January 25, 2009

An Analysis of the Dismal Theorem

by William Nordhaus

- In a series of papers, Martin Weitzman has proposed a Dismal Theorem. The general idea is that, under limited conditions concerning the structure of uncertainty and preferences, society has an indefinitely large expected loss from high-consequence, low-probability events. Under such conditions, standard economic analysis cannot be applied. The present study is intended to put the Dismal Theorem in context and examine the range of its applicability, with an application to catastrophic climate change. I conclude that Weitzman makes an important point about selection of distributions in the analysis of decision-making under uncertainty. However, the conditions necessary for the Dismal Theorem to hold are limited and do not apply to a wide range of potential uncertain scenarios.

Nordhaus, W. (2009). "An Analysis of the Dismal Theorem." Cowles Foudation Working Paper NO. 1686, Jan 2009.