2 - LEC 1 - TIME INCONSISTENCIES Flashcards
what is intertemporal choice
Outcomes distributed across time
what are the psychological factors promoting the desire to accumulate
Bequest motive
Capacity for self-restraint
-Willpower to put long-term interests ahead of short-term ones
what are the inhibiting factors to accumulate
The uncertainty of human life
The urge for instant gratification
what’s the discount utility model
what does the following look like:
per period discount factor
discount factor
discount rate
what is the discount rate
Interest rate at which future utilities are discounted
When the discount rate is constant we have time-consistent preferences
what is the discount factor
The proportion by which each period’s utility is multiplied to calculate present value of utility
what’s the per period discount factor
what does a discount factor of 0.8 on 10 pounds mean
A discount factor δ of 0.8 means that £10 worth of utility next period is equivalent to £8 today
£10 next period is equivalent to 𝛿£10 (=£8) today
The smaller the discount factor. The more impatient
how do u rearrange the equation to show a discount factor is equal to a discount rate
what would the discount rate and discount factor of someone very patient be
discount rate = 0
discount factor = 1
what how is a discount factor of 0.8 the equivalent as a discount rate 0.25
A discount factor δ of 0.80 is equivalent to a discount rate ρ of 0.25
I.e. instead of £8 today you want £8*1.25=£10 in the future
The higher the discount rate the more impatient (has to be compensated a lot in the future to wait)
what are they key assumptions of discount utility model
Utility independence - pattern of utilities does not matter
The sum of the discounted utilities matter
Consumption independence - consumption in one period does not affect utility in other periods (independence axiom)
..”one’s preference between an Italian and Thai restaurant tonight should not depend on whether one had Italian last night nor whether one expects to have it tomorrow”
Stationary instantaneous utility - preferences don’t change over time
Independence of discounting from consumption
all forms of consumption, costs and benefits, discounted at same rate. Otherwise, no uniform time preference (banana time preference, vacation time preference)
what does consistent time preferences require
Stationary discounting - people use same discount rate over lifetime (i.e. it doesn’t vary with age)
Constant discounting - same discount rate for all future periods
3 experimental methods on how elicit discount rates
choice tasks
matching tasks
pricing tasks
what’s the methodology for choice tasks. and what’s the problem
Do you prefer £100 now to £110 in one year? If yes. Discount rate is at least ?%
Series of questions to establish exact discount rate (i.e. Indifferent between sum today and another sum one year from now)
Problem; anchoring effect
The subjects’ answers may be influenced by the first question
explain the methodology of matching tasks. what’s the problems
How much money would you require in one year to be indifferent between that sum an £100 now?
OR
How much money would you require now to be indifferent between that sum and £100 one year from now now?
provides us with exact discount rate
no anchoring problem
problems; inconsistencies
- Higher discount rates (more impatient)
When asked to state the future amount that would be equivalent to a specified amount today
-Lower discount rate
when asked to state the amount today that is equivalent to a specified future amount
explain the pricing tasks methodology
Eliciting a willingness-to-pay in order to receive or avoid a particular outcome in the future
Monetary or non-monetary outcomes
what’s the wealth effect
The wealth effect examines how a change in personal wealth influences consumer spending and economic growth. Rising wealth has a positive impact on consumer spending.
why use front end delay (paying someone in one month and 7 months)
so transaction costs are constant. setting up bank accounts etc.
what’s the issue with time inconsistent preferences
smaller sooner vs larger later
temptation, procrastination
example:
Prefer a prize of $100 immediately to $200 in two years
do not Prefer a prize of $100 in 6 years to $200 in eight years
what’s present bias
People tend to be more impatient in the short run (higher discount rate) and become more patient over longer periods of time i.e. a declining discount rate - passion for the present
Sharp discounting of near future relative to the present
But not much discounting of very distant future relative to not quite so distant future
what’s the three different discount functions
DUM. Exponential
Quasi-hyperbolic
Hyperbolic
describe the discounted utility model
describe the hyperbolic discounting model
describe the quasi hyperbolic discounting model
what are naive consumers like
Naïve agents assume future preferences identical to current ones, overestimating their β;
Think they will prefer LL to SS in future
Think they will use a constant discount rate in future but use a hyperbolic
what are smart consumers like
Smart agents can predict accurately how their preferences will change over time (e.g. learning) (β = b)
what’s the sign effect
People use much lower discount rates for losses than when gains are involved
a gain in future is discounted heavily. It is not worth that much.
A loss in future is not discounted heavily -> you don’t get less loss by waiting
Many prefer an immediate loss rather than to delay it (zero discount rate)
what’s the The ‘delay-speedup’ asymmetry
people prepared to pay less to speed-up delivery (gain) than need to be compensated for delay (loss)
Losses loom larger than gains
what’s the preference for improving sequence
DUM; people will prefer a declining sequence to an increasing sequence since later outcomes are discounted more heavily
However; people like rising income and consumption profiles
Eg. wages
sheet in class for time inconsistencies
on phone - 10-2-22
explain the Harrison et al. 2002. Estimating Individual Discount Rates in Denmark: A Field Experiment paper.
Choice tasks - Twenty different amounts were offered as alternatives to the fixed option - Random payment used as incentive - Use of ‘front-end delay’
Use of different time horizons
hypothesis 1 - The discount rates for given time horizons do not differ across households
2 - The discount rate for given households do not differ across time horizon
Hypothesis 1; rejected
Variation in discount rates across socio-demographic characteristics (income, age etc.)
Hypothesis 2; confirmed
Constant discount rates (beyond one year) for given households
