Behavioural Economics (Spring 2020) : HD and Commitment HD in The Field Tutorial

From L4 Commitment Neuroeconomics HD Example 1 Commitment Example 1 Commitment Example 2 Tutorial
23005 Behavioural Economics

(Spring 2020)
Lecture V
HD and Commitment
HD in the field
Tutorial
Andrea Giovannetti
andrea.giovannetti@uts.edu.au
Office Hour: Fri (10:30-11:30) / Zoom: 871213666
Tutorial 1 (11am): 96814181523
Tutorial 2 (12am): 99495181512 1 / 35
Battleplan:
1. EFS
I Thanks!!
I Tragedy of time
I Tragedy of medium
I Tragedy of life
2. Short recap from L4

3. Commitment1
4. Empirical Examples of Hyperbolic Discounting2
5. Tutorial I (in class): Hyperbolic Discounting and commitment
6. Tutorial II (with Luz): The magic of consistency of Inter-temporal
consumption in ED
1
Cartwright (Chapter 4, focus on 147-152), Dhami (Chapter 11.2-11.3, challenging: examples with models with dynamic
optimization, Chapter 11.5)
2
D. Laibson and S. DellaVigna series in ”Psychology and Economics”
2 / 35
How to tackle Tutorial of L5

◦ PS1 seems OK! So I won’t put in future PS or exams numerical exercises on
intertemporal consumption of the type we’ll see today in tutorial II
◦ Features a typical ”research-grade” (i.e. workhorse in current research in Academia /
Private) ED inter-temporal consumption problem: 3 periods + budget constraint.
What is not consumed in one period will be saved (with positive interest rate) and
consumed in future periods.
◦ We study the model because it is extremely useful for other courses (especially
macro) and many jobs
Key ideas:
◦ Consistency of ED: agent assesses the optimal intertemporal consumption orbit in
period 0 and doesn’t deviate from that orbit as he goes through periods.
◦ The sense of the Tutorial is to verify the above.
◦ Why handy? Because with one single optimization we can determine life-time
consumption orbit without caring of per-period decisions! (hence, math simplifies
massively)
3 / 35
1. If something doesn’t add up don’t stress out!

2. Send an email, and/or:
3. For communications: Make use of the anonymous suggestion box in: Subject
Documents / Suggestion Box
I For (anonymous) comments and feelings that do not require 1:1 interaction and
only I can read
I Example: ”I would like clearer definitions”, ”I liked example x, can we use it to
explain y?”
4. For interaction: (Anonymous) forum in: Subject Documents / Agora
I To share thoughts
I To talk about specific issues. Multilateral conversation is very beneficial,
everybody can join!
I Example: ”I don’t understand why we put (t) under DU (by xx)”, ”we use it because
blabla (by yy)”, ”oh I see, then blabla (by xx)”, So, this is why we also blabla? (by
zz)....
3 / 35
From L4...
Hyperbolic Discounting - Solution cookbook
Naive Agent: (forward reasoning)
1. Start from date 0
2. Solve for the optimal action given all the possible subsequent histories
3. Move to next step
4. Iterate
Sophisticated Agent: (backward reasoning)

1. Start from last date
2. Look for the optimal action
3. Go back 1 step and solve for optimal action accounting for the payoff obtained in (2)
4. Iterate
4 / 35
Important: Sophisticated doesn’t mean Optimal!!

