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The divergence between the low discount rate used by Stern and the higher rate favored by critics like Nordhaus leads to substantially different policy recommendations. For example, a \$100 benefit occurring 100 years in the future is valued at only \$1.48 today using Nordhaus's 4.3% rate, whereas it is valued at \$24.90 with Stern's 1.4% rate. Consequently, Nordhaus’s proposals for climate change abatement were less extensive and costly. This is exemplified by their contrasting carbon price recommendations for 2015: Nordhaus proposed \$35 per ton, while Stern recommended a price of \$360 per ton.

Comparison of Policy Implications: Stern vs. Nordhaus Discount Rates

CORE Econ offers an educational spreadsheet for simulating the impact of various discount rates on present value. This tool calculates the present value of $1 for future periods of 1, 10, 50, and 100 years. It facilitates a comparison among four different discount rates. Three are fixed for reference: a zero rate, the rate from the Stern Review, and the one proposed by William Nordhaus. The fourth rate is customizable, allowing users to select a rate they deem suitable for evaluating future climate change policies via a slider.

Discount Rate Simulation Spreadsheet (CORE Econ)

Imagine an industry where a few firms have successfully maintained high prices through a secret agreement. Explain two distinct reasons why this agreement becomes significantly harder to maintain if many new firms enter the market.

The Challenge of Maintaining Collusion

A government is evaluating a major climate mitigation project that costs $50 billion today but is projected to prevent $1 trillion in environmental damages 100 years in the future. Advisor X recommends using a 1.4% rate to evaluate the future benefits, while Advisor Y recommends a 4.3% rate. Based on this information, which of the following conclusions is most likely correct?

A national government is evaluating two long-term climate mitigation strategies. Strategy Alpha requires a significant immediate investment of $500 billion and is projected to prevent $10 trillion in climate-related damages 100 years from now. Strategy Beta requires a more modest investment of $50 billion now and is projected to prevent $1 trillion in damages in 100 years. Two economic advisors are consulted:

*   **Advisor 1** argues for using a very low discount rate (e.g., 1.4%) to calculate the present value of future benefits, emphasizing a strong ethical weight for the welfare of future generations.
*   **Advisor 2** argues for using a higher discount rate (e.g., 4.3%), contending that this rate better reflects the opportunity cost of capital and how markets typically value future returns.

Analyze the situation and explain which strategy each advisor is more likely to recommend. Justify your answer by explaining how each advisor's chosen discount rate influences their valuation of the long-term benefits.

Evaluating Climate Investment Strategies

Match each economic approach to valuing future climate change impacts with its corresponding characteristic and policy implication.

Two prominent economic analyses of climate change reached vastly different conclusions about the appropriate price of carbon for the year 2015. One recommended a price of $360 per ton, while the other suggested only $35 per ton. Explain how the choice of a social discount rate is the primary driver of this significant difference in policy recommendations. In your answer, contrast the implications of using a low discount rate versus a high discount rate for valuing future climate damages.

Discount Rates and Climate Policy Urgency

An economist who is highly concerned about the welfare of future generations and believes in taking strong, immediate action on climate change would likely advocate for a high discount rate when evaluating climate policies.

In 2015, one prominent economist recommended a carbon price of $360 per ton, while another recommended a price of only $35 per ton. Briefly explain how the two economists' differing choices for the rate used to value future costs and benefits could lead to such a large divergence in their policy recommendations.

Discount Rates and Carbon Pricing

An environmental project is expected to yield a benefit of $1,000 in 50 years. Using a discount rate of 4.3% per year, the present value of this future benefit is approximately $____. (Round your answer to the nearest whole number and do not include the dollar sign or commas).

Three economic advisors are evaluating the same long-term climate change damage model to recommend a carbon price. They differ only in the annual rate they use to discount future damages. Advisor A uses a rate of 1.4%. Advisor B uses a rate of 4.3%. Advisor C uses a rate of 7.0%. Arrange the resulting carbon price recommendations from highest to lowest.

A coastal city is considering a major infrastructure project: building a comprehensive seawall system to protect against significant sea-level rise projected to occur in 80 years. The project has a large upfront cost. You are presented with two conflicting recommendations from economic advisors:

*   **Advisor A:** "We must act decisively now. The future welfare of our citizens is just as important as our own. By using a low discount rate (e.g., 1.4%), we correctly value the immense future benefits of protection, justifying the significant immediate investment."
*   **Advisor B:** "While the future is important, we must be realistic. A high upfront cost will divert funds from current pressing needs like education and healthcare. Furthermore, future generations will likely be wealthier and have better technology to tackle this problem. Using a higher discount rate (e.g., 4.3%) reflects these realities and suggests a more gradual, less costly approach is optimal."

Critically evaluate the arguments of both Advisor A and Advisor B. In your evaluation, explain how each advisor's choice of discount rate reflects a different stance on intergenerational equity and assumptions about future economic growth.

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