intertemporal-choice

Intertemporal Choice

Business / By / November 27, 2023

Intertemporal choice is a decision-making process where individuals weigh immediate rewards against delayed outcomes. It’s characterized by time preference and discounting. Factors like delayed rewards and risk aversion influence choices, while biases like hyperbolic discounting can lead to present bias. Different models describe discounting patterns, and it has implications for savings, health, and environmental decisions.

Understanding Intertemporal Choice:

What is Intertemporal Choice?

Intertemporal choice is a concept in economics and psychology that revolves around the decisions individuals make when faced with trade-offs between immediate rewards and future benefits. It explores the complexities of decision-making where individuals must weigh the pleasure of instant gratification against the potential for greater long-term gains.

Key Elements of Intertemporal Choice:

  1. Temporal Discounting: Temporal discounting is the tendency of individuals to place lower value on rewards or benefits that are deferred into the future. It reflects the idea that people generally prefer immediate rewards over delayed ones.
  2. Delay Discounting Curve: The delay discounting curve illustrates how the subjective value of a reward diminishes as the delay to its receipt increases. This curve varies from person to person and can provide insights into an individual’s time preferences.
  3. Impulsivity vs. Patience: Intertemporal choice explores the continuum between impulsivity (choosing immediate rewards) and patience (choosing delayed, larger rewards). It examines factors that influence where individuals fall on this continuum.
  4. Decision-Making Strategies: It also considers the strategies people employ when making intertemporal choices, such as commitment strategies (e.g., pre-committing to future rewards) and self-control mechanisms.

Why Intertemporal Choice Matters:

Understanding intertemporal choice is crucial because it has significant implications for various aspects of life, including personal finance, health behavior, addiction, and even policy-making. Recognizing the significance of this concept, its benefits, and its challenges is essential for individuals seeking to make more informed decisions.

The Impact of Time Preferences:

  • Financial Well-Being: Time preferences can significantly impact an individual’s financial stability, as choosing immediate spending over saving can lead to financial challenges in the future.
  • Health Outcomes: In health behavior, decisions related to diet, exercise, and medical adherence are often influenced by time preferences. Delaying gratification can lead to better long-term health outcomes.

Benefits of Understanding Intertemporal Choice:

  • Improved Decision-Making: Understanding one’s time preferences can lead to better decision-making, as individuals become more aware of the trade-offs they face.
  • Behavior Modification: Knowledge of intertemporal choice can be used to develop strategies for modifying behavior and promoting healthier choices.

Challenges in Intertemporal Choice:

  • Impulsivity: The allure of immediate rewards can lead to impulsive decisions, often at the expense of long-term well-being.
  • Self-Control: Maintaining self-control and resisting instant gratification can be challenging, especially when confronted with tempting choices.
  • Complexity: Intertemporal choices can be complex, as they involve predicting future outcomes and considering subjective values over time.

Challenges in Implementing Intertemporal Choice:

Implementing intertemporal choice effectively can be challenging due to the psychological factors that influence decision-making. Recognizing and addressing these challenges is vital for individuals seeking to make better intertemporal choices.

Psychological Biases:

  • Hyperbolic Discounting: The tendency to strongly devalue future rewards, especially in the near term, can lead to suboptimal decisions.
  • Present Bias: Individuals may overvalue immediate rewards and underestimate the importance of future consequences.

Limited Willpower:

  • Self-Control Depletion: Making intertemporal choices often requires self-control, which can become depleted over time, making it more challenging to resist immediate gratification.
  • External Influences: External factors, such as advertising and social pressure, can undermine self-control and lead to impulsive decisions.

Uncertainty:

  • Future Uncertainty: The unpredictability of future events can make it difficult to assess the potential consequences of intertemporal choices accurately.
  • Preference Reversal: Preferences may change over time, leading to “preference reversals” where an individual’s choice differs when the decision is revisited.

