Finally, the analyst must consider whether the outcomes of interest are inter-temporal. This
is a complication that often arises, as formal decision making frequently requires comparing
costs and benefits obtained at different points in time. Economists typically use a discounting
function to decrease the importance of costs or benefits occurring further in the future.
Discount rates relate future monetary values to the present, corresponding to the empirical
reality that actors prefer current consumption to future consumption. Discount rates arise for
two reasons. First, there is an macroeconomic basis to discount rates, whereby economic
growth and inflation rates mean that the real purchasing power of a unit of wealth decreases
over time. Second, there is a moral (or social) element of discount rates when seen from
an intergenerational perspective, whereby the discount rate represents the preference of
consumption of this generation over consumption of future generations.
Uncertainty, expected outcome and expected utility
In cases where there is uncertainty about outcomes, further complications arise. The analyst
may consider whether there is probabilistic information on potential outcomes. If outcomes
can be represented through a probability density function, then an option can be assigned a
value according to the expected outcome. However, uncertainty in outcomes raises a further
issue as both economic theory and empirical evidence has shown that people generally
have preferences on uncertainty. Therefore valuation can be applied to the uncertainty in
outcomes. In other words, a relevant question to consider is how much more would people
pay for an outcome that is certain than they would for an uncertain outcome, but with the
same expected value? In order to address this, it is necessary to estimate a utility function for
an individual respect to the outcome. In general, the utility function is shaped by diminishing
marginal utility, which reflects the principle that past a certain threshold increasing quantities
of the same good bring little additional utility. Because of this the expected utility of option
will differ from the expected outcome, as outcomes which are at the tail end of an expected
outcome distribution contribute little to expected utility. This is another way of saying that
people are generally risk averse, and in general prefer a certain outcome to an uncertain
outcome with an equal expected value.
For a public actor, the utility functions of affected actors must be aggregated into a social
welfare function. These considerations apply to situations in which outcomes can be
represented probabilistically. When future outcomes cannot be represented probabilistically,
valuation methods are not applicable.
While the tasks and methods discussed in this section have been applied extensively, it is
important to note that they have also been subjected to substantial criticisms. The valuation
tasks and methods described in this subsection are largely based on the neoclassical
economics approaches of welfare economics. Criticism of these approaches has focused
on the unrealistic assumptions made about actor’s choice processes in order to support
valuation methods. Critics point to the empirical fact that regularities in cognitive biases exist
in individual decision making, so that framing effects may influence valuation (Kahneman
et al. 1982). Others have criticised valuation methods for enabling trade-offs to be made
between outcomes should be seen as incommensurable. There are, for example, arguments
to be made against the valuation of species extinction or human suffering (Vatn, 2005).
In this sense, applying valuation may encompass a strong normative component and the
analyst should be aware of these issues when deciding whether to apply valuation methods.
