Archive for December 6th, 2014

December 6, 2014

Dynamic Inconsistency

Hyperbolic discounting

siren

In economics, dynamic inconsistency, or time inconsistency, describes the situation: A decision-maker’s preferences change over time, in such a way that a preference, at one point in time, is inconsistent with a preference at another point in time. It is often easiest to think about preferences over time in this context by thinking of decision-makers as being made up of many different ‘selves,’ with each self representing the decision-maker at a different point in time. So, for example, there is my today self, my tomorrow self, my next Tuesday self, my year from now self, etc. The inconsistency will occur when somehow the preferences of some of the selves are not aligned with each other.

In the context of behavioral economics, time inconsistency is related to how each different self of a decision-maker may have different preferences over current and future choices.¬†One common way in which selves may differ in their preferences is they may be modeled as all holding the view that now has especially high value compared to any future time. This is sometimes called the ‘immediacy effect’ or ‘temporal discounting.’ As a result the present self will care too much about herself and not enough about her future selves. Self control literature relies heavily on this type of time inconsistency, and it relates to a variety of topics including procrastination, addiction, efforts at weight loss, and saving for retirement.

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