week 5 - intertemporal choice Flashcards
what is the standard model of intertemporal choice
max (c1) U(c1, w - c1)
what is the interpretation of the components in the standard model of intertemporal choice
- w is initial wealth
- wealth is divided into consuming now and in the future
- the model resembles a two commodity model
- w2 = c2
- future utility is discounted
- Often economists assume a preference to consume now rather than in the future.
- Future utility is discounted
How is this written in utility
U(c1, c2) = u(c1) + δu(c2)
where 0 < δ < 1 is a discount factor and u(c) is instantaneous utility
what does a larger δ indicate
flatter indifference curve, more patience
how can the indifference curve of the standard model of inter-temporal choice be written
dc2/dc1 = -u’(c1)/δu’(c2)
what is mispredicting utility also known as
- projection bias
- people believe that they will value options in the future as they are valuing them today
what does u˜(c,s | s′) represent
the predicted utility of consumption under state s when the decision maker makes the prediction while in state s’
when does one display projection bias
u˜(c,s | s′) = (1 − α)u(c,s) + αu (c,s’)
where 0 < α <= 1
what is the model of projection bias under time inconsistent preferences
max c1 u (c1,s′) + δu˜(w − c1,s | s′) = u (c1,s′) + δ [(1 − α)u (w − c1,s) + αu (w − c1,s′)]
i.e. predicting consumption conditional on state s’, if there is no prediction bias α = 0
graph for mispredicting utility
lecture 5, slide 21
point B = no projection bias
point A = projection bias
how can we model addiction
- a two period and two good model, coffee and food
- utility could be lower the higher the coffee consumption in the last period
- marginal utility of coffee depends on the last period
- marginal consumption of food is constant in this model
- diminishing marginal utility in current consumption
- there are two periods and before the first period no coffee is consumed
- the discount factor δ, and prices for both food and coffee are equal to 1
what is the maximisation problem of the addiction model
what does the exponential discounting model
- can be used to model procrastination
- preference to consume now rather than in the future
- 0 < δ < 1, higher δ = more patience
- procrastination means that preferences are inconsistent over time
why is a constant δ in a fully additive model attractive
if its not constant, can lead to time inconsistent preferences
if α = 1 in the model of projection bias what can we deduce
that the utility in state s is predicted to be identical to current state s’ utility
what is sachett and torrance’s (1978) example of mispredicting utility
they looked at those with kidney disease and the individuals who were currently undergoing treated mispredicted (overpredicted) the effect that the disease will actually have on their life
what is simonsohn’s (2010) example of mispredicting utility
they found that when people visited prestigious universitys on days with bad weather, people were more likely to apply to that university
what is the economic explanation of simonsohn’s (2010) example of mispredicting utility
- rainy days: increases the utility of studying at both prestigious and party uni, but more at prestigious
- sunny days: increases the utility of recreational activities at both unis but more for party uni
- i.e. if they visit on a sunny day, people mispredict that it will be sunny most days when they actually attend, vice versa
what is δ sometimes referred to as
a measure of patience
what do time inconsistent preferences lead to
lower lifetime utility
over a short period of time what should δ equal
close to 1, choices over a short period of time should be consistent, a choice from today to tomorrow should not differ too much
if preferences are not consistent what does this mean for the value of δ
δ is not constant
what is the implication of procrastination
preferences are inconsistent over time
what is a property of the fully additive model with exponential discounting
it is stationary, because it assumes a constant discount rate
