Behavioral Economics: Hyperbolic Discounting
This week we’ll be discussing hyperbolic discounting. This is the human tendency to prefer smaller payoffs now over larger payoffs later. This is essentially caused because humans’ perception of time is not linear; people tend to think of time in relative terms.
An example of hyperbolic discounting would be to ask someone if they would prefer $50 now or $100 a year from now. Chances are, they would pick the $50. But, given the choice between $50 in nine years or $100 in ten years, they would choose the $100.
Hyperbolic discounting is important to understand because it factors into many of our everyday decisions. DamnInteresting explains it is one reason why people will “make commitments long in advance that they would never make if the commitment required immediate action. The same defective reasoning causes people to underestimate the future consequences of drug use, unhealthy diets, procrastination, etc.”
Banks and credit card companies take advantage of this irrationality. People wanting to buy expensive items will borrow money not giving anything a second thought, discounting the future impact that these these payments and interest rates will have.
An interesting finding to leave you with: Research has been done on animals, and similar behaviors involving hyperbolic discounting have been observed. (In one particular study, pigeons were given two buttons to choose between. Button A provided them with a small amount of food now, while button B provided them with a larger amount of food in the future. Like humans, the pigeons preferred the immediate reward from button A!)
If you would like to read more information about time discounting and time preference, including the history and modeling, click here.
One Reply to “Behavioral Economics: Hyperbolic Discounting”
Hmm. A little bizarre to refer to a natural selection advantage displayed by animals in general as ‘defective reasoning’ if you ask me, but on a par with a lot of other economic theorizing on the mythical ‘homo oeconomicus’. Biologists have little trouble explaining why people, in common with most other animals, do this: in an uncertain world we can never be sure that ‘the long run’ will ever arrive. Those who prefer the big risk over the small certainty often don’t survive long enough to reproduce. Thus, most of us have risk aversion as part of our genetic makeup. Of course a few daredevils can be useful- every so often one of them gets really lucky, to the benefit of their whole kin group, so there are usually a few of ’em ready to ready to slough off the civilized shackles and go exploring. If we lose most of them, well, they’re usually excess males anyway, so no great loss. ;-)