Intertemporal Decisions

Topics: Economics, Utility, Preference Pages: 8 (2690 words) Published: February 24, 2013
intertemporal decisions

In attempt to outline the standard economic theory about how people make intertemporal decisions we must first begin by looking at what intertemporal decision are, using examples to receive a clear understanding of the full concept. Once we have a distinguished understanding of intertemporal choice we must then look berifly at the economic and psycholigical history which formed this concept and ultimatally lead to the theory of discounting utility. It is then that we will proceed to examine the discount utility model, or the DU model as we will refear to it.

Intertemporal choice once defined by Senior as "It may be said that pure abstinence, being a mere negation, cannot produce positive effects; the same remark might as well be applied to intrepidity, or even to liberty; but who ever objected to their being considered as equivalent to active agents? To abstain from the enjoyment which is in our power, or to seek distant rather than immediate results, are among the most painful exertions of the human will. It is true that such exertions are made, and indeed are frequent in every state of society, except perhaps in the very lowest, and have been made in the very lowest, for society could not otherwise have improved; but of all the means by which man can be raised in the scale of being, abstinence, as it is perhaps the most effective, is the slowest in its increase, and the least generally diffused." (Senior, 2002). Intertemporal choice attempts to explain the rational for impulsive vs prolonged consumption by companies, governments and individuals. Laibson in a lecture given in Harvard attempts to simplify this concept with the example of a massage treatements at a spa complex. He considers this a motivating experiment, or a thought experiment. He asks the clas to display a show of hands for their choice. He first questions that when arriving at the spa resort is giving the option of a 15 minute masage now or a 20 minute massage in one hour, which option would the cla choose, this reulting in the clas being split, half choosing the first option and the remainding half choosing the second option. The when aked if they were asked one week in advance which they would rather a 15 minute massage in one week or a 20 minute massage in one week and one hour, the entire class prefered the second option (Laibson). This is a prime example of how when chosing for now, impulsive instincts cause one to see the hour as a large substantial time frame, and are therefore willing to forgo the extra 5 minute massage. Yet when this hour is added to the week, it then becomes small and insigificant in proportion to the large time frame of the week which must be waited by the subject anyway. Intertemporal decisions have even been described by Adam Smith as so significant in life as to "not only affect ones health, wealth and happiness, but may also...determine the economic prosperity of nations" (p351)

The concept of intertemporal choice was first brought about by the economist Adam Smith. Smith was the first to call attention to "the importance of intertemporal choice to the wealth of nations" (Frederick, Loewenstein, O'donoghue, p1). This concept of intertemporal choice was then adapted and further improved by economist John Rae who took a sociological and psychological approach to his examination of this theory (Frederick, Loewenstein, O'Donoghue, p1). Rae beleived that the missing element of Smiths work was "the effective desire of accumulation" (Reading p353). Eugen Von Bohm-Bawerk also added his contribution to this theory adding the concept of how "humans suffer from a systematic tendency to underestimate future wants" (reading p351). This addition can be illistrated perfectly in the experiment conducted by Read and Von Leeuwen. This ecperiment involved Dutch workers being asked to chose between fruit, the healthy option or chocolate, the unhealthy option for their lunch one day...
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