◦ In L4 fines example, agents minimize disutility. Sophisticated achieved better result.
◦ Consider instead the case of maximization of positive utility.
Assume Chi and Daniel buy a frozen pizza each. Utility of consumption increases in
the time the pizza is heated. For both agents:
U(eat after 10 min) = 1, U(eat after 20 min) = 5, U(eat after 30 min) = 20
We assume again δ = 1 and β = 0.1.
Naive Daniel Sophisticated Chi
at t=10min: DU(30m) = 2 > U(10m) = 1 > DU(20m) = 0.5 (eat at 30m) at t=20m: DU(30m) = 2 < U(20m) = 5 (eat at 20m)
at t=20min: U(20m) = 5 > DU(30m) = 2 (eat at 20m) at t=10m: U(10m) = 1 > DU(20m) = 0.5 (eat at 10m)
Net gain: 5 Net gain: 1
◦ Daniel eats the pizza when 20m have passed. Better than what Chi does:
◦ Chi knows that if she fasts for 20m, she will not resist and eat the pizza. Therefore, when
she hits 10m, because she knows that if she does not eat the pizza when 10m are
passed she will certainty eat it after 20m, she decides to eat the pizza after 10m.
◦ General rule: Sophisticated agents take action no later than naive agents.
5 / 35
The mechanism
◦ Suboptimality of sophisticated with utility from action arises from two tensions:
(1) Chi understands she will not be able to wait for the best time to eat the pizza
(2) Furthermore, she craves due to β = 0.1.
◦ Then (1) and (2) imply she will take action at an earlier stage than the naive player
What’s the point of waiting if I know I will fail to stick to my plan...
◦ On the other hand, in the case of disutility (e.g. the fines), (1) + (2) allow Chi to reduce
the costs of procrastination
◦ I know I’ll be unable to stick to my plan, better I pay straight away!
Rule:
If deviation in future time makes more expensive to deviate today, then sophistication
avoids or reduces deviation along the whole sequence
If deviation in future increases the benefit from acting today, then sophistication in-
creases the likelihood of deviation by depressing the value of waiting
6 / 35
Commitment - General Idea
◦ Let’s get back to the Pizza example:
◦ Chi is aware that eating the pizza at 10m is suboptimal and wishes to eat it at 30m.
However, she knows that nothing will prevent her from eating at 20m
Hence, at 10m: D.U10 (eat at 20m) < U10 (eat at 10m) < D.U10 (eat at 30m):
| {z }
impossible
→ Since going for 30m is impossible, she goes for 10m
Such a pity! Chi understands her future inconsistency but nonetheless acts subopti-
mally! Let’s assume instead that at 10min Chi could commit not to eat the pizza at
20m (e.g. she asks Rupert to lock the oven’s door)
Then, at 10m: D.U10 (eat at 20m) < U10 (eat at 10m) < D.U30 (eat at 30m):
| {z }
now possible
→ Hence, with a commitment device, she will optimally wait until 30m
7 / 35
Early issues
Agents wish to use a commitment device if:

1. They would otherwise take the wrong course of actions
2. They take the right course of actions but end up with suboptimal outcome
Commitment and the psychology of agents:

◦ Suppose we are a Ghost Modeller who happens to stand in front of the bed of Daniel
and Chi at 6:00am on a stormy morning
◦ The Ghost Modeller hears and see:
Naive Daniel: ”6.00?? Let me have another 1m and I’ll get up, pleease.”
Outcome: Daniel gets up at 6 : 30
Sophisticated Chi: ”6.00?? Let me have another 30m. Indeed I shall have 1m at
most. But I know I will oversleep. No worries: at 6.30 I’ll freak and certainly get up.”
Outcome: Chi gets up at 6 : 30
(... spooky ...)

8 / 35
Early issues
◦ How would the ghost modeler interpret the above story:
I Both naive and sophisticated know it would be better to wake up after 1 m

I Sophisticated is aware that if she stays in bed, she will oversleep.
I Nonetheless at 0m she decides to stay in bed because her U function must be
something like:
1. For all t < 6 : 30:
U6:00 (get up at 6 : 00) < D.U6:00 ( get up later than 6 : 00)

