Lecture 7: Intertemporal Choice Flashcards
intertemporal choices
involve trade-offs among outcomes that differ in their timing, and often in their quality and quantity
- e.g. smaller immediate reward vs large future reward
intertemporal choice wants vs shoulds
- wants: more pleasure at the time of choice
- should: better for us in the long run
what is the rational thing to do
given that there is uncertainty about future outcomes, rationally we should:
- maximize expected outcomes
- maximize expected utility
discount rate
how much we discount future outcomes vs current outcomes
- high discount rate: values present much more than future
- low discount rate: values future closer to present
exponential rational discount rate
visceral factors
people act against self-interest due to visceral factors (hunger, emotions, pain)
- have an immediate, powerful impact on behavior, overshadowing other goals
- people often underweight or ignore past/future or other’s visceral factors
experiencing self vs remembering self
being happy in your life vs being happy about your life
evaluation of past/future
we do not evaluate the past or future well
peak and end rule
we remember the peaks and end more
how do people make trade offs in intertemporal choices
- time
- amount
- valence
how do people trade off time delays
when the time delay is short there is a strong preference for now
- people have lower discount rates for longer delays
present bias (now vs later)
people are more likely to choose ‘want’ options over ‘should’ options the sooner their choices will take effect
- people are more impatient and prefer the early option the closer they are to the decision making time
hyperbolic discounting
the closer in time, the larger the ‘premium’ people want in order to wait
- more impatient = higher discount rates
dynamic inconsistency
situations in which our preference change over time in a way that is inconsistent with another point in time
commitment devices
the far-sighted current self is willing to impose ‘costs’ on the future, myopic self
- the ‘costs’ will be paid only if the future self makes an impulsive/’bad’ choice
how do people trade off amounts (& time)
people have higher discount rates for smaller amounts
- 15 now = 30 in 3 months (277%)
- 3000 now = 3500 in 3 months (62%)
why people have higher discount rates for smaller amounts
- absolute difference
- mental accounting
how do people trade off amounts & time in gains and losses
people have a higher discount rate for gains than for losses
- 15 now = 30 in 3 months (277%)
- -15 now = -16 in 3 months (26%)
savoring
the positive utility derived from anticipating future pleasant outcomes
dread
the negative contemplation of unpleasant outcomes
savoring and dread rational choice
delay negative outcomes, speed up positive outcomes
anomaly
an empirical result qualifies as an anomlay if it is difficult to “rationalize”, or if implausible assumptions are necessary to explain it within the paradigm
pattern of increasing utility over time
people prefer a pattern of increasing utility over time as people are loss averse
human capital
the human capital argument is that firms offer the increasing age-earnings profile to encourage workers to stay in the firm long enough to make firm-specific training pay off
agency cost
the agency cost argument suggests that firms offer wages above marginal product for older workers to prevent workers from cheating and shirking
explanation for the preference of an increasing income stream
loss aversion
- explains why workers prefer an increasing consumption profile (since the utility of current consumption will depend on previous consumption)
self-control
- explains why workers want an increasing income profile, because they cannot rely on themselves to save enough from a flat income (or declining) profile to produce the desired increasing consumption profile
habit formation
the utility of current consumption depends on past levels of consumption