EC - 4394 - Week - 2 2 PDF

1
EC4394: Behavioral Economics

Week 2: Time Preferences - Present Bias
WANG Ao
National University of Singapore
1
These and future slides are partially based notes by Stefano DellaVigna, Lorenz
Goette, and Zhong Songfa. I would like to thank them, without implicating them in any
way, for sharing their materials with me.
Roadmap for Today
• Motivating Examples
Û Marshmallow & Film
Û Money Now vs. Later
Û Exponential vs. Hyperbolic Discounting
• Present-Bias Model (O’Donoghue and Rabin, 1999)

of self-control
→ Namely think the will not exist in
Û Predictions of Naivete
issues
Û Predictions of Sophisticated 7 future self

naivete
Û Commitment Device opposite of
.
etc
↳ binding hands of future self → cos you foresee fut self procrastinating
.
• Tutorial
Û Working Over Time (Augenblick et al., 2015)
Û Partial Naivete
Marshmallow & Film
• Children are given a marshmallow: eat now OR wait for 15 minutes to

get a second one.
• Children with better ability to delay instant gratification (wait) are
Û Psychologically better adjusted
Û More dependable persons
Û Scored significantly greater grades in the SAT
• Patience does seem to have a big impact on one’s life!
• If you are impatient, is that always what you want?
2 / 44
Marshmallow & Film
• An experiment by Read et al. (1999)

• Design: Choose among 24 movie videos
Û “low brow” (popular, entertaining): Four Weddings and a Funeral
Û “high brow” (educational): Schindler’s List
• Results
Û For tonight: 66% of subjects choose low brow.
Û For next Wednesday: 37% choose low brow.
Û For second Wednesday: 29% choose low brow.
• “Tonight I want to have fun... next week I want things that are good
for me”.
• You are impatient now, but you want your future self to be a
better self.
3 / 44
Roadmap for Today

Û Predictions of Sophisticated
Û Commitment Device
• Tutorial
Û Partial Naivete
Money Now vs. Later
like
you
so
late payment
/
6€ .
• Suppose that you are asked to state the equivalent late payment of
$100 early payment for each of the three cases.
1×15100
0/83*120
utility
=
:
Early payment Late payment Discount Factor

1 $100 today $120 30 days later 100/120 = 0.83
2 $100 5 days later $110 35 days later 100/110 = 0.91
3 $100 300 days later $105 330 days later 100/105 = 0.95
• Discount factor seems to be closer to 1 for distant dates

• Psychologically, the difference between day 300 and 330 is not as
much as the difference between today versus 30 days later.
4 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Exponential discounting
• Let xt denote the amount of payment you get in day t. Your utility
flow on day t is defined as u(xt ), where u(.) is your utility over
money.
• At day 0, your total discounted utility is
u(x0 ) + ”u(x1 ) + ” 2 u(x2 ) + ” 3 u(x3 ) + ” 4 u(x4 ) + ...

day
• Discount factor #
from the perspective of day-0 self: (1, ”, ” 2 , ” 3 , ” 4 ...)
• The discount factor between any adjacent periods is the same ”.
• 0<”<1, constant impatient over time
5 / 44
Exponential discounting
• What does this say about the classroom experiment?
Early payment Late payment

1 $100 today $x30 30 days later
2 $100 5 days later $x35 35 days later
3 $100 300 days later $x330 330 days later
• If you are sticking to this formula:
u(100) = ” 30 u(x30 )
” 5 u(100) = ” 35 u(x35 ) all 007=8%(1/35)

” 300 u(100) = ” 330 u(x330 ) ul 1003=83%(1/330)
• What is the relationship between x30 , x35 , x330 ? =
they r the same
6 / 44
Hyperbolic discounting
• Constant ” implies x30 = x35 = x330 !
• What we often observe: x30 > x35 > x330 ...
Û Let ”t denote the discount factor by postponing the payment in day