...
...
2. At t = 30:
U6:30 (get up at 6 : 30) > D.U6:30 (get up af ter 6 : 30)
9 / 35
◦ However, there’s something more in the above speech: Chi doesn’t really like the idea
of procrastinating beyond 6:01.
◦ In fact, Chi said that it is a growing bad feeling that eventually pushes her out of bed at
6.30h
◦ Therefore, we may further characterize U so that something like the following applies:
For any t between 6:01 and 6:29:
D.Ut (get up at t + 2m) < Ut (get up at t) < D.Ut (get up at t + 1m)
◦ If the above holds, at t = 6 : 00 she must be relatively unsatisfied with the eventual
result of getting up at t = 30:
D.U0 (get up at 6.00 + 30m) < U0 (get up at 6.00) < D.U0 (get up at 6.00 + 1m)
◦ Hence, Chi may look for a device that shuts down the mechanism causing
procrastination.
◦ In this example the procrastination is caused by the following mechanism:
Ut (get up at t) < D.Ut (get up at t + 1m)
◦ Example of possible commitment device in this context?
10 / 35
Definition: ”A commitment device is a mechanism which locks yourself into a course

of action that you might not otherwise choose but that produces the desired result”
(S. Levitt, Freakconomics)
Properties:
1. The decision does not have any strategic purpose with respect to others.
2. The implementation is costly (otherwise the mechanism would be implemented in
first place)
3. Due to discounting, the implementation cost pt drops in t (i.e. the value of
commitment drops) as the agent approaches the moment in which he would
misbehave:
◦ Therefore, the agent evaluates whether to implement the device at t by comparing:
pt ≤ DUt [new action sequence|device] − DUt [action sequence| no device]
◦ Commitment devices may work through the following channels:

1. Artificially depress the value of the bad course of action
I Watch me!
2. Artificially increase the value of the optimal course of action
3. Forces the agent in maintaining the optimal course of action (e.g. think of the
myth of Ulysses and the Sirens!)
11 / 35
Commitment in non-directly-related-to-economics domains
12 / 35
Further examples:
◦ FreedomT M is the cornerstone of internet restriction programs. Set the $10 program
and you’ll be barred from surfing the net for up to eight hours at a time. It Claims to have
more than 100,000 users.
◦ Cell phones that block numbers after midnight
◦ Freezing credit cards in blocks of ice
◦ forced or automatic saving (Social Security)
◦ Setting rules
13 / 35
◦ To some extent, as members of capitalistic (t = $) societies, we are all aware of the

anomalies in time preferences discussed so far.
◦ Irrational behaviour induce costly deviations we can easily metricize
◦ I present a set of empirical results which allow us to frame hyperbolic discounting in
real-life policy relevant problems
14 / 35
◦ First, we need to understand whether a problem can be looked at under the lenses of
hyperbolic discounting
◦ There are ways to identify hyperbolic discounters
Signals of HD in experimental settings

I Cognitive Neuroscience + Economics = Neuro-economics: brain imaging (PET,
EEG, fMRI) can be used to link brain metabolism and decision making
I Not the focus of this module. We will go through a couple of facts shortly.
Signals of HD in natural setting

1. Look for joint evidence of impatience in the ”now” domain and patience in the
”future” domain
I Naivety is signaled by repeated mis-prediction of future behaviors
I Sophistication is signaled by presence of (successful or unsuccessful)
commitment devices
Warning: ”Procrastination” = HD: also exponential discounters can have appetite
for postponed effort and anticipated pleasure!
15 / 35
Physiological evidence of Time Inconsistency
◦ Key difference between ED and HD: the former presumes one single decision center in
the brain. The latter assumes two distinct evaluation systems which are alternatively
activated depending of how distant is the prospect from ”now”.
◦ McClure and coauthors (2004) isolated brain regions activated by generic

inter-temporal choices (i.e. δ region) and specific brain regions activated by present
choices (β region) using monetary rewards:
I Agents went through a series of problems involving inter-temporal substitution
I Some problems dealt with substitution between ”now” vs ”future”
I Other problems dealt with substitution between ”future” vs ”further in future”
◦ What is ”present” for our brain? Present measured in seconds (money right now) or
hours (money at end of experiment).
◦ Two distinct macro-areas emerge from fMRI scanning
16 / 35
δ-area: Postponed rewards
17 / 35
β-area: Immediate rewards
18 / 35
HD in natural setting: Organ Donations in Europe
◦ In the above group of EU countries people decide whether to donate their organs in
case of death following car accident
◦ Puzzle: Remarkable gap in % of organ donors: two blocks of countries appear. Why?
19 / 35
◦ Gray countries: opt-in policy. Green countries: opt-out policy.

