PrintDiscount Rate
The discount rate is often approximated as the real rate of return on capital, R, along an optimal path. This is given by the Ramsey equation, which in turn is made up of three parts.
The first is the growth rate of consumption per person in the economy, Ġ.
The second is the elasticity of the marginal utility of consumption, S. The marginal utility of consumption is how much good you get from consuming something, and its elasticity here is taken as how this good changes as you consume more. Wealthy people get less good from the next dollar than poor people do, but how much less? If we think that the good decreases rapidly as people get richer, and we don't want to help rich people in the future who won't appreciate the help, then we have a large discount rate and tend to help ourselves rather than them by spending on us rather than investing for them.
The third part of the discount rate is the pure rate of time preference, E. This is related to our observed tendency to choose to have something, such as an apple, or an Apple, now rather than in the future.
The Ramsey equation puts these together to give the real rate of return on capital as R=E+ĠS. And, economists often set this as being equal to the discount rate.