(t ≠ 1) to t.
u(100) = ”1 ”2 ...”30 u(x30 )
”1 ”2 ...”5 u(100) = ”1 ”2 ...”35 u(x35 )
”1 ”2 ...”300 u(100) = ”1 ”2 ...”330 u(x330 )
7 / 44
• Simplify the expression:
u(100) = ”1 ”2 ...”30 u(x30 )
u(100) = ”6 ”7 ...”35 u(x35 )

u(100) = ”301 ”302 ...”330 u(x330 )
• Since we observe x30 > x35 > x330 , we have
”1 ”2 ...”30 < ”6 ”7 ...”35 < ”301 ”302 ...”330
• Discount the first 30 days much more than discount some other 30
days (e.g. 301-330) in distant future!
• Be careful: smaller ” means discounting more!
8 / 44
• An example for formula that capture this idea (r > 0):
1 1 1 1
u(x0 ) + u(x1 ) + u(x2 ) + u(x3 ) + ...
1+0 1+r 1 + 2r 1 + 3r
• Discount factor between today and tomorrow is 1
ᵈ
1+r :
1
• Discount factor between tomorrow and the day after is 1+r
1+2r
1 = 1+2r
ᵗY%a¥gm
1+r
• 1 1+r
<
1+r 1+2r
less discounted
↑ btwtmv
drained
more
them
btwtdyt.rs
trrnmr
9 / 44
• An example for formula that capture this idea (r > 0):
1 1 1 1
u(x0 ) + u(x1 ) + u(x2 ) + u(x3 ) + ...
1+0 1+r 1 + 2r 1 + 3r
• Discount factor between today and tomorrow is 1

1+r
1
• Discount factor between tomorrow and the day after is 1+r
1+2r
1 = 1+2r
1+r
• 1 1+r
1+r < 1+2r
1
• In general 1+r 1+r 1+2r 1+3r
< 1+2r < 1+3r < 1+4r ...
• Can you prove this?
9 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Present-Bias Model: Formula
• The most popular formula is present-bias model.

Û Let xt denote the amount of consumption in day t. Your utility flow on
day t is defined as u(xt ), where u(.) is your utility function.
Û At day 0, your total discounted utility is

diet from
exponential .
"" discounting
2 3 4
u(x0 ) + —”u(x1 ) + —” u(x2 ) + —” u(x3 ) + —” u(x4 ) + ... model,
Std exponential
-
--
• Compared to standard economic model, the change is minimal diowuntis

is the B
— = 1 corresponds to the case of standard (exponential) discounting.
.
Û
Û Discount factor between today and tomorrow is —”
Discount factor between any adjacent days afterwards is still ”
I
Û
Û Hence the name, "present-bias"... discount more between present and
future, but constant discount factor between near and distant future
(the same as standard model)
•
vstmrisdiltofpobutatterthemtfisbyfaeto.cl
now
10 / 44
Present-Bias Model: Naivete
• This simple change yields surprising predictions on how people should

behave!
• Consider the following scenario: our essay assignment is due in week

13. It is already week 10. To meet the deadline, you have four choice
regarding when to write the essay: week 10, 11, 12, or 13.
• The disutility of writing the essay occurs when you are doing it, and is
3, 5, 8, 12 for week 10, 11, 12, 13 respectively.
(3) (5) (8) and
Û Cost increases over time because you may get overwhelmed as the final
projects of other courses are approaching.
a-
• Goal: minimize disutility!
11 / 44
Week of finishing 10 11 12 13
Cost 3 5 8 12
• For simplicity, assume ” = 1 (you are patient and do not discount

future more beyond next week)
• Suppose you are not present-biased (— = 1).
• What do you think when you are in week 10?
Week of finishing 10 11 12 13 7 :*
discounting
Discounted Cost 3 5” = 5 8” 2 =8 12” 3 = 12
• You will do it in week 10!
12 / 44
Cost 3 5 8 12

Discounted Cost 3 5 8” = 8 12” 2= 12
13 / 44
Cost 3 5 8 12

Discounted Cost 3 5 8 < 12” = 12
14 / 44
Now looking at present -

biased agent
Cost 3 5 8 12
• Suppose you are present-biased (— = 0.5), but do not discount future

very much (” = 1).
wk 10 the cost is
• What do you think when you are in week 10? in immediate
,
Discounted Cost 3 5—” = 2.5 8—” 2 = 4 12—” 3 = 6
05thmediate
• You will not do it in week 10, instead plan to do it in week 11.
15 / 44
Cost 3 5 8 12

