Lecture 5 Time Preferences

Question 1

Intertemporal Choice

Answer 1

Decisions in which the timing of costs and benefits are spread out over time

Question 2

dicounted utility

Answer 2

In choices that involve a tradeoff between current and future outcomes people discount the future to some extent. People are impatient and earlier outcomes add more to their utility than later outcomes

Question 3

What are the three time preferences of the Homo Economicus

Answer 3

• Constant impatience over time
• No systematic time-inconsistence
• Exponentially discounts the future

Question 4

Why is the Exponential Discounting not a realistic model?

Answer 4

decreasing impatience -People are generally more willing to wait in the future than in the present

Self-control problems - People make plans for the future, but often do not behave accordingly

Question 5

Which two selves do we have?

Answer 5

The should self
The want self

Question 6

What are characteristics of the should self?

Answer 6

Planner: long-run optimizing
reasoning, system 2
comparison of options

Question 7

What are characteristics of the want self?

Answer 7

doer: short-run gratification
emotions, system 1
one-at-a-time evaluation

Question 8

present bias or immediacy effect

Answer 8

tendency to prefer a smaller instant reward over a larger later reward, and to reverse this preference when both rewards are equally delayed

Question 9

What are five ways to precommit yourself because of the dynamically inconsistent preferences and the meaning?

Answer 9

1. Cutting- off options -Making some options not possible anymore | Extreme
2. Hurdles - A problem you have to solve first before being able to progress
3. Bright-line rules - I no longer eat chocolate. Easy concrete rules
4. Delays - You have to wait, maybe after the time
5. Prearranged deals - Ok I will do this, but this in return

Question 10

What are two theories of Risky Choice?

Answer 10

Expected Utility Theory - Evaluation of final wealth states; stable risk preferences
Prospect Theorie - Evaluation of gains and losses; risk preferences depend on the reference point

Question 11

If people do not update their reference points, prospect theory lead to the two following predictions:

Answer 11

Break-Even effect: after losses, people tend to make more risk to achieve their reference point
House-Money Effect: after large gains, people are willing to take more risk, because losing “house money” does not hurt as much as losing “own money”