◦ Typical example of Default Effect:
I Extreme yet common form of procrastination
I Agents perceive immediate cost of making choice (time, effort, money)

I Agents perceive the future benefit of their action
I Yet, when it comes to actually switch, they put it off even though cost is practically
zero since they believe they will switch in next period
I Consequently, people do not exert their right to choose once they are allocated
some options
◦ The Default effect is a common issue in several domains
◦ Policy makers can factor in such inertia for designing welfare-improving policies
◦ → E.g: Design better opt-in opt-out pension plans
20 / 35
◦ Gray countries: opt-in policy. Green countries: opt-out policy.

◦ Typical example of Default Effect:
I Extreme yet common form of procrastination
I β → 0, δ → 1
I Agents perceive immediate cost of making choice (time, effort, money)
I Agents perceive the future benefit of their action
I Yet, when it comes to actually switch, they put it off even though cost is practically
zero since they believe they will switch in next period
I Consequently, people do not exert their right to choose once they are allocated
some options
◦ The Default effect is a common issue in several domains
◦ Policy makers can factor in such inertia for designing welfare-improving policies
◦ → E.g: Design better opt-in opt-out pension plans
20 / 35
Commitment I
Motivation: Savings in the Philippines has stagnated. In the 1960s, the domestic savings rate was over 20%/GDP
(one of highest in Asia)
◦ At present, the country’s savings rate hovers between 12 and 15 percent - far below the level of savings for most East
Asian countries,
◦ Low savings contribute to slow growth. Studies showed Filipinos are consumption-oriented, with little desire or
capacity to save.
21 / 35
Methods: Ashraf, Karlan, and Yin (2006) offered a commitment savings product called SEED (Save, Earn, Enjoy
Deposits) to randomly chosen clients of a Philippine bank. SEED restricted access to savings for one year.
◦ Other than providing a possible commitment savings device, no further benefit accrued to individuals with this account
Result 1: 28.4% take-up rate of the two commitment protocols studies (either goal or time-based goal)
Result 2: Average savings balance increased by 42% after six months and by 82% after one year.
Result 3: More decision making power for women in the household, and increase in purchases of durable goods.
◦ Similar experiment run with Malawi farmers: SEED adopters able to buy 26% more seeds than control-group farmers
22 / 35
Commitment II
◦ Gine, Karlan, Zinman (2009) Tested a voluntary commitment product (CARES) for
smoking cessation.
◦ Smokers offered a savings account in which they deposit funds for six months, after
which take urine tests for nicotine and cotinine.
◦ If they pass, money is returned; otherwise, forfeited
◦ Results: 11% of smokers offered CARES take it up, and smokers offered CARES were
3 percentage points more likely to pass the 6-month test than the control group
◦ effect persisted in surprise tests at 12 months.
23 / 35
References cited in this Lecture

Ashraf, N., Karlan. D., Yin, W., Tying Odysseus to the Mast: Evidence From a
Commitment Savings Product in the Philippines, Quarterly Journal of Economics, 2006
Gine, Karlan, Zinman, Put Your Money Where Your Butt Is: A Commitment Contract for
Smoking Cessation, American Economic Journal: Applied Economics, vol 2, no. 4, 2010
Johnson, E., Goldstein, E., Do Default Save Lifes?, Nature, 302
McClure, S., Laibson, D., Loewenstein, G., Cohen, J., Separate Neural Systems Value
Immediate and Delayed Monetary Rewards, Science, 306
24 / 35
Inconsistent Time Preferences (based on Rocky II)
25 / 35
◦ During a boxing match On Sunday morning (t = 0) Apollo is humiliated by Rocky