Discounted Cost 3 5 8—” = 4 12—” 2 = 6

_
16 / 44
Cost 3 5 8 12

Discounted Cost 3 5 8 12—” = 6
17 / 44
Present Bias: Naivete
• Compare exponential discounting (” = 1, — = 1) with naive

present-biased discounting (” = 1, — = 0.5) in this essay writing
example:
Û Both have the same long-run discounting utility (” = 1), do not
discount more beyond tomorrow.
Û Exponential discounting guy always does the job immediately, whenever
it get a chance.
Û Present-biased guy plan to do it next week, but never did it until
deadline.
Û Hence the name, "naivete": the present-guy naively thinks he will do it
next week, but delay his action (change the plan) again and again!
Û Hence we also refer to those who possess present-biased preferences as
having self-control problem. ← they cannot control their future self
-
• In other words, naive present-biased guy mistakenly believe that he

will use standard economic model (exponential discounting) to make
decisions in the future.
18 / 44
Present Bias: Naivete Revise! ! ! Benefit &wH .
☆
• Not every place in the world has deadlines as fail-safe though...may have more
adverse oonseq
• Coming back to the gym example. You can choose to or not to go for
.
the next three days.

• If you go, you will get tired and experience disutility of 10 that day,
but enjoy incrementally improved physical and mental health of 18
-
the next day. Dayt Dayttl

disunity :O -5×10 0-5×18 diswuntthebevetit
• If — = 0.5, ” = 1, would you ever exercise? No: 0.5*18 < 10
• Would you ☐ plan to exercise tomorrow? Yes: 0.5*18 > 0.5*10
(both cost & benefit is
future south
in the
discount both
19 / 44
Present Bias: Naivete
• This could be even more harmful.
• If today I am selling a gym membership for the next three days, where
the amount payable results in a immediate disutility of 10, would you
purchase the membership?
Û Yes! You believe yourself will attend the next three days because
discounted benefit exceeds discounted cost (weight of both is — = 0.5).
Û The utility of exercising in the next three days:
-
≠10—” + 18—” 2 ≠ 10—” 2 + 18—” 3 ≠ 10—” 3 + 18—” 4 = 12, larger than

the cost of membership.
• Would you use the membership properly, as planned?
benefit is still delayed
Û When each future day comes, you choose not to go because
≠10 + 18—” < 0. is sunk v4 & exit
once you
pay membership fee it
,
the process
• Naivete is exploited! (Do not come in none of the next three days)
• Empirical evidence will be discussed next week.
20 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Present-Bias: Sophisticated
• Most of us are present-biased, this is who we are. We can’t change

our own —.
mitigation
• Some people outsmart others by recognizing their self-control
problems, and that their future self is not entirely reliable.
21 / 44
• Most of us are present-biased, this is who we are. We can’t change

our own —.
• Some people outsmart others by recognizing their self-control
problems, and that their future self is not entirely reliable.
• We use —ˆ to quantify such sophistication, let — Æ —ˆ Æ 1 its
• Right now at day 0 your preferences is: means
-
-
later reduces
U = u(x0 ) + ☐ 2 3
—{”u(x1 ) + ” u(x2 ) + ” u(x3 ) + ...}
present
• she believes that her future self at any day t Ø 1 has the following ;
↳ preferences:
What your current hinbyuutfmdo
.
ˆ 2 3 I
U = u(xt ) + —{”u(x t+1 ) + ” u(xt+2 ) + ” u(xt+3 ) + ...}
/
↳ inthefutwhethwhevenow.tw .
_
21 / 44
• she believes that her future self at any day t Ø 1 has the following
preferences:
ˆ
U = u(xt ) + —{”u(x 2 3
t+1 ) + ” u(xt+2 ) + ” u(xt+3 ) + ...}
• If you are naive, —ˆ = 1. c- WHY ? ?

• Sophisticated: you understand perfectly about your future self, who
will have the same preferences as you do (—ˆ = —)
• What is the effect of such sophistication?

