Time Preference & Inter temporal Choice

8/12/2019 Time Preference & Inter temporal Choice

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Intertemporal Choice:Applications

AE63 7Behavioral Economics for Policy Analysis


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Wertenbroch-Ariely (2002), Procrastination, Deadlines, andPerformance, Psychological Science.

Classroom experiment executive education students atMIT.

They had to write 3 papers in a semester for a particularclass.

Students were divided into 2 groups:

Group I: They were given evenly spaced deadlines

throughout the semester for those 3 papers.

Group II: They were free to set up their own deadlines.

Penalty for overdue paper same for both groups.

Wertenbroch-Ariely 2002)


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Group II: Own choices of deadlines.

Around 68% set deadlines prior to last week. There are only32% set deadlines on the last week.

People are willing to self-impose deadline to overcome

procrastinationdemand for commitment (sophistication).

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Results on completion and grades:

No late submissions.

Grades in Group I is higher than grades in Group II.

if students have self-control problems, and use

deadlines to overcome the problems, but do not set thedeadlines optimally greater flexibility may lead tolower grades.

Run another experiment: proofreading (finding errors/ typos)exercise over 21 days with 60 MIT students participated.

Group I: evenly-spaced deadlines

Group II: no deadlines

Group III: self-imposed deadlines



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Hypothesis:

People realize their tendency to procrastinate and wouldwant to bind (commit) themselves, however they face strongtemptationto set the deadline as late as possible as aresult the deadlines they set are suboptimal.

Predictions:

Time consistent: II=III>I

Sophisticatedtime inconsistent would want and fully able

to commit: III>I>II

Partially navetime inconsistent would want to commitbut not fully able to do so: I>III>II

Wertenbroch-Ariely 2002) Group I: evenly-spaced deadlines Group II: no deadlines

Group III: self-imposed deadlines


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Results on performance: I>III>II evidence of imperfectsophistication or partial navet.

Reason for partial navet? cognitive limitation?, or deliberatestrategy, or?

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Duflo, Kremer and Robinson (2009), Nudging Farmers to UseFertilizer: Theory and Experimental Evidence from Kenya.

Research question: Why there is so little adoption of fertilizerdespite the fact that applying limited quantities of fertilizer givelarge potential returns?

The paper looks at the effect of fertilizer in a poor area ofwestern Kenya, where farmers grow maize.

Farmers buy and sell maize on the market and store it at home.

Fertilizers are available for purchase at market center (30 min

walk).

Only 40% of farmers in their sample ever used fertilizer.

When asked overwhelmingly said that they want to usefertilizer but no money to buy it.

Duflo, Kremer and Robinson 2009)


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But their answer is puzzling

the fact is that:

Fertilizer can be bought in small quantity (1 kg).

Only small quantity is needed to fertilize.

The potential return is high generate sufficient funds to

buy fertilizer.

Even poor farmers in principle can re-allocate their harvestproceeds (some) from consumption to fertilizer investment.

Possible explanation: Farmers would like to purchase fertilizer,

but they run out of money by the time of the new season comesand fertilizer is needed self-control problem.

So they conducted field experimentsavings and fertilizerinitiative (SAFI) program.



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How does SAFI work?

A field officer visited farmers immediately after harvestoffered an opportunity to buy a voucherfor fertilizer at theregular price but with free delivery.

Farmers can decide whether or not to enroll and buy anyamount of fertilizer.

Farmers can pay either in cash or maize (at market price).

They also can sell the maize without enrolling.

The timing of adoption is left to farmers much like inWertenbroch-Arielys experiment.



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Result: significant effect on adoption


LR '

i 1 1i i iy =+ T + X +


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Ashraf, Karlan and Yin (2005), Tying Odysseus to the Mast:Evidence from a Commitment Savings Product in thePhilippines, Quarterly Journal of Economics.

A natural field experimentto test whether individuals wouldopen a savings account with a commitmentfeaturethat restrictstheir access to the funds but has no further benefits.

If individuals have time inconsistent preferences, they: 1)wouldhave an incentive to have a commitment device, and 2)end upsaving more.

They partnered with the Green bank of Caraga, a rural bank in

Mindanao1777 existing and former bank clients.

Procedures: Identify clients with hyperbolic (time inconsistent)

preferences with hypothetical time discounting questions.

Ashraf, Karlan and Yin 2005)


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Procedures: Choice between 200Pesosnowand XPesos in 1 month

near-term frame.

Choice between 200Pesos in 6 monthsand XPesos in 7

monthsdistant frame.



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Procedures: Result: evidence on hyperbolic-discounting type of

preferences

No gender difference in the degree of impatient.



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Procedures: Run 3 treatments:

SEED(Save, Earn and Enjoy Deposits) Treatment

(N=842)encouraged to save and offered SEEDaccount (a commitment device).

MarketingTreatment (N=466) encouraged to saveusing existing schemes, but not offered SEED account.

ControlTreatment (N=466) received noencouragement nor SEED account.

Comparison:

SEED vs Marketing Treatmentidentify the effect ofcommitment device on top of the encouragement.



