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Public Choice

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21-02-2018

Remembering Kenneth Arrow: discount rates

Author: Kenneth A. Shepsle

Published in: Public Choice | Issue 1-2/2019

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Abstract

This remembrance of Kenneth Arrow describes his contribution to the consideration of social discount rates applied to intertemporal flows of costs and benefits.

previous article A defense of Arrow’s independence of irrelevant alternatives

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His papers on this subject are collected in Arrow (1971).

This is not the debate between exponential and hyperbolic discounting regimes that currently preoccupies behavioral economics.

If the agent is risk neutral, then the certainty equivalent of this random variable is simply its expected value. If, on the other hand, the agent is risk averse (risk acceptant), then the certainty equivalent will be less than (greater than) the expected value.

A positive present value is necessary but not sufficient. According to one classic exposition on this subject (McKean 1958), the normative rule is to rank-order projects by present value and move down the list implementing projects until an exogenously provided budget is exhausted. That rule may leave unfunded some projects with positive present value.

Arrow, K. J. (1971). Essays in the theory of risk-bearing. Chicago, IL: Markham.

Arrow, K. J., & Lind, R. C. (1970). Uncertainty and the evaluation of public investments. American Economic Review, 60, 364–378.

McKean, R. M. (1958). Efficiency in government through systems analysis. New York, NY: Wiley.

Shepsle, K. A. (1972). The strategy of ambiguity: Uncertainty and electoral competition. American Political Science Review, 66, 555–569.CrossRef

Shepsle, K. A. (1978). Risk and the discount rate for investments yielding public goods: The Arrow–Lind theorem reconsidered. In Gordon Tullock & Richard E. Wagner (Eds.), Policy analysis and deductive reasoning (pp. 167–179). Lexington, MA: Lexington Books.

Title: Remembering Kenneth Arrow: discount rates
Author: Kenneth A. Shepsle
Publication date: 21-02-2018
Publisher: Springer US
Published in: Public Choice / Issue 1-2/2019
Print ISSN: 0048-5829
Electronic ISSN: 1573-7101
DOI: https://doi.org/10.1007/s11127-018-0520-x

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