◦ Apollo promises revenge for next Saturday’s match (t = 6).
◦ Rocky has to train hard for the rest of the week (t = 0, ..., 5) in order to win against
Apollo on t = 6.
◦ If Rocky wins, he earns Adriana’s kiss (worth $40) at t = 6. If he abandons even one
training session, he will be knocked down in next match and get instead a tin medal
(worth $3.64).
◦ Further, Rocky can start the training only on t = 0. In periods t = 1, ..., 5 he can either
(T)rain or (A)bandon training and once he abandons, he can’t go back training.
◦ Therefore, the feasible action plans are: AAAAAA, T AAAAA, T T AAAA,...,
T T T T T T A, T T T T T T T .
◦ Training costs are a combination of increasing linear costs in stamina depletion (valued
6 · $t) and quadratic adrenaline (valued −$t2 ) such that total costs are:
C(t) = 6 · t − t2
◦ Rocky is δ = 1 and β = 0.55
◦ Q.1 What would a naive Rocky do?

◦ Q.2 What would a sophisticate Rocky do?
◦ Q.3 Does it make sense to implement a commitment device?
26 / 35
Q.1 Naive Rocky - Solution

◦ Let’s compute the cost C(t) structure along the whole time-span:
t 0 1 2 3 4 5
cost 0 5 8 9 8 5
◦ At t = 0 Rocky compares the prospect of (A)bandon: DU0 [AAAAAA] ≈ 2 against the

one of (T)rain along all the week, that is:
5
!
X
D.U0 [T T T T T T ] = −C(0) + 0.55 40 − C(t) = −0 + 0.55(40 − 35) = 2.75
t=1
◦ Therefore, he will train3 on t = 0. Next, we compare U1 [T AAAAA] = 2 with:
5
!
X
D.U1 [T T T T T T ] = −C(1) + 0.55 40 − C(t) = −5 + 0.55(40 − 30) = 0.5
t=2
◦ Clearly, the naive Rocky will train only 1 period and get massacred on Saturday’s
match.
◦ Notice that from the t = 0 perspective, this implies a net payoff of: 2 − 0 = 2.
3
Formally, we should compare the above prospect with all the alternative prospects T AAAAA, T T A,..., yet, given
how the problem is devised, it’s clear that all other plans end in payoffs either equal to U0 [A] = 2 or are dominated by
TTTTTT
27 / 35
Q.2 Sophisticated Rocky - Solution

◦ At t = 0, Rocky anticipates that his t = 5 self will compare the prospect of abandoning training
DU5 [T T T T T A] = 2, against:
D.U5 [T T T T T T ] = −C(5) + 0.55 (40) = −5 + 0.55(40) = −5 + 22 = 17
◦ Hence, at t = 0 Rocky predicts that his period t = 5 self will train. Moving one step backward, he compares
DU4 [T T T T A] = 2 against:
D.U4 [T T T T T T ] = −C(4) + 0.55 (40 − 5) = −8 + 0.55 · 35 = 11.25
DU3 [T T T AAA] = 2 against:
D.U3 [T T T T T T ] = −C(3) + 0.55 (40 − 5 − 8) = −9 + 0.55 · 27 = 5.85
DU2 [T T AAAA] = 2 against:
D.U2 [T T T T T T ] = −C(2) + 0.55 (40 − 5 − 8 − 9) = −8 + 0.55 · 18 = −8 + 9.9 = 1.9
◦ Hence, at t = 0 Rocky predicts that his period t = 2 self will not train. This generates a cascade effect over the
remaining periods. Moving one step backward, he compares DU1 [T AAAAA] = 2 against:
D.U1 [T T AAAA] = −C(1) + 0.55 (2) = −5 + 1.1 = −3.9
◦ This implies that in period 0 he will compare no training at all DU0 [AAAAAA] = 2 with a even more pessimistic
prospect than the one considered by naive!
D.U0 [T AAAAA] = −C(0) + 0.55 (2) = 0 + 0.55 · 2 = 1.1 < U0 [AAAAAA] = 2
◦ Hence, the sophisticated Rocky will not train at all and get massacred on Saturday’s match.
◦ And pessimism due to his awareness of the consequences engendered by time inconsistency make things even
worst...
28 / 35
Q.3 Commitment - Solution

