Lecture 7: Intertemporal Choice

Question 1

intertemporal choices

Answer 1

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

Question 2

intertemporal choice wants vs shoulds

Answer 2

• wants: more pleasure at the time of choice
• should: better for us in the long run

Question 3

what is the rational thing to do

Answer 3

given that there is uncertainty about future outcomes, rationally we should:
- maximize expected outcomes
- maximize expected utility

Question 4

discount rate

Answer 4

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

Question 5

exponential rational discount rate

Answer 5

Question 6

visceral factors

Answer 6

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

Question 7

experiencing self vs remembering self

Answer 7

being happy in your life vs being happy about your life

Question 8

evaluation of past/future

Answer 8

we do not evaluate the past or future well

Question 9

peak and end rule

Answer 9

we remember the peaks and end more

Question 10

how do people make trade offs in intertemporal choices

Answer 10

• time
• amount
• valence

Question 11

how do people trade off time delays

Answer 11

when the time delay is short there is a strong preference for now
- people have lower discount rates for longer delays

Question 12

present bias (now vs later)

Answer 12

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

Question 13

hyperbolic discounting

Answer 13

the closer in time, the larger the ‘premium’ people want in order to wait
- more impatient = higher discount rates

Question 14

dynamic inconsistency

Answer 14

situations in which our preference change over time in a way that is inconsistent with another point in time

Question 15

commitment devices

Answer 15

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

Question 16

how do people trade off amounts (& time)

Answer 16

people have higher discount rates for smaller amounts
- 15 now = 30 in 3 months (277%)
- 3000 now = 3500 in 3 months (62%)

Question 17

why people have higher discount rates for smaller amounts

Answer 17

• absolute difference
• mental accounting

Question 18

how do people trade off amounts & time in gains and losses

Answer 18

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%)

Question 19

savoring

Answer 19

the positive utility derived from anticipating future pleasant outcomes

Question 20

dread

Answer 20

the negative contemplation of unpleasant outcomes

Question 21

savoring and dread rational choice

Answer 21

delay negative outcomes, speed up positive outcomes

Question 22

anomaly

Answer 22

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

Question 23

pattern of increasing utility over time

Answer 23

people prefer a pattern of increasing utility over time as people are loss averse

Question 24

human capital

Answer 24

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

Question 25

agency cost

Answer 25

the agency cost argument suggests that firms offer wages above marginal product for older workers to prevent workers from cheating and shirking

Question 26

explanation for the preference of an increasing income stream

Answer 26

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

Question 27

habit formation

Answer 27

the utility of current consumption depends on past levels of consumption