = delta + eta + g
utility discount rate (delta)
delta: how much do we value future utility
how much is 1 util tomorrow worth today
elasticity of marginal utility (eta)
eta: how quickly does marginal utility (benefit) decline in consumption
how much do we value poorer vs. richer generations
growth rate (g)
g: how fast does consumption grow over time?
how rich will future generations be compared to today
Descriptive approach
calibrate the discount rate to the real world
get terms from observed data
prescriptive approach
observe g in data, choose delta and eta based on philosophy/ethics
economic scarcity
the stock of natural resource depends on physical availability and marginal extraction cost and willingness of people to pay
example of non-renewable resource becoming less economically scarce
US crude oil and natural gas reserves
marginal user cost (MUC)/scarcity rent
the opportunity cost of using a resource
Hotelling Rule
states that the marginal user cost (MUC = P* - MC)
