In behavioral economics, time preference (or time discounting, delay discounting, temporal discounting, long-term orientation) is the current relative valuation placed on receiving a good at an earlier date compared with receiving it at a later date. Applications for these preferences include finance, health, and climate change. Time preferences are captured mathematically in the discount function. The main models of discounting include exponential, hyperbolic, and quasi hyperbolic. The higher the time preference, the higher the discount placed on returns receivable or costs payable in the future. Several factors correlate with an individual's time preference, including age, income, race, risk, and temptation. On a larger level, ideas such as sign effects, sub-additivity, and the elicitation method can influence how people display time preference. Time preference can also inform wider preferences about real world behavior and attitudes, such as pro-social behavior. Cultural differences can explain differences in discounting as they both have similar underlying psychological influences. The discount rate is also useful in many fields, such as finance and climate change.
Example An individual's time preference can be found in choices between smaller-sooner and larger-later rewards. A person offered $100 today or $110 in one month reveals their discount rate. Choosing the immediate $100, suggests an annual discount rate of at least 10%, whereas indifference of preference for the delayed amount indicates a lower rate. Psychologists and economists use series of similar questions (money earlier or later or MEL methods) to estimate preferences. In everyday terms, time preferences appear in decisions like whether or not to contribute to a retirement account. Choosing to not contribute a portion of one's paycheck to a retirement account is a high time preference decision, whereas contributing to said account is a low time preference decision.
History and development Work on time preference began with John Rae's "The Sociological Theory of Capital" in an attempt to answer why wealth differed across nations. He theorized that it was due to differences in saving an investment from the population, ultimately driven by tolerance for uncertainty and ability to delay gratification. Later, views expanded to examine why individuals may have differences in how they trade off benefits between the present and the future. Some theories include risk, preferences for immediate gratification, and ability to estimate future wants. This means that people may view the future as uncertain, and therefore, they should consume now instead of saving for later. They may also have a compulsion to consume now and are unable to delay the pleasure. Lastly, they may be unable to comprehend their future needs and wants. Irving Fisher was the first person to model these choices economically as a tradeoff between your current and future self. Such ideas were later formalized by Paul Samuelson in "A Note on Measurement of Utility." In this paper, he described a model wherein people want to maximize their utility over all future periods, with future utility being devalued exponentially from the present value.
Neoclassical views In the neoclassical theory of interest due to Irving Fisher, the rate of time preference is usually taken as a parameter in an individual's utility function which captures the trade off between consumption today and consumption in the future, and is thus exogenous and subjective. It is also the underlying determinant of the real rate of interest. The rate of return on investment is generally seen as return on capital, with the real rate of interest equal to the marginal product of capital at any point in time. Arbitrage, in turn, implies that the return on capital is equalized with the interest rate on financial assets (adjusting for factors such as inflation and risk). Consumers, who are facing a choice between consumption and saving, respond to the difference between the market interest rate and their own subjective rate of time preference ("impatience") and increase or decrease their current consumption according to this difference. This changes the amount of funds available for investment and capital accumulation, as in for example the Ramsey growth model. In the long run steady state, consumption's share in a person's income is constant which pins down the rate of interest as equal to the rate of time preference, with the marginal product of capital adjusting to ensure this equality holds. In this view, it is not that people discount the future because they can receive positive interest rates on their savings. Rather, the causality goes in the opposite direction; interest rates must be positive in order to induce impatient individuals to forgo current consumption in favor of future. Time preference is a key component of the Austrian school of economics; it is used to understand the relationship between saving, investment and interest rates.
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