Cognitive Load:

  • Complex Decisions: Making intertemporal choices can be cognitively taxing, particularly when evaluating multiple options with varying delays and rewards.
  • Information Overload: Having access to too much information about potential choices can overwhelm decision-makers.

Intertemporal Choice in Action:

To understand intertemporal choice better, let’s explore how it can be applied in real-life scenarios and what it reveals about human behavior.

Financial Planning:

  • Scenario: An individual is deciding whether to spend their bonus on a vacation or invest it in a retirement fund.
  • Intertemporal Choice in Action:
    • Temporal Discounting: The individual may experience temporal discounting, placing greater value on the immediate pleasure of a vacation and undervaluing the long-term financial security of retirement savings.
    • Self-Control Mechanisms: To counter impulsivity, they may employ self-control mechanisms, such as setting up automatic contributions to their retirement account to ensure savings.

Health and Diet:

  • Scenario: A person is choosing between indulging in a sugary dessert or sticking to a healthy eating plan.
  • Intertemporal Choice in Action:
    • Present Bias: The allure of the dessert represents a present bias, where the immediate gratification of taste overrides concerns about future health.
    • Commitment Strategy: To combat present bias, the individual may employ a commitment strategy, such as removing unhealthy snacks from their home, making it more challenging to indulge impulsively.

Education and Skill Development:

  • Scenario: A student is deciding whether to study for an upcoming exam or spend the evening socializing with friends.
  • Intertemporal Choice in Action:
    • Hyperbolic Discounting: The student may struggle with hyperbolic discounting, devaluing the future benefits of good grades in favor of immediate social enjoyment.
    • Time Management: To balance immediate desires with long-term goals, the student can implement effective time management strategies, allocating specific study periods and socializing breaks.

Addiction Recovery:

  • Scenario: An individual in addiction recovery faces the choice of attending a support group meeting or succumbing to cravings.
  • Intertemporal Choice in Action:
    • Self-Control Depletion: Maintaining recovery requires significant self-control, which can become depleted over time, making it harder to resist cravings.
    • Support Network: Attending support group meetings can provide the social and emotional support needed to counter self-control depletion and make healthier choices.

Conclusion:

In conclusion, intertemporal choice delves into the complex decisions individuals make when balancing immediate rewards with future benefits. Understanding the significance of time preferences, the benefits of informed intertemporal choices, and the challenges they pose is crucial for making better decisions in various aspects of life.

Time preferences significantly impact financial well-being, health behavior, and overall life satisfaction. Intertemporal choice offers insights into how people navigate these trade-offs and make decisions. While challenges such as impulsivity, limited self-control, complexity, and cognitive load exist, individuals can employ strategies to overcome them.

Case Studies

  • Financial Investments: Investors often face intertemporal choices when deciding between immediate spending and investing in assets like stocks, bonds, or retirement funds. Choosing to invest can result in larger future gains but requires patience and delayed gratification.
  • Diet and Health: Individuals frequently make intertemporal choices related to their diet and health. Opting for a healthy meal today may provide long-term health benefits, while indulging in unhealthy foods offers immediate satisfaction but poses risks to health in the future.
  • Education: Students make intertemporal decisions regarding their education. They must choose between dedicating time and effort to studying now for better career opportunities later, or engaging in immediate leisure activities.
  • Environmental Conservation: Conservation efforts often require intertemporal choices. For instance, individuals might decide to reduce energy consumption by using energy-efficient appliances, even though the upfront cost is higher. The long-term benefit is lower energy bills and reduced environmental impact.
  • Retirement Planning: Saving for retirement is a classic intertemporal choice. People must decide how much of their current income to allocate toward retirement savings to secure financial stability in the future.
  • Healthcare Decisions: Patients make intertemporal choices when considering medical treatments. They weigh the immediate costs, such as medical expenses and potential side effects, against the long-term benefits of improved health.
  • Environmental Sustainability: Companies and governments make intertemporal choices regarding sustainability initiatives. Investments in renewable energy sources may involve high upfront costs but yield long-term benefits in terms of reduced carbon emissions and energy savings.
  • Purchasing Decisions: Consumers face intertemporal choices when making purchases. For example, they may choose to buy a durable and more expensive product with a longer lifespan rather than a cheaper one that will need frequent replacement.
  • Exercise and Fitness: Deciding to exercise regularly and maintain a healthy lifestyle is an intertemporal choice. The immediate effort and time commitment contrast with the long-term benefits of improved fitness and overall health.
  • Time Management: Allocating time to various tasks and projects is an ongoing intertemporal choice. Prioritizing immediate tasks over important long-term projects can impact personal and professional success.