◦ Rocky doesn’t like the above outcome at all. He really wishes this story to be altered by
a tiny > 2 − 1.9 = 0.1
1. This can be done by either depressing the outside option: U2 [T T AAAA] ˆ =2−
¯ 2 [T T T T T T ] = 1.9 +
2. ... or by increasing the discounted utility of the prize DU
3. ... or by simply forcing himself through the optimal course of action no matter his disgruntling t = 1 and
t = 2.
◦ Let’s assume that at t = 0 Rocky hires his former manager and trainer Mickey. Mickey
will force Rocky to train also in period t = 2 and period t = 1.
◦ Hence, at t = 0 Rocky predicts that thanks to the commitment device, his period t = 2
and period t = 1 selfs will train.
◦ Now t = 0 Rocky anticipates that his t = 1 self will train. Going back one period, his
period t = 0 self will compare U0 [A] = 2 with:
D.U [T T T T T T ] = C(0) + 0.55 (40 − 5 − 8 − 9 − 8 − 5) = 2.75
◦ Which is aligned to the wishful training plan of the naive agent. Thence, Rocky will train
hard all the week, knock down Apollo on Saturday, and get his well deserved kiss.
29 / 35
◦ After the celebrations, Rocky suddenly realizes he would have had a much more
miserable fate without Mickey’s help.
◦ Therefore, Rocky decides to pay Mickey for his services.
◦ Q.3 What is the maximum premium which Ricky is willing to give Mickey for his support?
30 / 35
◦ The amount is bounded above by:
p0 ≤ DU0 [T T T T T T |mechanism in place] − U0 [AAAAAA| no mechanism]

| {z } | {z }
optimal course of action suboptimal course of action
◦ which is simply given by:

p0 ≤ 2.75 − 2 = 0.75
30 / 35
◦ The amount is bounded above by:
p0 ≤ DU0 [T T T T T T |mechanism in place] − U0 [AAAAAA| no mechanism]

| {z } | {z }
optimal course of action suboptimal course of action
◦ which is simply given by:

p0 ≤ 2.75 − 2 = 0.75
◦ Not a big prize for Mickey after all, but this is precisely the difference between the
discounted values of the two decision paths as evaluated at t = 0.
30 / 35
Tutorial:
Consistent Inter-temporal consumption in ED
Read-me !!
◦ PS1 went well, so I won’t put in future PS or exams numerical exercises on intertemporal consumption of the
caliber of the following tutorial.
◦ The exercise features a typical ”research-grade” (i.e. workhorse in current research in Academia / Private) ED
inter-temporal consumption problem: 3 periods + budget constraint. What is not consumed in one period will be
saved (with positive interest rate) and consumed in future periods.
◦ Why we study this model if we don’t examine it? First, we can appreciate the (technical) virtues of ED in a
high-grade situation. Second, it allows us to make very interesting comparison with HD modelling. Third, it’s
extremely useful for other modules (especially macro) and several jobs.
◦ The workout will be made available on blackboard
Key ideas:
◦ Consistency of ED: agent assesses the optimal intertemporal consumption orbit in period 0 and doesn’t deviate
from that orbit as he goes through periods.
→ The sense of the Tutorial is to verify the above.
◦ Why is ED handy? Because with one single optimization we can determine life-time consumption orbit without
caring of per-period decisions! (hence, math simplifies massively)
31 / 35
Standard Inter-temporal consumption problem