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Procedures: Run 3 treatments:

SEED(Save, Earn and Enjoy Deposits) Treatment

(N=842)encouraged to save and offered SEEDaccount (a commitment device).

MarketingTreatment (N=466) encouraged to saveusing existing schemes, but not offered SEED account.

ControlTreatment (N=466) received noencouragement nor SEED account.

Analysis:

SEED vs Marketing Treatmentidentify the effect ofcommitment device on top of the encouragement.

Measure the effect on total savings.



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SEED treatment:

Out of N=842, 202 take up SEED.

167 also opted to get lock-up box (piggy bank) cannot observe savings there.

Results:



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Results on demand for commitment: Time inconsistent individuals more likely to take up SEED

demand for commitment.

Impatient female are more likely to take up SEED than

patient female insignificant for male.

Individuals with college education more likely to take upSEED.

Results on amount of savings:

Significant increase in savings after taking up SEED. It isinsignificant for other treatments.



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Laibson, Repetto and Tobacman 2010)

Laibson, Repetto and Tobacman (2010), Estimating DiscountFunctions with Consumption Choices over the Lifecycle(forthcoming AER).

Research Idea: Intertemporal preferences (and ) are difficult

to measure most rely on (lab) experimentsbut real world is

more complex than the lab

can we really use the lab estimateof and .

The paper: estimate time preferences with field data using a

two-stage Method of Simulated Moments (MSM) procedure structural estimation.

Objective: based on the estimates, which model (exponential orhyperbolic discounting) fit better?


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Laibson, Repetto and Tobacman 2010)

Data: wealth accumulation, credit card borrowing, income andconsumptionUS households (whose head has a high schooldegree only) 59% of population.

Stylized facts:

Low liquid wealth accumulation and substantial illiquidwealth.

Extensive credit card borrowing.

Consumption-income co-movementhigher income leadsto higher consumption, instead of saving.

Evidence seems to suggest that people face temptation to over-consume at present.


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Laibson, Repetto and Tobacman 2010) Other evidence:

76% of US households believe that they should besavingmore for retirement already out of these 6% report beingahead in their saving, while 55% report being behind.

Data:


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Laibson, Repetto and Tobacman 2010) Results:

estimated significantlybelow 1.

Reject =1 null hypothesis.

Specification tests rejectonly the exponential modelwealth accumulation


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Madrian and Shea 2001)Choi, Laibson, Madrian and Metrick 2004)

Self control problem (time inconsistency) in saving forretirement 401K Plan

What is 401K Plan?

Principal source of discretionary retirement savings in theUS.

Contributions taken out of each paycheck, and some firmsmatch employee contributions.

Contributions invested in mutual funds.

Penalties for early withdrawal.

Employees have a hard time carrying out the actions they saythey want to take.

From a survey, out of 100 employees, 68report saving toolittle, and 24out of 68 plan to raise401K contribution rate

in the next 2 months but only 3actually do so in the next4 months.


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Madrian and Shea 2001)Choi, Laibson, Madrian and Metrick 2004) Standard enrollment most companies require employees to

initiate 401K enrollment themselves (opt-in).

Welcome to the company. If you want to enroll in the 401Kcall this phone number. If you dont do anything, you will

not be enrolled in the 401K.

In contrastautomatic enrollment (opt-out).

Welcome to the company. If you dont do anything, you are

automatically enrolled in the 401K at 2% savings rate. Yourcontribution will go into a money market fund. Call thisphone number to opt out of enrollment or change yourinvestment allocations.


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Madrian and Shea 2001)Choi, Laibson, Madrian and Metrick 2004) Employees enrolled under the automatic enrollment cluster at

the default contribution rate.


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Participants stay at the automatic enrollment defaults for a longtime.

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Do workers like automatic enrollment?

In firms with standard 401K plans (no automaticenrollment), 2/3 of workers say that they should save more.

Opt-out rates under automatic enrollment are typically only

15% (opt-out rates rarely exceed 20%).

Under automatic enrollment employers report nocomplaints in 401K plans.

97% of employees in auto enrollment firms approve of auto

enrollment.

US government (Obamas administration) is about to adoptautomatic enrollment.



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Intermezzo: Singapore


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Benartzi and Thaler (2007), Heuristics and Biases in RetirementSavings Behavior,Journal of Economic Perspectives.

Idea: although automatic enrollment is good at overcomingself-control problem and increasing participation, participants

tend to stick with default contribution rateloss aversion

maybe the reason

how to increase contribution? BT came up with Save More Tomorrow (SMarT) program.

SMarT invites participants to commit themselves, inadvance, to a series of contribution increases align with payrises up to a maximum allowable contribution.

With this take home pay does not go down andparticipants do not view the increase in contribution aslosses.

Benartzi and Thaler 2007)


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Benartzi and Thaler 2007) First implementation of SMarT was in a midsized manufacturing

firm in 1998.

Financial advisor was hired to advise employees on saving rateand advisor typically recommended a 5% increase.

Employees are free to accept or not to accept the advice theywere offered SMarT plan with 3% auto increases in saving rate ateach subsequent pay rise.


