What are the types of intertemporal decision situations?
- immediate benefits, deferred cost
- immediate costs, deferred benefits
What is time discounting?
when things that happen in the future do not give you as much (dis)utility, from the point of view of today, as things that happen today
How is time preference captured?
The delta discount factor
0 < δ < 1
and beta discount factor
0 < β </ 1
What does a High δ discount factor mean?
- what happens in the future period matters a great deal
Patience: do not discount future very much - individual values future rewards over immediate ones
What does a Low δ discount factor mean?
What happens in future periods matters little
Impatience: discount future heavily
- individual prefers immediate rewards rather than future ones
what are the criteria of the standard model of intertemporal decision making?
standard model: exponential discounting model ( δ delta-model)
- captures the idea that people typically prefer their money sooner rather than later (via delta discount factor)
- used in cost-benefit analysis of different projects and to determine value of alternative investments (which delta is chosen matters for comparison of investments and decisions to invest or not)
What are the criteria of the behavioural model of intertemporal decision making?
Behavioural model: Quasi-hyperbolic Discounting Model (also called Hyperbolic discounting or Beta-delta model)
- also captures the idea that people typically prefer their money sooner rather than later (again via delta discount factor)
- but more descriptively accurate than the standard model as it can capture time-inconsistent preferences
- standard model can be seen as special case of the behavioural model (with β = 1)
What does the discount factor capture?
the discount factor captures the idea that people prefer their money sooner rather than later
What are the features of the Exponential Discounting Model?
- the discount factor is merely a time preference
- low discount factors can help explain behaviour such as addiction
- key assumption/feature of the model: preferences are time consistent (cannot change simply because time passes)
But: empirical evidence that it does not describe behaviour sufficiently well - preferences are often time inconsistent
What is meant by the time consistent preferences in the exponential discounting model
- preferences cannot simply change because time passes
- if today a is preferred to b, then yesterday a is preferred to b, and tomorrow a is preferred to b
Give an example of people violating time consistency
- In the morning deciding not to touch alcohol ever again and then having a martini in the evening
What is temptation?
smaller-sooner benefit vs larger-later benefit
e.g.,
- choosing junk food now over better health later
- spending money to buy a car now rather than saving for retirement
What is procrastination?
Smaller-sooner cost vs larger-later cost
e.g.,
- starting a project earlier involves small cost sooner instead of a larger cost later as it would be more stressful and more difficult to do in the last moment before the deadline
- going to the dentist sooner may involve a smaller cost than going to the dentist later when tooth damage may be bigger
Beta (discount factor) looks at what?
0 < β </ 1 NB: it can be equal to 1
captures present-bias or the preference for immediate rewards over future ones (captures the present bias, where individuals may over value immediate rewards relative to future ones)
delta (discount factor) looks at what?
0 < δ < 1
captures the idea that people prefer their money sooner rather than later
- long-term discount factor, reflecting how much someone values future rewards over present rewards. (captures the long-term patience or discount rate for future rewards)
Exponential discounting deals with which discount factor?
δ delta discount factor
Quasi-hyperbolic discounting model deal with what discount factor(s)?
deals with both discount factors - δ delta and β beta
What are the key features of Quasi-hyperbolic Discounting?
- modification of the Exponential Discounting Model that can account for time inconsistent preferences, i.e. for preference reversals
- by introducing β <1, outcomes beyond the present time get discounted more than under exponential discounting
What are the faults with the Quasi-hyperbolic Discounting Model?
- In real-world settings, time preferences are often influenced by many factors such as risk, uncertainty, expectations about future outcomes, and mental accounting. The model doesn’t take these complexities into account e.g. someone might prefer to exercise tomorrow instead of today, but when tomorrow arrives, they might again delay it.
- some people like to distribute pleasant and unpleasant events over time. If so, they are said to exhibit a preference for spread
- people might also have preferences over the shape of their utility profile. They might prefer increasing utility profiles, and/or like to end on a high note
Naive time inconsistent individuals are who?
those who are unaware of their self-control problems; they assume that their future preferences will be exactly the same as their preferences today
Sophisticated time inconsistent individuals are who?
individuals who are aware of their self-control problems
- they may devise plans to prevent self-control issues
Summary of Health club study
Health club attendance features:
- immediate effort costs and
- delayed health benefits
- overestimating of future self-control or future efficiency can explain the findings
- study suggests that caution is needed when inferring consumer preference from observed choices of products or contracts as the revealed preference approach would assume that consumers have rational expectations and are utility maximisers
- the study suggests consumers do not have rational expectations in the context studied
What does β = 1 mean?
there is no present bias (the person is perfectly patient about the difference between “now” and the near future) - don’t discount the future heavily
what does β <1 mean?
the person has a strong preference for receiving rewards immediately - individual heavily discounts the future (i.e., they greatly prefer “now” over “later”) - heavily discounts the future
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Lecture 1 - Methodology27
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Deviations from Rational Choice under Certainty22
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Probability, Heuristics, and Biases34
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Prospect Theory and Mental Accounting26
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Intertemporal Choice25
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Social Preferences in Dictator and Ultimatum Games24
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Social Preferences in Public Goods and Prisoner's Dilemma Games28
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Nudges and Behavioural Public Policy16
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Nudges and Behavioural Public Policy 227