• Now you know that your tomorrow self will procrastinate as much as
your current self (membership? no thanks)
22 / 44
• she believes that her future self at any day t Ø 1 has the following
preferences:
ˆ
U = u(xt ) + —{”u(x 2 3
t+1 ) + ” u(xt+2 ) + ” u(xt+3 ) + ...}
• If you are naive, —ˆ = 1.

• Sophisticated: you understand perfectly about your future self, who
will have the same preferences as you do (—ˆ = —)
• What is the effect of such sophistication?

• Now you know that your tomorrow self will procrastinate as much as
your current self (membership? no thanks)
• How about the example of essay writing? How does it work in the
economic modeling?
22 / 44
• Backward induction: sophisticated starts by thinking about whether

their future self would betray themselves, so that they can make
(informed) plan accordingly.
Cost 3 5 8 12
Û Your preferences — = 0.5, ” = 1
Û Your (correctly) believe that future self will act according to —ˆ = 0.5.
Û Your week-10 self starts by thinking about the last week.
Discounted Cost 3 5 8 12
Û You will do it if it ever progresses to week 13.
23 / 44
Present-Bias: Sophiticated

Cost 3 5 8 12
Û Your week-10 self then thinks about week 12.
Discounted Cost 3 5 8 ˆ
12—” = 6
Û Your week-12 self will not do it and wait until week 13.
24 / 44

Cost 3 5 8 12
Û Your week-10 self then thinks about week-11.
Û Week-11 self knows that week-12 will do nothing!
Discounted Cost 3 5 ˆ
8—” = 4 ˆ
12—” 2 = 6
Û Your week-11 will do it.
25 / 44

Cost 3 5 8 12
Û Your week-10 self finally thinks about now, knowing that week-11 self
will do it if you procrastinate.
Discounted Cost 3 5—” = 2.5 ˆ
8—” 2 = 4 ˆ
12—” 3 = 6
Û Your week-10 self will wait.
26 / 44
• Take away: sophistication (i.e. correctly anticipate future self’s

behavior) induces you to finish the essay at an earlier date, despite
the present-bias preferences!
• This result reflects something general: regardless of the numeric value

of cost, sophisticated always take action no later than naifs.
• Intuition:
Û Sophisticated understand that if she doesn’t do it now, she will only be
able to do it at some (not all) days in the future.
Û This constraint makes doing the task in the future (weakly) less
attractive.
• Explore more of this in the problem set.
27 / 44
• Does the knowledge of future self always make you better off?
• It is Wednesday. This week, you can watch one of the movies played
at the theater.
• Your utility from watching the movies played on Wednesday,

Thursday, Friday, Saturday is 3,5,8,12 respectively.
• — = 0.5, ” = 1.
• If you are naive, when will you watch a movie? Now .
wed sat
d§wunkÉ5
utility Thur Fri
costs 3 5 8 12
28 / 44
☆☆
• Does the knowledge of future self always make you better off?
• It is Wednesday. This week, you can watch one of the movies played
at the theater.

• — = 0.5, ” = 1.
• If you are naive, when will you watch a movie?
• Wed self - utility of watching on Wed, Thur, Fri, Sat is 3, 2.5, 4, 6, so
wait
• Thur self - utility of watching on Thur, Fri, Sat is 5, 4, 6, so wait
• Fri self - utility of watching on Fri, Sat is 8, 6, so watch on Friday!
28 / 44

• — = 0.5, ” = 1. You believe future self will use same present-bias
model (—ˆ = 0.5) to make decisions. When will you watch a movie?
29 / 44

Û If it is Sat, of course you watch the movie.
29 / 44

Û If it is Fri, the utility of watching on Fri and Sat is 8 and 6. So
watching on Fri. why?
Huh
29 / 44

watching on Fri.
Û If it is Thur, the utility of watching on Thur, Fri is 5, 4. Sat is
irrelevant because you will do Fri you don’t do it now, so it is better to
watch on Thur.
29 / 44

watching on Fri.
Û If it is Thur, the utility of watching on Thur, Fri is 5, 4. Sat is
irrelevant because you will do Fri you don’t do it now, so it is better to
watch on Thur.
Û If it is Wed, the utility of watching on Wed, Thur is 3, 2.5. Watching
Fri and Sat is infeasible, so you will watch on Wed.
29 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Present-Bias: Commitment Device
• Could sophisticated help themselves?