Key Highlights

  • Time Trade-Offs: Intertemporal choice involves making decisions that trade off between outcomes at different points in time. Individuals must weigh immediate benefits against future gains or losses.
  • Discounting: People tend to discount the value of future rewards or costs, meaning they place less importance on outcomes that occur further in the future. This psychological phenomenon can influence decision-making.
  • Delayed Gratification: Intertemporal choices often require individuals to delay immediate gratification for the sake of long-term benefits. This self-control aspect can be challenging but is essential for achieving future goals.
  • Impulsivity vs. Patience: The balance between impulsivity (choosing immediate rewards) and patience (prioritizing delayed rewards) varies among individuals and contexts. It can impact financial decisions, health behaviors, and more.
  • Hyperbolic Discounting: Hyperbolic discounting is a common pattern where individuals prefer smaller, immediate rewards over larger, delayed rewards when choices are close in time. This can lead to suboptimal decision-making.
  • Behavioral Economics: Intertemporal choice is a central topic in behavioral economics, which explores how individuals deviate from purely rational economic decision-making and considers psychological biases and heuristics.
  • Savings and Investment: Saving for retirement, investing, and financial planning involve intertemporal choices. Decisions about allocating income and resources today affect financial security in the future.
  • Health and Well-being: Health-related behaviors, such as diet, exercise, and healthcare choices, often involve intertemporal trade-offs. Decisions made today can impact long-term health outcomes.
  • Environmental Sustainability: Environmental decisions, both at the individual and policy levels, require consideration of intertemporal consequences. Sustainable practices often involve upfront costs for future ecological benefits.
  • Decision Architecture: Understanding intertemporal choice is crucial for designing effective decision architecture, such as nudges and incentives, to encourage desirable behaviors and long-term planning.
  • Economic Policy: Policymakers consider intertemporal effects when crafting economic policies, such as taxation, inflation targeting, and social safety nets, to address economic stability and well-being over time.
  • Personal Finance: Intertemporal choices play a vital role in personal finance, including budgeting, saving, debt management, and retirement planning. Financial literacy is essential for making informed decisions.

Connected Thinking Frameworks

Convergent vs. Divergent Thinking

convergent-vs-divergent-thinking
Convergent thinking occurs when the solution to a problem can be found by applying established rules and logical reasoning. Whereas divergent thinking is an unstructured problem-solving method where participants are encouraged to develop many innovative ideas or solutions to a given problem. Where convergent thinking might work for larger, mature organizations where divergent thinking is more suited for startups and innovative companies.

Critical Thinking

critical-thinking
Critical thinking involves analyzing observations, facts, evidence, and arguments to form a judgment about what someone reads, hears, says, or writes.

Biases

biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.

Second-Order Thinking

second-order-thinking
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.

Lateral Thinking

lateral-thinking
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.

Bounded Rationality

bounded-rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.

Dunning-Kruger Effect

dunning-kruger-effect
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.

Occam’s Razor

occams-razor
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.

Lindy Effect

lindy-effect
The Lindy Effect is a theory about the ageing of non-perishable things, like technology or ideas. Popularized by author Nicholas Nassim Taleb, the Lindy Effect states that non-perishable things like technology age – linearly – in reverse. Therefore, the older an idea or a technology, the same will be its life expectancy.

