Episode 8: Time Discounting and Time Preference


What is the nature of time? Oh how I love Carl Sagan. But we’re not talking about spacetime, rather, we’re talking about humantime. Or how humans value time.

How humans perceive time is a tricky question, and one that I am not going to answer today. Too much unknown and unexplored psychology and not enough behavioral economics. Maybe how humans perceive time is a more interesting question, I’m not sure.

But what is easier to measure is how much you are willing to be paid to wait. In that way you can put a value on how much it is worth to get something sooner. This will be my first post in a series on time and what economists call time discounting.

Time discounting as an economic concept is pretty simple. I can pay $6 to get an online order to me today, or $5 to receive it tomorrow. There’s a discount if I wait.

In later posts I’m going to dig into some of the specific research that gives some concrete numbers on time discounting. But today I am going to stick with the theoretical.

Just like you can make a choice between things, you can make a choice to give or get something between times. The technical term for this is “intertemporal choices”. In “Time Discounting and Time Preference: A Critical Review” by Frederick, Loewenstein and O’Donoghue they define intertemporal choices as decisions involving tradeoffs among costs and benefits, that occur at different times. Choice means choice, intertemporal means between times.

How have economists dealt with this problem in the past? Like the rest of economics, the answer is they did so by oversimplifying the situation. Let’s start with the idea of discount utility because it’s very straightforward. Mind journey!

It’s a nice crisp fall day and you know what time of year it is… Pumpkin latte season! Your favorite. As you walk into your neighborhood coffee shop you can smell the strong aroma of nutmeg and pumpkin pie spice drift over you. You check the big board menu for ideas but let’s be honest; you’re getting your first pumpkin latte of the year and you’re really excited about it.

After waiting your turn in line, you give your order to the barista. At checkout you’re asked if you would like your order right now, or tomorrow. “Say what?” you ask. “Well, we’re giving you a choice. We can give you your order now, or you can choose to pick it up tomorrow. It’s the same price, and you have to pay now regardless of your choice”.

Ummm… You’re getting that latte right then and there. It’d be silly to wait until tomorrow! But what if they gave you a discount off your bill, say, $1 to wait until tomorrow. Or $2. At some point they can bribe you enough to wait.

That’s what is called your discount utility: the amount of value (utility) that you derive from getting your latte that instant.

Further, let’s assume you’re willing to take $1 to wait one day. The assumption in the old economics world is that time preferences are linear. Therefore, if you would take $1 to wait one day, then you would accept $2 to wait two days.

There are many psychology research studies that suggest that the discount utility model of time is wrong, and, in fact, in “Time Discounting and Time Preference: A Critical Review”, they painstakingly look at academic evidence for the traditional view of discount utility. And conclude that the old model has little empirical support.

“Economics has always been both an art and a science” says the paper’s authors. And that is a statement this author also agrees with. Simple discount utility is far too simple to accurately model human behavior.

This idea is only the tip of the iceberg.  There is research that shows that dopamine is released in anticipation of a reward, not when a reward is actually received (CITE), so sometimes it’s more fun and addictive to be forced to wait.

Here’s a video where Sapolsky goes through this research: http://library.fora.tv/2011/02/15/Robert_Sapolsky_Are_Humans_Just_Another_Primate

Humans certainly don’t value time linearly, and there are a lot of behavioral science papers about that I’ll be discussing later in this series. Briefly, making me wait one week is going to be expensive. But making me wait 10 weeks is not going to be 10x as expensive. It’s at least not linear.

And then there are the other wonderful human traits of scheming, plotting, planning, investing, gratification, and being lazy. There are a lot of competing factors about how we value time.

Frederick, Loewenstein and O’Donoghue encourage economists to abandon using the fundamental idea of discount utility altogether since it doesn’t seem to line up with what is happening in human heads. I quote from the paper:

“In sum, we believe that economists’ understanding of intertemporal choices will progress most rapidly by continuing to import insights from psychology, by relinquishing the assumption that the key to understanding intertemporal choices is finding the right discount rate (or even the right discount function), and by readopting the view that intertemporal choices reflect many distinct considerations and often involve the interplay of several competing motives.”

Sorry for the long, complicated paragraph, but I feel it is a great summary. Use insights from psychology. Stop trying to find a magical discount formula. Accept the messiness and strangeness of human decision making.

That’s great you may say, but if not discount utility, then what?

There is a competing way to define time discounting in economics and it’s called hyperbolic discounting. Pardon the name. But it’s a general understanding that human discounting is not time-consistent. Humans probably don’t even perceive time linearly, or consistently; much less value it that way. Its value is random and weird, just like humans.

Sure, there might be patterns that behavioral economists can find, but humans just don’t value or devalue things in linear, simple ways. It’s messy.

Again, I plan on talking about more specifics about how behavioral economists should think about humans and how we value time. But for now I just wanted to cover the big idea of even thinking about how to measure the value of time using economics.

In sum, if you are working on anything that involves time passing, don’t assume that there will be a lot of rational consistency in how people value waiting.

Frederick, S., Loewenstein, G., & O’Donoghue, T. (2002). Time Discounting and Time Preference: A Critical Review. Journal of Economic Literature40(2), 351-401. doi:10.1257/002205102320161311

Fiorello: Fiorillo C. D., Tobler P. N., Schultz W. (2003). Discrete coding of reward probability and uncertainty by dopamine neurons. Science 299, 1898–1902 10.1126/science.1077349 [PubMed] [Cross Ref] (dopamine anticipation)

100 Things You Should Know About People: #59 — Time Is Perceived as Relative

Picture of a wall clock
Time Is Relative

Has this ever happened to you? You are traveling 2 hours to visit friends. It’s two hours to get there and 2 hours to get back, but the trip there feels much longer.

It’s about the mental processing — In his interesting book, The Time Paradox, Philip Zimbardo discusses how our experience of time is relative, not absolute. There are time illusions, just like there are visual illusions. The more mental processing you do, the more time you think has elapsed. If people have to stop and think at each step of a task, they will feel that the task is taking too long. The mental processing makes the amount of time seem longer.

It’s about expectations — The perception of time and your reaction to it, is also greatly influenced by predictability and expectations. Let’s say you are editing video on your computer. You’ve just clicked the button to produce the video file from your edits. Will you be frustrated by how long it takes to produce the video? If you do this task often, and it normally takes 3 minutes, then 3 minutes will not seem like a long time. If there is an in-progress indicator, for example a bar that is moving, or a message that says “2 minutes 48 seconds left to completion”, then you know what to expect. You’ll go pour yourself a cup of coffee and come back. But if it sometimes takes 30 seconds and sometimes takes 5 minutes, and you don’t which one it is going to be this time, then you will be very frustrated if it takes 3 minutes. Three minutes will seem much longer than it usually does.

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