Intertemporal Choice Flashcards
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)