Antifragility

antifragility
Antifragility was first coined as a term by author, and options trader Nassim Nicholas Taleb. Antifragility is a characteristic of systems that thrive as a result of stressors, volatility, and randomness. Therefore, Antifragile is the opposite of fragile. Where a fragile thing breaks up to volatility; a robust thing resists volatility. An antifragile thing gets stronger from volatility (provided the level of stressors and randomness doesn’t pass a certain threshold).

Systems Thinking

systems-thinking
Systems thinking is a holistic means of investigating the factors and interactions that could contribute to a potential outcome. It is about thinking non-linearly, and understanding the second-order consequences of actions and input into the system.

Vertical Thinking

vertical-thinking
Vertical thinking, on the other hand, is a problem-solving approach that favors a selective, analytical, structured, and sequential mindset. The focus of vertical thinking is to arrive at a reasoned, defined solution.

Maslow’s Hammer

einstellung-effect
Maslow’s Hammer, otherwise known as the law of the instrument or the Einstellung effect, is a cognitive bias causing an over-reliance on a familiar tool. This can be expressed as the tendency to overuse a known tool (perhaps a hammer) to solve issues that might require a different tool. This problem is persistent in the business world where perhaps known tools or frameworks might be used in the wrong context (like business plans used as planning tools instead of only investors’ pitches).

Peter Principle

peter-principle
The Peter Principle was first described by Canadian sociologist Lawrence J. Peter in his 1969 book The Peter Principle. The Peter Principle states that people are continually promoted within an organization until they reach their level of incompetence.

Straw Man Fallacy

straw-man-fallacy
The straw man fallacy describes an argument that misrepresents an opponent’s stance to make rebuttal more convenient. The straw man fallacy is a type of informal logical fallacy, defined as a flaw in the structure of an argument that renders it invalid.

Streisand Effect

streisand-effect
The Streisand Effect is a paradoxical phenomenon where the act of suppressing information to reduce visibility causes it to become more visible. In 2003, Streisand attempted to suppress aerial photographs of her Californian home by suing photographer Kenneth Adelman for an invasion of privacy. Adelman, who Streisand assumed was paparazzi, was instead taking photographs to document and study coastal erosion. In her quest for more privacy, Streisand’s efforts had the opposite effect.

Heuristic

heuristic
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.

Recognition Heuristic

recognition-heuristic
The recognition heuristic is a psychological model of judgment and decision making. It is part of a suite of simple and economical heuristics proposed by psychologists Daniel Goldstein and Gerd Gigerenzer. The recognition heuristic argues that inferences are made about an object based on whether it is recognized or not.

Representativeness Heuristic

representativeness-heuristic
The representativeness heuristic was first described by psychologists Daniel Kahneman and Amos Tversky. The representativeness heuristic judges the probability of an event according to the degree to which that event resembles a broader class. When queried, most will choose the first option because the description of John matches the stereotype we may hold for an archaeologist.

Take-The-Best Heuristic

take-the-best-heuristic
The take-the-best heuristic is a decision-making shortcut that helps an individual choose between several alternatives. The take-the-best (TTB) heuristic decides between two or more alternatives based on a single good attribute, otherwise known as a cue. In the process, less desirable attributes are ignored.

Bundling Bias

bundling-bias
The bundling bias is a cognitive bias in e-commerce where a consumer tends not to use all of the products bought as a group, or bundle. Bundling occurs when individual products or services are sold together as a bundle. Common examples are tickets and experiences. The bundling bias dictates that consumers are less likely to use each item in the bundle. This means that the value of the bundle and indeed the value of each item in the bundle is decreased.

Barnum Effect

barnum-effect
The Barnum Effect is a cognitive bias where individuals believe that generic information – which applies to most people – is specifically tailored for themselves.

First-Principles Thinking

first-principles-thinking
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.

Ladder Of Inference

ladder-of-inference
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.

