Time and the decision maker Flashcards
What are inter-temporal choices?
Choices that involve time and, often, investments.
What is the choice between in an inter-temporal choice?
A (notional) immediate investment and a long term reward OR an immediate gain (notional no spend) and no long term reward (potential loss).
What do the majority of people choose between £500 now (A) and £1000 in 10 years (B)?
£500 now (A) over £1000 in 10 years (B). A is of lower value than B but it has higher utility as the utility of B is discounted by its delay.
How can choosing an immediate gain over a long term reward be explained?
By Paul Samuelson’s (1937) Discounted Utility Model. The normative assumption is that the discount function is an exponential constant rate.
What does the equation V = Ve-kd apply to and what do the letters mean?
Exponential discounting. v = subjective discount value, k = the discount rate (related to personal impulsivity and self-control), and d = the delay.
What three properties does the exponential function have that fit empirical behaviour?
- If there’s no delay there’s no discounting
- As delay increases the present value decreases
- As delay approaches infinity the present value approaches zero
How does the normative model of exponential discounting fail?
When the delay changes. Given the choice between £500 in 10yrs (A) or £1000 in 20yrs (B), most people choose B. This is a preference reversal which the exponential discount function can’t accommodate.
Why can the exponential discount function not explain preference reversals over longer delays?
Because it implies that two discount functions with the same discount rates cannot cross.
How can the dynamic inconsistency of the exponential discount function be accommodated?
If the discount function is hyperbolic in form (Mazur, 1987; Ainslie, 1992).
What does the equation V = V/1+kD apply to and what do the letters mean?
The hyperbolic discount function. v = subjective discount value, k = the discount rate (related to personal impulsivity and self-control), and d = the delay.
For what three reasons do we discount the future?
Interest rates, uncertainty and emotional based theories.
Why do we discount the future due to interest rates?
Because if the money is taken now, it could be invested for a higher rate of return than the delayed alternative.
How does uncertainty cause us to discount the future?
The future is both risky and uncertain - for example the bank holding your investment, and indeed the currency itself, might collapse. Probability itself is discounted in a similar way (see Green & Myerson, 2005).
How do emotional-based theories (e.g. Loewenstein, 1996) explain why we discount the future?
Temporal and physical proximity of options that can reduce aversive states (e.g. hunger, withdrawal) leads to a disproportionate increase in the attractiveness of those options. There’s an empathy gap between the present and future, as you feel the current state but not the future.
What is an example of emotional-based theories (empathy gap) explaining an inter-temporal choice?
Smoking - people with low discount rates rather than exhibiting self-control are savouring the delayed gratification (enjoying the wait in the knowledge that the result will be greater).