• They know that future self will not act as their current self wish.
30 / 44

• Potential solution: bind the hands of their future selves (commit to

the plan of present self beforehand!)
30 / 44

• Potential solution: bind the hands of their future selves (commit to

the plan of present self beforehand!)

• — = 0.5, ” = 1, —ˆ = 0.5
• It is Tuesday. You want to bind the hands of future self.
30 / 44

• — = 0.5, ” = 1, —ˆ = 0.5
• On Tuesday, you ask your friends to watch the Saturday movie
together!
• If you watch other movies without friends, you can only get 70% of
the utility because you upset your friends.
• Which movie would you watch?
31 / 44

• — = 0.5, ” = 1, —ˆ = 0.5
together!
Û If it is Sat, you will watch.
31 / 44

• — = 0.5, ” = 1, —ˆ = 0.5
together!
Û If it is Fri, the utility of watch on Fri and Sat is 5.6 and 6, so you will
wait.
31 / 44

• — = 0.5, ” = 1, —ˆ = 0.5
together!
wait.
Û If it is Thur, the utility of watch on Thur and Sat is 3.5, 6, so you will
wait.
31 / 44

• — = 0.5, ” = 1, —ˆ = 0.5
together!
wait.
wait.
Û If it is Wed, the utility of watch on Wed and Sat is 2.1 and 6, so you
will also wait!
31 / 44
• If finding friends to watch movies is costly - you loss 1 unit of utility

on Tue. Would you still do it?
32 / 44

Û If you do it, total discounted utility is ≠1 + — ú 12 = 5

Û If you don’t it, total discounted utility is — ú 3 = 1.5
32 / 44

Û If you do it, total discounted utility is ≠1 + — ú 12 = 5

Û If you don’t it, total discounted utility is — ú 3 = 1.5
• You are willing to pay to bind your future self!
• More examples of commitment device next week.
32 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Working Over Time: Setup
• Experiment: complete a tedious task in three weeks.
• Week 1: Plan on how much transcription boxes to finish in Week 2

(ê
o_O
2 ) and Week 3 (ê3 ) yourplan nrlbmding
-
• Week 2: Actually transcribe some Greek letter box (e2ú ), and leave the
rest to Week 3 (e3ú ). * ← actually did
33 / 44
• To earn the reward at the end of this experiment, the number of

tables finished in week 2 (e2 ) and week 3 (e3 ) must meet a minimum
E:
Lworkload e2 + Re3 = E
where R is specified by the experimenter:
Û R < 1: Easier to complete the task in week 2. Better to learn calculus

in the first year of your college!
Û R > 1: Easier to complete the task in week 3. Better to learn
l%fFY¥y
behavioral economics in the third or fourth year of your college!
Û R = 1: Total number of tables to be finished fixed regardless of timing.
dueto tired etc
if R < I ← canbe
eg
R> I ← could be dueto red efficiency
34 / 44
• The experimenters ask five values of R (R = 0.5, 0.75, 1, 1.25, 1.5)
35 / 44
• Subjects minimize the cost of effort. The disutility of transcribe e

tables in each period is e “ (“ > 1).
• For the week-1 self, the disutility of working in week 2 and 3 is
—”e2“ + —” 2 e3“
• Let ê2 denote the work week-1 self plans to do on week 2.

