4 Dynamic endogenous risk and social accounting Ram Ranjan and Jason F. Shogren 1 INTRODUCTION Social accounting aims to better understand the true performance of an economy by including the depreciation of the entire stock of capital, including reproducible capital, human capital and natural capital (see for example, Weitzman, 1976, Peskin and Peskin, 1978, Aronsson et al., 1997). Shadow prices can be used as relative weights to construct an index to measure changes in the capital stock or the entire capital stock. In theory, this index can be used to judge better if unobservable social well-being tracks observable economic progress or regress over time. For the most part, however, social accounting models have focused on temporal issues within deterministic environments. Incorporating risk would add more complications, but in theory at least the cost of risk should be reflected in the shadow prices of the capital stock. That is, if one assumes risk is exogenous and beyond the control of the representative agent (for example, Dasgupta, 2009). But when faced with risk, private citizens are free to choose whether to invest resources to change our beliefs about good and bad states of nature. We invest in self-protection to reduce the chance of a bad event or self-insurance to reduce the severity of a bad event or both (see for example, Ehrlich and Becker, 1972). Both actions make the risk endogenous to people. Understanding how people decide to go privately for self-protection and self-insurance is crucial for efficient provision of social goods...
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