Harris and Laibson - Dynamic Choices of Hyperbolic Consumers Flashcards
(19 cards)
What is hyperbolic discounting?
A time inconsistent preference patter where people discount the near future more steeply than in the distant future, leading to a higher discount rate than in the long term.
How does quasi hyperbolic discounting differ from standard exponential discounting?
Quasi-hyperbolic discounting uses a β-δ model where β (< 1) creates an immediate present bias, while δ represents standard exponential discounting thereafter. This creates time inconsistency absent in exponential discounting.
What is the β-δ model?
A mathematical representation of quasi-hyperbolic preferences where future utilities are discounted by βδ^t (for t > 0), with β representing present bias (β < 1) and δ representing long-run discounting
What is time inconsistency?
A situation where an individual’s preferences change over time such that what they prefer at one point in time is inconsistent with what they prefer at another point in time, even without new information.
What is the instantaneous utility function in Harris and Laibson’s model?
u(c), which is typically assumed to be CRRA (Constant Relative Risk Aversion) with form u(c) = c^(1-ρ)/(1-ρ), where ρ > 0 is the coefficient of relative risk aversion.
What is the consumption function in the Harris and Laibson model?
It describes the relationship between wealth and optimal consumption, taking into account both present bias and future selves’ behaviour.
What is the Euler equation in the hyperbolic model?
A modified version of the Euler Equation that accounts for present bias and strategic interactions between current and future selves.
What is a Markov Perfect equilibirum?
A set of strategies where each self optimises given the strategies of all future selves, with consumption dependent only on the current state (wealth).
What is the difference between naive and sophisticated consumers?
Naive consumers incorrectly believe tha their future selves will act according to their current preferences, while sophisticated consumers correctly anticipate their future selves’ present biased behaviour.
What is the “hyperbolic effective discount function”?
A mathematical representation combinigng the immediate discount factor (Beta) and the long run discount factors (Delta) that captures how hyperbolic consumers evaluate at different points in time
What is the buffer stock behaviour in the Harris-Laibson model?
Consumers maintain a target level of assets (buffer stock) as precautionary savings against income shocks, but hyperbolic discounting leads to lower buffer stocks than in exponential models.
How does present bias (beta less than 1) affect consumption?
It leads to higher consumption than would be optimal from a long-run perspective, resulting in lower savings and reduced lifetime welfare.
What is the impact of present bias on the MPC?
Present bias increases the MPC out of liquid wealth, making consumers more responsive to temporary income changes.
What happens to consumption as Beta approaches 1?
The model converges to the standard exponential discounting case, eliminating present bias and time inconsistency.
How does the Harris-Laibson model explain the excess sensitivity puzzle?
Hyperbolic discounters exhibit a higher marginal propensity to consume out of anticipated income changes than standard models predict, consistent with empirical evidence.
What policy implications arise from the model?
Support for commitment devices, illiquid savings vehicles, default options, and policies that “nudge” consumers toward higher savings rates.
How does liquidity affect consumption decisions of hyperbolic consumers?
Greater liquidity can reduce welfare for hyperbolic consumers by enabling present-biased overconsumption, explaining why consumers might prefer illiquid assets.
How does the model incorporate income uncertainty?
Through a stochastic income process, typically modeled as a diffusion process with Brownian motion, creating precautionary saving motives.
How is the model of hyperbolic discounting supported by empirical data?
Calibrtions shows that hyperbolic discounters accumulate 30-50% less wealth than exponential discounters.