◦ Suppose at t = 1 you plan consumption of the next 3 years c1 , c2 , c3 . Liquid assets can
be invested and give certain return of (1 + r) after 1 period is passed
◦ Suppose there’s only one good in the economy and no price. Essentially, money can be
”consumed” or invested (think of money as seeds, or coconuts)
◦ Along these years, you also receive some income Y1 , Y2 , Y3 .
◦ You have a logarithmic utility over c and have behave like an exponential discounter.
1. Write the optimization problem faced at t=1 (Exp Disc.)
32 / 35

max log(c1 ) + δlog(c2 ) + δ 2 log(c3 )

c1 ,c2 ,c3
c2 c3 Y2 Y3
subject to : c1 + + ≤ Y1 + + ≡W
1+r (1 + r)2 1+r (1 + r)2
32 / 35

max log(c1 ) + δlog(c2 ) + δ 2 log(c3 )

c1 ,c2 ,c3
c2 c3 Y2 Y3
subject to : c1 + + ≤ Y1 + + ≡W
1+r (1 + r)2 1+r (1 + r)2
◦ Lifetime budget constraint. It implicitly assumes consumption and income can be freely
moved across dates
◦ It includes the present value at t = 1 of lifetime consumption and income
◦ With r = 0, all components are equally weighted. For very high r, we care little about
future consumption and income
◦ That is to say relevance of income / consumption in future reflects the opportunity cost of
saving at t = 1.
32 / 35
2. Find optimal c1 , c2 , c3
33 / 35
W W δ(1 + r) W (δ(1 + r))2

c1 = , c2 = , c3 =
1 + δ + δ2 1 + δ + δ2 1 + δ + δ2
33 / 35
W W δ(1 + r) W (δ(1 + r))2

c1 = , c2 = , c3 =
1 + δ + δ2 1 + δ + δ2 1 + δ + δ2
◦ Notice there are two forces in opposing directions:

1. Impatience: δ < 1 implies that that c1 > c2 > c3
2. Consumption smoothing: Diminishing marginal utility implies that a feast on
Monday and eating nothing on Tuesday is not as desirable as a normal lunch on
both days. So, rather than stacking all consumption in period 1, its better to
smooth consumption towards period 2 as well.
◦ Consumption is independent of the timing of income! Holding lifetime wealth constant,
the optimal (c1 , c2 , c3 ) is the same whether all income comes in t = 1, t = 2, t = 3 or
some mixture of the two.
If Y1 < c1 Consumer borrows to reach desired consumption
If Y1 > c1 Consumer saves and consumes more in the second and third period
33 / 35
This is the permanent income / life-cycle hypothesis: consumption should not ”track”
income.
◦ people consume out of expectations of ”lifetime income”, and hence transitory
(expected) income shocks should have no effect
◦ A higher income in period 1 should lead to higher consumption in all periods.
◦ Equivalently, it should yield the exact same desired consumption as if the (present-value
adjusted) income increase happened in period 2 or 3 instead.
34 / 35
3. Show that ED preferences are time-consistent
35 / 35
◦ We want to show for instance that: c3 = c23 (i.e. period 3 consumption as planned in
period 1 = period 3 consumption as planned in period 2)
◦ Tricky part: from the perspective of ED optimizing at t = 2, the lifetime W is no longer
the bound of the budget constraint.
◦ Instead, it must account for wealth residual from period 1 which is saved and accrues
interests (i.e. savings)
35 / 35
c23

Y3
c22 + ≤ (Y1 − c1 )(1 + r) + Y2 + = (W − c1 )(1 + r)
1+r 1+r
35 / 35
c23

Y3
c22 + ≤ (Y1 − c1 )(1 + r) + Y2 + = (W − c1 )(1 + r)
1+r 1+r
Therefore, the problem reads:
max log(c22 ) + δlog(c23 )

c2 2
2 ,c3
c23
subject to : c22 = (W − c1 )(1 + r) −
1+r
If computations are OK you should find that: c3 = c23 .
35 / 35

Behavioural Economics (Spring 2020) : HD and Commitment HD in The Field Tutorial

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Behavioural Economics (Spring 2020) : HD and Commitment HD in The Field Tutorial

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From L4 Commitment Neuroeconomics HD Example 1 Commitment Example 1 Commitment Example 2 Tutorial

23005 Behavioural Economics

2. Short recap from L4

How to tackle Tutorial of L5

1. If something doesn’t add up don’t stress out!

Sophisticated Agent: (backward reasoning)

Important: Sophisticated doesn’t mean Optimal!!

