Discounting and Equity Weighting
Quantifying the damages from GHG emissions requires aggregation of damages that occur at different times extending centuries into the future and to different populations across the globe at each point in time. The method chosen for aggregation has implications for how effects on different people are weighed.
Two methods for aggregating effects on different people are common: using monetary and utility measures. The monetary measure assumes that $1 of benefit to one person is equally as good as $1 of benefit to another. The utility measure assumes that the gain in utility (or well-being) from receiving $1 is larger for a poor person than a rich person because the poor person is likely to have more pressing needs.
Aggregating across people using the monetary measure is straightforward: One simply sums the monetary values of benefits and harms across the relevant population. To implement the utility-based approach, one needs to make some assumptions about how individual utility varies with income (or wealth). Often, it is assumed that utility is proportional to the logarithm of income or to a power function of income, where the power is less than 1. These functions have the property that utility increases with income but at a diminishing rate. After choosing a function, one can weight the monetary value of benefits and harms to each person by the incremental utility of income and sum these values. This “equity weighting” gives more weight to the same monetary value of damages when they are suffered by a poor person rather than a rich person.
For aggregating effects across time, it is conventional to discount the monetary value of future effects by a factor of [1/(1 + r)]t that depends on the discount rate r and number of years in the future t at which the effect occurs. The present value of a stream of effects occurring at various times in the future is calculated by summing the discounted monetary values of the effects. In determining the appropriate discount rate to use for aggregating effects on the current and some future generation, one can distinguish between descriptive and prescriptive ap