Class notes
ECON0040 Weeks 4-5
- Course
- Institution
In depth notes on ECON0040 Weeks 4-5
[Show more]
Seller
Follow
zctpfru
Content preview
Weeks 4 and 5Intertemporal choice
Standard model - Exponential Discounted Utility (EDU) Model
Intro
• Samuelson (1937) proposed a discounted utility (DU) model
• The EDU has been accepted as a standard for public policy
Timeperiods te 0.1.2 tl
of
Temporalp rofile consumption C co ci
u tility
Discounted
É
at
uated discount
inI.n
instantaneous
We discount due to:
• Impatience
• Uncertainty about the future
• Memory utility- consuming sooner yields a longer time getting utility from memories
EDU
Discount
functionDlt 1,1 St
discount
disjoint factor
P 98 Ipresentvalue
Ucc
IIstop oh go gg
Properties:
• Constant discount rate
◦ The MRS between two periods t and t’ is DAY
Dlt
egDan S
Dct
• Integration of new alternatives into existing plans
◦ Suppose there are two consumption pro les C and C’
◦ The EDU maximiser will choose C over C’ i
UC Stuka StuG UIC
◦ Integration implies that a consumption choice is not evaluated in isolation, but against how it
would change consumption in all periods
• Utility independence
◦ Utility is the sum of all the discounted future utilities
◦ Individuals seek to maximise U(C)
◦ Therefore the time path of utility is irrelevant if the discounted sum is the same
• Consumption independence
◦ An individual's welfare in a time period is independent of consumption in any other period
◦ This rules out habit formation
• Stationarity
at ilytee a as gist
◦ ie. ranking of temporal payments depends only on the time distance and payment distance
between options
, ◦ This rules out changing tastes
• Time/ dynamic consistency
◦ The ranking of outcome-time pairs does not change depending on the the time period they
are asked in
Evidence against EDU
Declining discount rates
Plans made for the future tend to re ect more patience than choices made for the present
• Thaler, 1981 (1)
◦ One apple today two apples tomorrow
7
◦ One apple in 100 days two apples in 101 days
• Thaler, 1981 (2)
◦ Asked subjects to specify the amount of money they would require at various points in the
future to make them indi erent to receiving $15 now
◦ Median responses were $20 in 1 month, $50 in 1 year, $100 in 10 years
◦ By continuously compounding discount rates, he found median responses imply annual
discount rates of
‣ 345% for one month horizon
‣ 120% one year
‣ 19% ten year
• Friedrick et al, 2002
Preference reversal, dynamic inconsistency
1) Read et al., 1999
• Subjects asked to choose what lm to watch in 24hrs: high brow or low brow
• Advanced choices
◦ Day 1: 56% low brow
◦ Day 2: 37% low brow
◦ Day 3: 29% low brow
• Immediate choices
◦ Day 1: 58% low brow
◦ Day 2: 53% low brow
◦ Day 3: 56% low brow
• This shows time inconsistency, when the optimal decision at one point in time is no longer the
optimal choice at another point in time, causing preference reversals
◦ Reversed preferences because of a change in opportunity set rather than the passage of time
is not time inconsistency
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller zctpfru. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $9.68. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
79976 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now