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Benartzi and Thaler 2007) Results:


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Addiction Is addiction rational? or is it a self control problem (time

inconsistent preferences)?

Standard economic models argue that addiction is rational(Becker and Murphy, 1988).

Addiction is a forward looking consumption plan andindividual is pursuing utility maximization.

Addiction=a causal effect of past consumption on currentconsumption.

The addict knows exactly the impact of addictive substance,but decides to consume more and more (hooked) because

this is the consumption pattern that max his/ herdiscounted utility.

Past (current) consumption lowers current (future) utility,but raises current (future) marginal utility.


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Addiction Standard economic models argue that addiction is rational

(Becker and Murphy, 1988).

Example: A smoker consuming one cigarette now willreduce his health (reducing his future utility), but willincrease his desire to smoke tomorrow (habit formation).

Being hooked on smoking = a rational choicecomparisonof the benefit of smoking to the total discounted costs(health damages, monetary costs, etc).

Policy implicationinfluence the costs and (or) benefits an increase in cigarette taxes in the future will induce

smokers to cut their smoking today

because future costsof addiction gone up.

So smoking (or more generally, addiction) = rational forwardlooking behavior??


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Addiction Testing the rational theory of addiction: Does cigarette

consumption at t respond to future prices at t+1?

Becker, Grossman, Murphy (American Economic Review,1994) showed that future price increase (or credibleannouncement of price increase) lower currentconsumption.

Gruber and Koszegi (Quarterly Journal of Economics, 2001)showed some support to forward looking argument, but

also the present of time inconsistency (present bias) cannot separate them.

Levy (2009), revisit Gruber and Koszegi (2001) and foundsome evidence of present bias.

Gruber and Mullainathan (2006) use happiness data smokers and those with high propensity to smoke were

happier after cigarette taxes are raised rational response.


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Addiction Alternative theorypresent bias/ time inconsistency/ self-

controlODonoghue and Rabin (1997).

People consume addictive substances despite expressingdesire to quit.

People put attention to much on immediate gratification.They may wish to quit tomorrow, but when tomorrow comesthe temptation for immediate gratification is too strong andwill end up not quitting.

People may either be; sophisticate (fully aware of selfcontrol problems) may or may not quit, or nave (haveincorrect beliefs about their future behavior).

Policy implication: provide commitment devices forexample, smoking payment to stop smoking (Karlan, et.Al. 2008).


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Addiction Another New Alternative theoryCue-Conditioned Cognitive

Process

Bernheim and Rangel (American Economic Review,2009).

Other theories fail to explain important aspects of addictivebehavior.

Cognitive mechanisms (attention and mistakes), which

determine how an individual thinks about a decision,determine behavior (and choice) entirely apart frompreferences.

Addicts often describe their choices as mistakesthis factcannot be described by the existing theories.

An individual may enter a hot cognitive mode choosesto consume irrespective of underlying preferences, and pastchoices (experience usage) increases the prob. of enteringthe hot state and making mistake.


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Addiction Another New Alternative theoryCue-Conditioned Cognitive

ProcessBernheim and Rangel (American Economic Review,2009).

Policy implications: advocate the use of:

Public advertising campaigns with horrifying imagesrelated to the abuse (blackened lungs, impaired brains,gruesome car wrecks, and so on).

Use selective legalization (i.e. limit sale at particulartime and place, use on prescription basis and can onlyget the stuffs the next day) allow addicts to self-regulate.

Encourage addicts to impose self-regulation i.e.gamblers voluntarily ban themselves.

Criminalization and Sin taxation may or may not beoptimal.


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Addiction: Gambling Gambling addiction policies to deal with it:

paternalism libertarian

banning andcriminalization

completelegalization

libertarian paternalism

gamblers setown liquiditylimit

gamblers allowedto self-imposedbanning

impose time limiton buying chips (e.g.before midnight)

entry fee forcitizens and PR.

sin taxationon gains

Others??


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How Do You Commit http://www.stickk.com
http://www.stickk.com/http://www.stickk.com/


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How Do You Commit CARES smoking cessation


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How Do You Commit?http://www.fastcompany.com/magazine/134/bundle-up.html
http://www.fastcompany.com/magazine/134/bundle-up.htmlhttp://www.fastcompany.com/magazine/134/bundle-up.htmlhttp://www.fastcompany.com/magazine/134/bundle-up.htmlhttp://www.fastcompany.com/magazine/134/bundle-up.html


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Other Studies Della Vigna and Paserman (2008), job search.

Della Vigna and Malmendier (2006), gym membership.

Dufflo (2009), immunization.

Karlan and Zinman (2009), commitment to stop smoking.

Milkman, et.al. (2008), video rentals sequencing return.

Oster and Scott-Morton (2005), magazine subscription plan.

Sapienza and Zingales (2009), procrastination and timeinconsistency.

Thornton (2005), HIV testing.

Troppe and Fischbach (2000), commitment to medical adherence.

Wertenbroch (1998), individual packaging.

Time Preference & Inter temporal Choice

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