Losing the environment: the endowment effect and environmental discounting
It has recently been shown that, when discounting future improvements in the environment, relative prices matter. However, we argue relative prices are not the whole story. Not only is the environment a consumption good in its own right, with a corresponding environmental discount rate that depends on relative scarcity, it also matters that we tend to be losing it. That is, there is a considerable body of evidence from behavioural economics and stated-preference valuation showing that we are loss-averse, even in riskless choice settings. Therefore in this paper we introduce reference dependence and loss aversion – the endowment effect – to a model where welfare depends on consumption of a produced good and of environmental quality. We show that the endowment effect modifies the discount rate by introducing (i) an instantaneous endowment effect and (ii) a reference-level effect. Moreover we show that, when environmental quality is strictly decreasing, these two effects mostly combine to dampen our usual preference to smooth consumption over time – perhaps surprisingly, the endowment effect increases the environmental discount rate on these paths. In addition, on non-monotonic paths the endowment effect can give rise to substantial discontinuities in the discount rate.