• For the week-2 self, the disutility of working in week 2 and 3 is
e2“ + —”e3“
• Let e2ú denote the work week-2 self actually does week 2.
36 / 44
Working Over Time: Result
• Find out what ê2 and e2ú are, as a function of R.
37 / 44

E
Û ê2 = “
≠ 1
1+R “≠1 ” “≠1
E
Û e2ú = “
≠ 1
1+R “≠1 (—”) “≠1
• If there is no present bias (— = 1), which is larger, ê2 or e2ú ? Does the
value of R affect your answer?
37 / 44

E
Û ê2 = “
≠ 1
1+R “≠1 ” “≠1
E
Û e2ú = “
≠ 1
1+R “≠1 (—”) “≠1
• If there is present bias (— < 1), which is larger, ê2 or e2ú ? Does the
37 / 44

E
Û ê2 = “
≠ 1
1+R “≠1 ” “≠1
E
Û e2ú = “
≠ 1
1+R “≠1 (—”) “≠1
• If there is present bias (— < 1), which is larger, ê2 or e2ú ? Does the
• How to test from data whether — = 1?
37 / 44
Working Over Time: Results
• Vertical axis: effort in week 2; Horizontal axis: value of R

Û Diamond: ê2 ; Square: e2ú
• What can we conclude from this graph?

38 / 44
Working Over Time: Design
• If we only observe people’s actual effort in week 2, but not people’s

plan in week 1, would it be possible for us to test present bias?
• If not, would more values of R make up for it?
39 / 44

• Think about the following scenario, where (—1 , ”1 ) = (0.8, 1) and

(—2 , ”2 ) = (1, 0.8)
• Can you tell from people’s actual effort alone which pair of numbers
fit the data better?
39 / 44

• Think about the following scenario, where (—1 , ”1 ) = (0.8, 1) and

(—2 , ”2 ) = (1, 0.8)
• Can you tell from people’s actual effort alone which pair of numbers
fit the data better?
• Can you come up with other numerical examples which yield

equivalent outcomes in terms of people’s actual effort in week 2?
39 / 44
• Suppose we do observe both people’s planned effort for week 2 and

actual effort for week 2. But the experimenter only ask for one value
of R: R = 1.
• Is it possible to test present bias (i.e. — = 1)?
40 / 44

of R: R = 1.
• Is it possible to estimate the value of “, — and ” jointly?
40 / 44

of R: R = 1.
• Is it possible to estimate the value of “, — and ” jointly?
• How about two values of R? Three? Four?
40 / 44
Working Over Time: Commitment Device
• If in week 1, you want to make sure that your future self does not
shirk, what could you do?
41 / 44
Working Over Time: Commitment Device
• If in week 1, you want to make sure that your future self does not
shirk, what could you do?
• Which do you prefer, your planned effort ê2 or your actual effort e2ú ?
• Left graph is for people who NOT prefer a rigid plan in week 1, right
graph is for people who prefer a rigid plan in week 1, what can we
conclude?
41 / 44
Roadmap for Today

• Tutorial
Û Partial Naivete
Partial Naivete & Commitment Device

• — = 0.4, ” = 1, —ˆ = 0.5
Û You know your future self has self-control problems, but you
underestimate it!
together!
42 / 44

• — = 0.4, ” = 1, —ˆ = 0.5
underestimate it!
together!
42 / 44

• — = 0.4, ” = 1, —ˆ = 0.5
underestimate it!
together!
Û If it is Fri, you *think* the utility of watch on Fri and Sat is 5.6 and 6,
so you will wait.
42 / 44

• — = 0.4, ” = 1, —ˆ = 0.5
underestimate it!
together!
so you will wait.
wait.
42 / 44

• — = 0.4, ” = 1, —ˆ = 0.5
underestimate it!
together!
so you will wait.
wait.
Û If it is Wed, the utility of watch on Wed and Sat is 2.1 and 6, so you
will also wait!
42 / 44
• If finding the right friends cost 3 unit of utility on Tuesday, will you
act?
Û Find friends: — ú 12 ≠ 3 = 1.8
Û No friends: — ú 3 = 1.2
ˆ you find friends. Will it work?
• So based on —,
43 / 44
act?
43 / 44
act?
Û If it is Fri, the utility of watch on Fri, Sat is 5.6 and 4.8, so you will
*actually watch*.
43 / 44
act?
*actually watch*.
Û If it is Thur, the utility of watch on Thur, Sat is 3.5, 4.8. You do not
believe you will watch on Fri because —ˆ = 0.5. So you will wait
43 / 44
act?
*actually watch*.
Û If it is Thur, the utility of watch on Thur, Sat is 3.5, 4.8. You do not
believe you will watch on Fri because —ˆ = 0.5. So you will wait
Û If it is Wed, the utility of watch on Wed, Sat is 2.1, 4.8 (you do not
believe watching on Thur and Fri). So you will also wait!
43 / 44
• You find friends, but in the end you did not watch the movies with
them.
44 / 44
them.
• Actually, your total utility for Tue self is
— ú 70% ú 8 ≠ 3 < 0
• This is less than the case of no commitment device (no friend):
— ú 3 = 1.2
44 / 44
them.
• Actually, your total utility for Tue self is
— ú 70% ú 8 ≠ 3 < 0
• This is less than the case of no commitment device (no friend):
— ú 3 = 1.2
• Commitment device could hurt: partial awareness induces take-up,

