Intertemporal Choice

Intertemporal Choice

Intertemporal choice is a concept in economics and psychology that describes how individuals make decisions about what and how much to do at various points in time. These decisions often involve trade-offs among costs and benefits occurring at different times. The study of intertemporal choice is crucial for understanding behaviors such as saving, investing, and consuming, as well as broader economic phenomena like inflation and economic growth.

A person contemplating different options represented by clocks showing different times.

Theoretical Foundations

Intertemporal choice theory is grounded in the notion that individuals evaluate the desirability of outcomes occurring at different times by discounting the value of future rewards. This concept is encapsulated in the Discounted Utility Model, which posits that the present value of a future reward decreases as the delay to its receipt increases. The model assumes that individuals have a consistent rate of time preference, often represented by a discount rate.

Discounted Utility Model

The Discounted Utility Model, introduced by Paul Samuelson in 1937, is the cornerstone of intertemporal choice theory. According to this model, the present value \( PV \) of a future reward \( V \) received at time \( t \) is given by: \[ PV = \frac{V}{(1 + r)^t} \] where \( r \) is the discount rate. This model assumes exponential discounting, implying that the discount rate remains constant over time.

However, empirical evidence suggests that individuals often exhibit hyperbolic discounting, where the discount rate decreases over time, leading to time-inconsistent preferences. This means that people are more likely to prefer smaller-sooner rewards over larger-later rewards when the delay is short, but this preference can reverse when the delay is longer.

Behavioral Insights

Behavioral economics has provided significant insights into intertemporal choice, highlighting deviations from the rational agent model. Key concepts include:

Hyperbolic Discounting

Hyperbolic discounting describes a situation where the discount rate decreases as the delay to the reward increases. This leads to time-inconsistent preferences, where individuals may choose a smaller-sooner reward over a larger-later reward when both are in the near future but switch preferences when both are in the distant future. This phenomenon can explain behaviors like procrastination and impulsivity.

Present Bias

Present bias refers to the tendency of individuals to give stronger weight to payoffs that are closer to the present time compared to those further in the future. This bias can lead to suboptimal decision-making, such as under-saving for retirement or over-consuming in the present.

Self-Control Problems

Intertemporal choices often involve self-control problems, where individuals struggle to align their short-term actions with their long-term goals. This can be modeled using dual-self models, which posit the existence of a "planner" self that values long-term rewards and a "doer" self that seeks immediate gratification.

Empirical Evidence

Numerous empirical studies have examined intertemporal choice across different contexts and populations. Key findings include:

Laboratory Experiments

Laboratory experiments have been instrumental in studying intertemporal choice. These experiments typically involve offering participants choices between smaller-sooner and larger-later rewards, often in the form of monetary payments. Findings consistently show deviations from exponential discounting, with many participants exhibiting hyperbolic discounting and present bias.

Field Studies

Field studies provide insights into intertemporal choice in real-world settings. For example, research on savings behavior has shown that many individuals fail to save adequately for retirement, consistent with present bias and self-control problems. Similarly, studies on health behaviors, such as smoking and exercise, highlight the challenges individuals face in making intertemporal trade-offs.

Policy Implications

Understanding intertemporal choice has significant implications for public policy. Policymakers can design interventions to help individuals make better long-term decisions. Examples include:

Commitment Devices

Commitment devices are tools or mechanisms that help individuals stick to their long-term goals by restricting their future choices. For instance, automatic enrollment in retirement savings plans can increase savings rates by leveraging inertia and reducing the need for active decision-making.

Nudges

Nudges are subtle changes in the choice architecture that can influence behavior without restricting options. For example, framing health information in terms of long-term benefits rather than immediate costs can encourage healthier behaviors.

Education and Information

Providing education and information about the benefits of long-term planning and the costs of present bias can help individuals make more informed decisions. Financial literacy programs, for example, can improve savings and investment behaviors.

Applications in Various Fields

Intertemporal choice theory has applications across various fields, including:

Economics

In economics, intertemporal choice is fundamental to understanding consumption and savings behavior, investment decisions, and the formation of interest rates. The Life-Cycle Hypothesis and the Permanent Income Hypothesis are key models that incorporate intertemporal choice to explain how individuals plan their consumption and savings over their lifetime.

Psychology

In psychology, intertemporal choice is studied to understand decision-making processes, self-control, and the impact of cognitive biases. Research in this field often explores the neural and psychological mechanisms underlying time preferences and how they can be influenced by factors such as stress, emotions, and social context.

Public Health

Intertemporal choice is relevant to public health, particularly in understanding behaviors related to diet, exercise, and substance use. Interventions designed to promote long-term health benefits often need to address present bias and self-control issues.

Environmental Policy

In environmental policy, intertemporal choice plays a role in decisions about resource use, conservation, and climate change mitigation. Policies aimed at promoting sustainable practices must consider how individuals and societies value future environmental benefits relative to present costs.

Future Directions

Research on intertemporal choice continues to evolve, with several promising directions:

Neuroeconomics

Neuroeconomics combines insights from neuroscience, psychology, and economics to study the neural basis of decision-making. Advances in brain imaging techniques, such as fMRI, have allowed researchers to identify brain regions involved in intertemporal choice and understand how neural activity correlates with time preferences.

Cross-Cultural Studies

Cross-cultural studies examine how intertemporal preferences vary across different cultural and socioeconomic contexts. Understanding these differences can inform the design of culturally sensitive interventions and policies.

Longitudinal Studies

Longitudinal studies track individuals' intertemporal choices over time, providing insights into how preferences and behaviors change with age, life events, and changing circumstances. These studies can help identify factors that promote better long-term decision-making.

Technological Interventions

Technological interventions, such as mobile apps and digital platforms, offer new opportunities to support individuals in making better intertemporal choices. For example, apps that provide real-time feedback and reminders can help users stay on track with their long-term goals.

See Also

• Time Preference
• Behavioral Economics
• Self-Control
• Life-Cycle Hypothesis
• Permanent Income Hypothesis