the economics of patience: the endogenous determination of time preference

Future Focus: The endogenous determination

of time preference

Dr. Russell James IIITexas Tech University

Past Expected Future

Alternative

Nearby additional

Relevant Observed

Current

Multiple Alternative

Our choices and our satisfaction

are driven by the comparisons

we make

Behavioral Economics Concepts

Past Expected Future

Alternative

Nearby additional

Relevant Observed

Current

Multiple Alternative

Hedonic Adaptation

Placebo Effect;

Stereotypes

Peer Effects; Relative Standing

Endogenous Determination of Time Preference

Anchoring; Paradox of

Choice

Loss Aversion; Endowment Effect;

Status Quo Bias

Availability Effects

The tradeoff between now and later is called time discounting.We trade money/sensation/experience today for money/sensation/experience later.

How much future value you are willing to give up for current value is your rate of time discounting.

Some people have a high rate of discount for future utility.

Some people have a low rate of discount for future utility.

The tradeoff between now and later applies not just to money…

But, also to other tradeoffs of health and life

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And even to decisions about your weekend…

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Many self-inflicted harmful decisions are the result of exchanging instant gratification for risk of future negative consequences.

Short-term/impulsive DoerPassionsAffective/VisceralHot state

Long-term/patient PlannerImpartial spectatorDeliberative Cold state

These choices can result from deliberative decisions to accept future risk.

Or from impulsive decisions, when the “elephant” is put in tempting situations (ex: hyperbolic discounting or projection bias)

How can we change?

1. Alter our time preference (develop future-orientation or patience)

2. Pre-commitment strategies (change our elephant’s future environment)

Should we work to develop more future-orientation (patience)?

Victim of my insatiable need for instant gratification.

Standard economics You are already perfectly rational.

Behavioral economics

Economic Theory

• Nobel prize winning economist Gary Becker and Casey Mulligan present a model of time preference for imperfect humans.

• People may be too focused on instant gratification, but they can spend effort to develop patience (future-orientation).

G. Becker (Chicago) & C. Mulligan (Chicago), 1997, The endogenous determination of time preference. Quarterly Journal of Economics, 112(3), 729-758

Economic theory: People maximize…


The enjoyment of current consumption

The enjoyment of future consumption

A time discount factor (because future enjoyment is not the same as current enjoyment)





Becker & Mulligan say we can change it by spending effort (S) to become more future-focused.

In standard economics, our time discount preference (β) is pre-set.

G. Becker (Chicago) & C. Mulligan (Chicago), 1997, The endogenous determination of time preference. Quarterly Journal of Economics, 112(3), 729-758 , p. 734




A consumer can “make future pleasures less remote by spending resources (S) on imagining them”

G. Becker (Chicago), 1996, Accounting for Tastes. Cambridge, Massachusetts: Harvard University Press, p. 11

People can maximize utility “partly by spending time and other resources to produce

‘imagination capital’ that helps them better appreciate future utilities.”

A Nobel prize winning economist using an economic model incorporating

Imagination

“How can a person improve his capacity to appreciate the future? What exactly is S? First, S is partially determined by time and effort spent appreciating future pleasures.”


“While forming a mental picture of one’s future pleasures may not be incredibly difficult, the process of anticipation is not merely one of image formation but also one of scenario simulation.”


“Even image formation may not be cheap because images of future pleasures have to be repeatedly refreshed in one’s mind in order to compete with current pleasures.”


http://www.youtube.com/watch?v=wPFA8n7goio 1:13-4:30

Only emotional goals work

• The rider may be compelled by logic or emotion

• The elephant is purely emotional (visceral)

• To engage the elephant, the imagery of future goals must evoke emotion.

Suppose you are advising a friend whose goal is to become an Olympic athlete. What emotional images or scenes can you imagine that might be motivating?

Suppose you are advising a friend whose goal is to become a physician. What emotional images or scenes can you imagine that might prove motivating?

Avoid unfocused, unemotional goals…

Can education make you more future-oriented?Becker and Mulligan suggest, “through repeated practice at problem-solving, schooling helps children learn the art of scenario simulation. Thus, educated people should be more productive at reducing the remoteness of future pleasures.”


Focusing on long-term goals using imagery and emotion can change your future-orientation.

But, how do we go about selecting the best goals? More later…

Slides by: Russell James III, J.D., Ph.D., CFP®Associate Professor Division of Personal Financial Planning Texas Tech [email protected]

Please use these slides!

If you think you might use anything here in a classroom,

please CLICK HERE to let me know.

Thanks!

The outline for this behavioral economics series is at http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component

http://www.surveymonkey.com/s.aspx?sm=1jIdZgtJHGbjjqPRIjFP4Q_3d_3d

http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component

http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component

the economics of patience: the endogenous determination of time preference

Education

future enjoyment

future risk

future utility

future value

future focus

future utilities

mulligan chicago

becker chicago