Naive Daniel Sophisticated Chi

What’s the point of waiting if I know I will fail to stick to my plan...

◦ I know I’ll be unable to stick to my plan, better I pay straight away!

Commitment - General Idea

◦ Let’s get back to the Pizza example:

→ Since going for 30m is impossible, she goes for 10m

Agents wish to use a commitment device if:

Commitment and the psychology of agents:

(... spooky ...)

◦ How would the ghost modeler interpret the above story:

I Both naive and sophisticated know it would be better to wake up after 1 m

1. For all t < 6 : 30:

U6:00 (get up at 6 : 00) < D.U6:00 ( get up later than 6 : 00)

U6:30 (get up at 6 : 30) > D.U6:30 (get up af ter 6 : 30)

D.Ut (get up at t + 2m) < Ut (get up at t) < D.Ut (get up at t + 1m)

Ut (get up at t) < D.Ut (get up at t + 1m)

◦ Example of possible commitment device in this context?

Definition: ”A commitment device is a mechanism which locks yourself into a course

pt ≤ DUt [new action sequence|device] − DUt [action sequence| no device]

◦ Commitment devices may work through the following channels:

Commitment in non-directly-related-to-economics domains

◦ To some extent, as members of capitalistic (t = $) societies, we are all aware of the

Signals of HD in experimental settings

Signals of HD in natural setting

Physiological evidence of Time Inconsistency

◦ McClure and coauthors (2004) isolated brain regions activated by generic

δ-area: Postponed rewards

β-area: Immediate rewards

HD in natural setting: Organ Donations in Europe

◦ Gray countries: opt-in policy. Green countries: opt-out policy.

I Agents perceive immediate cost of making choice (time, effort, money)

◦ Gray countries: opt-in policy. Green countries: opt-out policy.

References cited in this Lecture

Inconsistent Time Preferences (based on Rocky II)

◦ During a boxing match On Sunday morning (t = 0) Apollo is humiliated by Rocky

◦ Rocky is δ = 1 and β = 0.55

◦ Q.1 What would a naive Rocky do?

Q.1 Naive Rocky - Solution

◦ At t = 0 Rocky compares the prospect of (A)bandon: DU0 [AAAAAA] ≈ 2 against the

◦ Therefore, he will train3 on t = 0. Next, we compare U1 [T AAAAA] = 2 with:

Q.2 Sophisticated Rocky - Solution

D.U5 [T T T T T T ] = −C(5) + 0.55 (40) = −5 + 0.55(40) = −5 + 22 = 17

D.U4 [T T T T T T ] = −C(4) + 0.55 (40 − 5) = −8 + 0.55 · 35 = 11.25

D.U3 [T T T T T T ] = −C(3) + 0.55 (40 − 5 − 8) = −9 + 0.55 · 27 = 5.85

D.U2 [T T T T T T ] = −C(2) + 0.55 (40 − 5 − 8 − 9) = −8 + 0.55 · 18 = −8 + 9.9 = 1.9

D.U1 [T T AAAA] = −C(1) + 0.55 (2) = −5 + 1.1 = −3.9

D.U0 [T AAAAA] = −C(0) + 0.55 (2) = 0 + 0.55 · 2 = 1.1 < U0 [AAAAAA] = 2

Q.3 Commitment - Solution

D.U [T T T T T T ] = C(0) + 0.55 (40 − 5 − 8 − 9 − 8 − 5) = 2.75

◦ The amount is bounded above by:

p0 ≤ DU0 [T T T T T T |mechanism in place] − U0 [AAAAAA| no mechanism]

◦ which is simply given by:

◦ The amount is bounded above by:

p0 ≤ DU0 [T T T T T T |mechanism in place] − U0 [AAAAAA| no mechanism]

◦ which is simply given by:

Standard Inter-temporal consumption problem