Present bias

Present bias occurs when individuals place a greater value on goods/income achieved in the present moment – rather than receiving same goods/income in the future.

It suggests given a choice between a payoff today and a pay off in the future; we will choose to have the pay off now.

It suggests that people can be time inconsistent – making decisions that their future self may regret.

“Casual observation, introspection, and psychological research all suggest that the assumption of time consistency is importantly wrong. It ignores the human tendency to grab immediate rewards and to avoid immediate costs in a way that our “long-run selves’ do not appreciate.”

– Ted O’Donoghue and Matthew Rabin, “Doing it now or later” (1999)

Hyperbolic discounting and time inconsistent

This occurs when we discount the value of rewards in the future at a factor that increases with the length of the delay.

“When considering trade offs between two future moments, present-biased preferences give stronger relative weight to the earlier moment as it gets closer.”

Ted O’Donoghue and Matthew Rabin “Doing it now or later” (1999)

Example of time-inconsistent behaviour

Would you prefer £1,000 now or £1,100 in a week?
Many people would choose £1,000 now and not wait an extra week
Would you prefer £1,000 in a year’s time or £1,100 in a year and one week?
Most people would choose £1,100 and be willing to wait an extra week
In other words, in the short term, we are impatient for money now. But, a long-time in future, we are willing to wait.
Delaying work

If you were asked in twelve months time whether you would work an extra seven hour day on April 1st or an extra eight hours on April 30th, most would choose the seven hours on April 1st.

However, if next year on March 30th, we were asked the same question, we would be more likely to choose the eight hours on April 30th. The thought of working seven hours the next day is enough to put it off for four weeks. This is time-inconsistent as we choose differently depending on how close in the future the choice is.

Reasons for time-inconsistency

One thing worth bearing in mind is that if you were offered payment of £1,000 or £1,100 in a week’s time, you may feel there is a higher probability of receiving the £1,000 now, rather than £1,100 in a week’s time. For a firm getting payment for bills, they would rather have money now, rather than riskier option of getting payment + interest in the future.

Implications of present bias

  1. Insufficient saving for pensions. We discount value of future pension payments and save insufficiently
  2. Consumption of demerit goods. We ignore future health costs for short-run utility of enjoying the drug.
  3. Delaying decisions. Given a choice between doing a project now, when we have time, we may put off until last moment, when we are tired and can’t do as well.

Responses to present bias

  • Nudges. Governments/pension companies may give us incentives to nudge us into taking out pension commitments.
  • Highlight of costs. Government campaigns to highlight costs of consuming demerit goods or taxes to make them less palatable.

Related pages

References

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