Preferences• Optimal climate policy depends on how

we define better and best• We may want to take advise from

Socrates, Jesus, Mohammed, Lord Stern or Lady Gaga

• We may also want to measure people’s– time preference– risk aversion– inequity aversion

• But how?

Risk preference• Micro (von Neumann-Morgenstern)

• Prospect theory (Kahneman-Tversky)

• Latter approximates former• Simon would suggest people don’t

bother to be rational in low stake lottery

Ask for choice between two lotteries because peoplemay be biased towards sure things.

If someone accepts Lottery 2 for £750, then her risksensitivity must be greater than 0.9

If someone rejects Lottery 2 for £625, then her risksensitivity must be smaller than 1.2

If both, risk sensitivity lies between 0.9 and 1.2

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4 2.5340 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1375 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1415 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1465 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1530 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1625 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1750 -1 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1925 -1 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11100 -1 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11500 -1 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 12000 -1 -1 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 15000 -1 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 18500 -1 -1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

-1: Lott 1 is the better deal; 1: Lott 2 is the better deal

Risk preference• Prospect theory with Prelec risk bias

• Loss aversion

• So, three parameters to be estimated

Risk preference• Voors et al., AER, 2012

– Discrete choice, 3 alternatives– Variations in pay-offs, but not probabilities– 2 lotteries: 2 obs/person

• Tanaka et al., AER, 2010– Discrete choice, 14/14/7 alternatives– Variations in pay-offs, probabilities– 3 lotteries: 3 obs/person, 1 obs/par

• Voors do not distinguish between risk aversion and amplification

• Tanaka show urns with balls to represent chances, not sure whether this captures risk amplification, eye-sight or numeracy

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Time preference

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Time preference

𝐷𝐹=(1+𝑟𝑡 )− 1 , 𝛽=1∧𝜗=2

𝐷𝐹=𝑒−𝑟𝑡 , 𝛽=𝜗=1

𝐷𝐹=𝛽 (1− (1−𝜗 )𝑟𝑡 )1/1−𝜗

Time preference• Benhabib, Bisin & Schotter (2010, GEB) discount

function has 3 parameters• Voors et al., AER, 2012

– Discrete choice, 6 alternatives– 1 period, 1 sum: 1 observation per person

• Tanaka et al., AER, 2010– Discrete choice, 5 alternatives– 3 periods, 5 sums: 15 obs/person, 5 obs/par

• Ifcher & Zarghamee, AER, 2011– Open choice– 6 periods, 5 sums: 30 obs/person, 10 obs/par

• No distinction between utility, consumption, risk, time

• Commitment device implies short time horizons

Two are indifferent, presumably because of transfers

Two apply discount to child, heavier to grandchild

One applies discount to child, but not to grandchild

Inequity aversion• There is a lot of literature on fairness

– How to divide a windfall among a group of people?• Much less on equity

– What is the best income distribution in a population?• Choice experiment with leaky bucket• Any amount of risk aversion would imply an

egalitarian solution– {10000, 15000, 20000} – {9.2, 9.6, 9.9}– {12000, 15000, 18000} – {9.4, 9.6, 9.8}

• Okun: Imperfect income transfer– {10000, 15000, 20000} – {9.2, 9.6, 9.9}– {12000, 15000, 17000} – {9.4, 9.6, 9.7}

• Administration costs, incentives to work

Inequity aversion• Bergson-Samuelson

– No distinction between risk and inequity aversion

• Creedy (HARA) – Inequity aversion varies with average income

• Sen – Strong inequity aversion

• Forster – Weak inequity aversion

Sussex economists are egalitarians

Income distribution matters more for poorer societies

Wrap-up• Experiments and surveys reveal a lot about

our attitudes• But not necessarily in a tidy way that neatly

fits our theory• Revealed preferences overcome the issues

with low stakes, poor representativeness, but are always messy

• Investments in education, health, climate, pensions– Uncertain returns– Future returns– Disproportionate returns for some