Intertemporal Choice

Definition

Intertemporal choice refers to the decision-making process individuals engage in when making choices that involve trade-offs between costs and benefits occurring at different points in time. It encompasses the way people make decisions that balance present and future considerations.

5 Must Know Facts For Your Next Test

1. Intertemporal choices involve trade-offs between immediate and delayed costs and benefits, such as saving money now versus spending it on current consumption.
2. Individuals often exhibit a bias towards the present, valuing immediate rewards more than delayed ones, a phenomenon known as the 'present bias'.
3. The degree of time preference, or discounting of future outcomes, can vary across individuals and situations, and is influenced by factors like age, income, and personality traits.
4. Hyperbolic discounting describes the tendency for people to have a high discount rate for short-term delays, but a much lower discount rate for long-term delays.
5. Intertemporal choices are a central focus in behavioral economics, as they highlight how people's decisions can deviate from the predictions of traditional economic models.

Review Questions

• Explain how the concept of intertemporal choice relates to the framework of behavioral economics.
  • Intertemporal choice is a key concept in behavioral economics, as it highlights how individuals' decisions involving trade-offs between present and future costs and benefits often deviate from the predictions of traditional economic models. Behavioral economists study how factors like present bias, hyperbolic discounting, and other cognitive biases influence people's intertemporal choices, leading to decisions that may not align with the assumptions of rationality and time consistency made in neoclassical economics.
• Describe how the phenomenon of hyperbolic discounting can lead to inconsistent preferences in intertemporal choices.
  • Hyperbolic discounting refers to the tendency for individuals to have a high discount rate for short-term delays, but a much lower discount rate for long-term delays. This can lead to inconsistent preferences over time, where someone may prefer a smaller, more immediate reward over a larger, delayed one in the short-term, but then reverse their preference and choose the larger, delayed reward when the short-term option is no longer available. This pattern of inconsistent choices is a key departure from the predictions of traditional economic models of intertemporal decision-making.
• Analyze how individual differences in time preference can influence intertemporal choices and impact economic outcomes.
  • The degree of time preference, or the relative value individuals place on present versus future outcomes, can vary significantly across people and situations. Individuals with a higher time preference, or greater impatience, will tend to discount future rewards more heavily and make choices that favor immediate gratification over delayed but larger payoffs. This can have important economic consequences, such as lower rates of saving and investment, higher levels of borrowing and debt, and suboptimal long-term financial planning. In contrast, individuals with a lower time preference, or greater patience, will be more likely to make choices that prioritize future outcomes, leading to higher savings rates, more investment, and better long-term economic outcomes. Understanding these individual differences in time preference is crucial for predicting and influencing intertemporal economic decisions.

Related terms

Time Preference: The relative value an individual places on a reward or outcome in the present versus the future, which influences intertemporal choices.

Discounting: The process by which future rewards or costs are reduced in value compared to immediate ones, leading to preferences for more immediate gratification.

Hyperbolic Discounting:

A model of time preference where the discount rate decreases as the delay to the reward increases, leading to inconsistent preferences over time.