Goodhart’s Law

goodharts-law
Goodhart’s Law is named after British monetary policy theorist and economist Charles Goodhart. Speaking at a conference in Sydney in 1975, Goodhart said that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Goodhart’s Law states that when a measure becomes a target, it ceases to be a good measure.

Six Thinking Hats Model

six-thinking-hats-model
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.

Mandela Effect

mandela-effect
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.

Crowding-Out Effect

crowding-out-effect
The crowding-out effect occurs when public sector spending reduces spending in the private sector.

Bandwagon Effect

bandwagon-effect
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What in marketing can be associated with social proof.

Moore’s Law

moores-law
Moore’s law states that the number of transistors on a microchip doubles approximately every two years. This observation was made by Intel co-founder Gordon Moore in 1965 and it become a guiding principle for the semiconductor industry and has had far-reaching implications for technology as a whole.

Disruptive Innovation

disruptive-innovation
Disruptive innovation as a term was first described by Clayton M. Christensen, an American academic and business consultant whom The Economist called “the most influential management thinker of his time.” Disruptive innovation describes the process by which a product or service takes hold at the bottom of a market and eventually displaces established competitors, products, firms, or alliances.

Value Migration

value-migration
Value migration was first described by author Adrian Slywotzky in his 1996 book Value Migration – How to Think Several Moves Ahead of the Competition. Value migration is the transferal of value-creating forces from outdated business models to something better able to satisfy consumer demands.

Bye-Now Effect

bye-now-effect
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.

Groupthink

groupthink
Groupthink occurs when well-intentioned individuals make non-optimal or irrational decisions based on a belief that dissent is impossible or on a motivation to conform. Groupthink occurs when members of a group reach a consensus without critical reasoning or evaluation of the alternatives and their consequences.

Stereotyping

stereotyping
A stereotype is a fixed and over-generalized belief about a particular group or class of people. These beliefs are based on the false assumption that certain characteristics are common to every individual residing in that group. Many stereotypes have a long and sometimes controversial history and are a direct consequence of various political, social, or economic events. Stereotyping is the process of making assumptions about a person or group of people based on various attributes, including gender, race, religion, or physical traits.

Murphy’s Law

murphys-law
Murphy’s Law states that if anything can go wrong, it will go wrong. Murphy’s Law was named after aerospace engineer Edward A. Murphy. During his time working at Edwards Air Force Base in 1949, Murphy cursed a technician who had improperly wired an electrical component and said, “If there is any way to do it wrong, he’ll find it.”

Law of Unintended Consequences

law-of-unintended-consequences
The law of unintended consequences was first mentioned by British philosopher John Locke when writing to parliament about the unintended effects of interest rate rises. However, it was popularized in 1936 by American sociologist Robert K. Merton who looked at unexpected, unanticipated, and unintended consequences and their impact on society.

Fundamental Attribution Error

fundamental-attribution-error
Fundamental attribution error is a bias people display when judging the behavior of others. The tendency is to over-emphasize personal characteristics and under-emphasize environmental and situational factors.

Outcome Bias

outcome-bias
Outcome bias describes a tendency to evaluate a decision based on its outcome and not on the process by which the decision was reached. In other words, the quality of a decision is only determined once the outcome is known. Outcome bias occurs when a decision is based on the outcome of previous events without regard for how those events developed.

Hindsight Bias

hindsight-bias
Hindsight bias is the tendency for people to perceive past events as more predictable than they actually were. The result of a presidential election, for example, seems more obvious when the winner is announced. The same can also be said for the avid sports fan who predicted the correct outcome of a match regardless of whether their team won or lost. Hindsight bias, therefore, is the tendency for an individual to convince themselves that they accurately predicted an event before it happened.

Read Next: Biases, Bounded Rationality, Mandela Effect, Dunning-Kruger Effect, Lindy Effect, Crowding Out Effect, Bandwagon Effect.

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About The Author

Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
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