1. Social Discount Rate /

2. Admin Issues Pipeline case study writeup - due Monday
Format expectations:
Framing of problem (see p. 7!),
Answer/justify with preliminary calculations
Don’t just estimate the answer!
Do not need to submit an excel printout, but feel free to paste a table into a document
Length: Less than 2 pages.

3. Real and Nominal Values
Nominal: ‘current’ or historical data
Real: ‘constant’ or adjusted data
Use deflator or price index for real
Generally “Real” has had inflation/price changes factored in and nominal has not
For investment problems:
If B&C in real dollars, use real disc rate
If B&C in nominal dollars, use nominal rate
Both methods will give the same answer

4. Similar to Real/Nominal : Foreign Exchange Rates / PPP
Big Mac handout
Common Definition of inputs
Should be able to compare cost across countries
Interesting results? Why?
What are limitations?

5. Is it worth to spend $1 million today to save a life 10 years from now?
How about spending $1 million today so that your grandchildren can have a lifestyle similar to yours?
Ask for someone to give a summary of handout!!!!!!

6. RFF Discounting Handout
How much do/should we care about people born after we die?
Ethically, no one’s interests should count more than another’s: “Equal Standing”
Higher the discount rate, the less future values will count compared to today
Implies there is no justification for discounting across long time periods

7. Social Discount Rate
Rate used to make investment decisions for society
Most people 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

8. Intergenerational effects
We have tended to discuss only short term investment analyses (e.g. 5 yrs)
Economists agree that discounting should be done for public projects
Do not agree on positive discount rate
What about effects in distant future?
Called intergenerational effects

9. 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?

10. 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 medicine would have higher benefits!

11. Government Discount Rates
US Government Office of Management and Budget (OMB) Circular A-94
Discusses how to do BCA and related performance studies
What discount, inflation, etc. rates to use
Basically says “use this rate, but do sensitivity analysis with nearby rates”
The document in this website explains how the OMB calculated this rates. The numbers in the basic document are for The Apendix is updated every year and it is where we can find current rates.

12. OMB Circular A-94, Appendix C
Provides the current suggested values to use for federal government analyses
Revised yearly, usually “good until January of the next year”
How would the government decide its discount rates?
What is the government’s MARR?
MARR is Minimum Acceptable Rate of Return
2008: 2.5 to 3.0 % for real discount rate

13. Historic Nominal Interest Rates (from OMB A-94)

14. Real Discount Rates (from A-94)
Depending on the length of project, use different rates. If project is between 7 and 10 years, you can do a linear approximation.
What is implication of a 2% real discount rate for government projects?

15. What do people think Cropper et al surveyed 3000 homes
Asked about saving lives in the future
Found a 4% discount rate for lives 100 years from now
We should sacrifice for future generations only if their average well-being of future generations goes up by more than we lose today

16. Hume’s Law 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

17. Some Issues Arise
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

18. 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)
Based on these arguments, what discount rates should we use for policy problems (eg climate)

19. A Few More Questions
Current government discount rates are ‘effectively zero’
What does this mean for projects and project selection decisions?
What does it say about intergenerational effects?
What are implications of zero or negative discount rates?
It basically means we don’t discount very much.
There are really no preferences for time. Generations equal.

20. Comprehensive Everglades Restoration Project
Comprehensive project to restore natural water flow to the Florida Everglades.
Enhance water supply to South Florida region.
Provide continuous flood protection.
See more info at

21. Indian River Lagoon-South (IRLS)
Part of Everglades Restoration Project.
Total Cost of $1.21 billion.
Annual Benefits of $159 million after project is completed in 2015.
Find NPV of first 25 years of project.

22. IRLS Cash Schedule All values are in millions $159 per year $0.42500 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
$0.425
$748.3
$2.043
$447.3
$12.62
$159 per year
All values are in millions

23. NPV of Project
What would NPV be if we used a negative discount rate?

24. NPV of Project

25. Which is the right discount rate?
What are implications of each?

26. Show of Hands Example Choice #1: Choice #2:
$50 today or $100 paid 1 year from now?
Why?
Choice #2:
$50 to be paid in 5 years or $100 in 6 years?

27. Hyperbolic Discounting
Behavioral economics:
We generally prefer smaller, sooner payoffs to larger, later payoffs when the smaller payoffs would be imminent;
When same payoffs are distant in time, we tend to prefer the larger, even though the time lag (e.g., 1 year) would be the same

28. Hyperbolic Discounting
Our “preferences” follow a hyperbolic curve rather than the conventional, exponential curve that would produce consistent choice over time
We are time inconsistent (we don’t perceive the same tradeoff values today vs. in 5+ years)
Recall: Continuous P=F * e-in
P=F /(1+kn)
Where k is still the steepness of our tradeoff

29. Hyperbolic versus standard

30. Hyperbolic Discounting- Implications
If we actually have hyperbolic preferences
What do our discount rates look like?
How would that affect our preferences for social projects, especially those with long time horizons?
Time inconsistency known in advance
We have high short-term discount rates, but lower in the distant future
IF we are time inconsistent, we should plan for the future knowing that. Eg we otherwise think that we know we will act in year 10 the same way we would today - but in 10 years, we will again have a preference for short term versus long term gains.

31. Next Up: Friday’s review: more discounting Monday Loans, taxes, etc.
Pipeline Case
Sensitivity Analysis