Choice Over Time:

How Consumers Really Discount

Consumer Behavior
Dan Bartels

Intertemporal Choice
Temporal discounting: Tradeoffs
How much more do we want something now as
opposed to later?
$10 today OR $12 in a year?
$10,000 today OR $12,000 in a year?
How do our preferences change when we are
deciding about an immediate reward vs. deciding
for the future?
$10,000 one year from now OR $12,000 two years
from now?

Invest $10,000 now

to get $12,000 in a year?
Economic Theory Makes a Clear Prediction:
If the rate of return is higher than the interest rate,
take the offer
In fact, you can borrow money and profit even more.
If the rate of return is lower than the interest rate,
refuse

What can we say about people who accept,

refuse?
What does this imply about their discount rates?
What should those rates be?
Should they be zero? Why or why not?

1
 Why discount rates should be positive
Discount rate:
The rate of interest you demand
to make you happily wait for
something

These preferences have large

effects

Why positive?
Future outcomes are uncertain "Theartofprophecyisverydifficult,
especiallywithregardtothefuture."
Possibility of preference change
Declining marginal utility
Delays entail opportunity costs

Homo Economicus
Each individual has their own, positive discount rate
Stable across
Length of wait
Delay in wait
Amount of money
Thus, immune to framing

Can be expressed as:

r is constant for all t: exponential discounting
r is constant for all amounts of money, frames, and, perhaps
goods.

A graphical view
of exponential discounting
Waitingtakesthevalueoutofstuffataconstantrate
Valueof$5,000

Delaytoreceivingthemoney

2
 Homo Sapiens:
Why are discount rates positive?
Irrational (?) reasons
We are myopic: our telescopic faculty is
defective, and we therefore see future pleasures,
as it were, on a diminished scale
A. Pigou 1920

We lack self-control: 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
N. W. Senior 1836

An example of real consequence

After the Gulf War in the early 90s, military
reduced its size by buying soldiers into
retirement
A lump sum payment (median about $20K)
An annuity (median $40K in present value)

More than 90% of 55,000 enlisted men chose the

lump sum, implying discount rates of 17-20%
Savings to U.S. Government: $1.7 billion

If the soldiers really wanted money now, they

could have taken out a loan and used the annuity
income to pay it back.

Agenda: The anomalies

expressed by homo sapiens
Discount rates decrease over time
Hyperbolic discounting
Discount rates decrease with larger amounts
Magnitude effect
Discount rates show reference effects
Delay premiums > Speed-up costs
Negative discount rates?
Dynamic inconsistency and self-control

3
 A graphical view of exponential
and hyperbolic discounting
Waitingtakesthevalueoutofstuffataconstantrate
Stufflosesvaluemorequicklyinthenearfuture
Valueof$5,000

Delaytoreceivingthemoney

Discount Rates over Time

Thaler (1981): If you could have $15 right
now, how much would you need to instead
get money
in a month? $20 (345% interest rate)
in a year? $50 (120%)
in 10 years? $100 (19%)

I asked you:
$85 vs. $x in 1 month, 1 year, 10 years
$5,500 vs $x in 1 month, 1 year, 10 years

Prior results
Discountrate

$85
$5500

Monthswaiting

4
 Myopic preferences
Short-term consequences are weighed more
heavily than long-term ones

My patients are much more compliant about

avoiding the sun when I tell them that it can
cause large pores and blackheads rather than
warn them about skin cancer
Dermatologist quoted in Thaler & Loewenstein

How people make money

off our myopia
Loans higher than the interest rate
Instant Income Tax refunds
Credit card debt
Buying people out:
Lottery winners
Owed insurance settlements
Adjustable rate mortgages
Inefficient appliances

High Interest Rate Loans

$500 fast payday loans
No interest rate, rather a $75 fee
Every month the loan isnt paid back, another $75
First month: 168% interest

Overdraft protection

5
 Reference Points and Framing
If we have fixed discount rates, it shouldnt
matter whether something is called a speed-
up or a delay, they should have the same
effect on the value.

Delay Premiums
Speed-Up Costs
Loewenstein (1988)
Respondents who didnt expect to receive a VCR
for a year would pay $54 to receive it
immediately
However, those expecting it immediately
demanded $126 to have it delayed by a year

People demanded twice as much to delay

than they were willing to pay for equivalent
speedups
Your data:

Negative Discount Rates

Positive discount rates: we prefer today to
tomorrow because waiting makes it worth
less
Negative discount rates: we prefer tomorrow
to today because waiting makes it worth
more. Impossible?
Teachers 12 month salaries
Overpaying the IRS
Bills paid as soon as they arrive

6
 Why negative discount rates?
Anticipation (or dread)
Would you rather have 3 two-second very
painful, but non-lethal shocks in 2 minutes or
Thursday at 4 PM?

Preferences over sequences

Preferences for Sequences

$1500 in January, $1400 in March, $1300 in
May, $1200 in July, $1100 in September, and
$1000 in November.

$1000 in January, $1100 in March, $1200 in

May, $1300 in July, $1400 in September, and
$1500 in November

Exponential vs. Hyperbolic Discounting

Dynamic (In)Consistency
Homo economicus x2

Exponential discounting
x1
Lines dont cross
Utility

Time consistency

Time

Homo sapiens x2

Hyperbolic discounting x1
Utility

Lines cross
Dynamic inconsistency

Time

7
 Dynamic Inconsistency
and Failures of Self-Control
Do you really want that 4th bottle of beer?
At breakfast, no
x2 Nohangover,
11:30 PM at the bar, YES! Clearhead

BEER!
x1
Utility

Time

At breakfast At bar

Other Examples
Go to gym / sleeping in
Bringing lunch / buying lunch
Smoking / not smoking
Working / procrastinating
Saving for retirement / spending now
Staying up late / Go to bed early
Buying coffee / Making coffee

Examples of Vices
High price / low quantity / impulse buys
Liquor by the register
Candy by the register
Tabloids by the register
Candy in hotel rooms

Credit card interest rates

8
 How do we control ourselves to do
the right thing?
To decrease vicious behavior, raise the price:
Throw away cigarettes, scotch, ice cream
Alarm clock on other side of the room
Buy in smaller units
You pay more
Close coupling of cost with consumption
Additional ways, from earlier in the class:
Larger units, flat fees, indirect costs, and defaults:
Gyms, schools, book-of-the-month clubs
Pay for parks by taxes, not per use
Automatic deduction for 401k

Summary of Time Preferences

People do not naturally use NPV

People express hyperbolic, rather than

exponential, discounting
Magnitude effects
Delay/Acceleration asymmetry
Negative discount rates
Self-control and dynamic inconsistencies

Things to remember
People have really high discount rates, seem
to value immediate outcomes

Consumer patience is malleable:

More impatient for small amounts
Can even create negative discounting when
decision framed as sequence
More impatient when thinking about delaying
(rather than accelerating) consumption