but in the end you fail the commitment and lose utility because you
underestimate the extent of self-control problem.
44 / 44

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EC4394: Behavioral Economics

• Present-Bias Model (O’Donoghue and Rabin, 1999)

Û Predictions of Sophisticated 7 future self

• Children are given a marshmallow: eat now OR wait for 15 minutes to

• Patience does seem to have a big impact on one’s life!

• If you are impatient, is that always what you want?

• An experiment by Read et al. (1999)

• Present-Bias Model (O’Donoghue and Rabin, 1999)

Early payment Late payment Discount Factor

• Discount factor seems to be closer to 1 for distant dates

• Present-Bias Model (O’Donoghue and Rabin, 1999)

• At day 0, your total discounted utility is

u(x0 ) + ”u(x1 ) + ” 2 u(x2 ) + ” 3 u(x3 ) + ” 4 u(x4 ) + ...

• What does this say about the classroom experiment?

Early payment Late payment

• If you are sticking to this formula:

” 5 u(100) = ” 35 u(x35 ) all 007=8%(1/35)

• Constant ” implies x30 = x35 = x330 !

• What we often observe: x30 > x35 > x330 ...

Û Let ”t denote the discount factor by postponing the payment in day

• Simplify the expression:

u(100) = ”1 ”2 ...”30 u(x30 )

u(100) = ”6 ”7 ...”35 u(x35 )

”1 ”2 ...”30 < ”6 ”7 ...”35 < ”301 ”302 ...”330

• An example for formula that capture this idea (r > 0):

• Discount factor between today and tomorrow is 1

• An example for formula that capture this idea (r > 0):

• Discount factor between today and tomorrow is 1

• Present-Bias Model (O’Donoghue and Rabin, 1999)

• The most popular formula is present-bias model.

Û At day 0, your total discounted utility is

• Compared to standard economic model, the change is minimal diowuntis

• This simple change yields surprising predictions on how people should

• Consider the following scenario: our essay assignment is due in week

• Goal: minimize disutility!

• For simplicity, assume ” = 1 (you are patient and do not discount

• You will do it in week 10!

• For simplicity, assume ” = 1 (you are patient and do not discount

• You will do it in week 11!

• For simplicity, assume ” = 1 (you are patient and do not discount

• You will do it in week 12!

Now looking at present -

• Suppose you are present-biased (— = 0.5), but do not discount future

• Suppose you are present-biased (— = 0.5), but do not discount future

• You will not do it in week 11, instead plan to do it in week 12.

• Suppose you are present-biased (— = 0.5), but do not discount future

• You will not do it in week 12, instead plan to do it in week 13.

• Compare exponential discounting (” = 1, — = 1) with naive

• In other words, naive present-biased guy mistakenly believe that he

the next three days.

the next day. Dayt Dayttl

• This could be even more harmful.

≠10—” + 18—” 2 ≠ 10—” 2 + 18—” 3 ≠ 10—” 3 + 18—” 4 = 12, larger than

• Present-Bias Model (O’Donoghue and Rabin, 1999)

• Most of us are present-biased, this is who we are. We can’t change

• Most of us are present-biased, this is who we are. We can’t change

• If you are naive, —ˆ = 1. c- WHY ? ?

• What is the effect of such sophistication?

• If you are naive, —ˆ = 1.

• What is the effect of such sophistication?

• Backward induction: sophisticated starts by thinking about whether