Behavioural economics is a field that combines psychology and economics to understand how individuals make decisions. It challenges the traditional economic assumption that individuals are rational and always make decisions that maximize their own self-interest. Instead, behavioural economics recognizes that human behaviour is influenced by various factors, including emotions, biases, and social norms.
The Concept of Time Discounting
One of the key concepts in behavioural economics is time discounting. It refers to the tendency of individuals to value immediate rewards more than future rewards.In other words, people tend to prefer smaller rewards that they can receive immediately rather than larger rewards that they can only receive in the future. This concept has significant implications for decision-making, as it can lead individuals to make choices that are not in their long-term best interest. For example, someone might choose to spend money on a new phone instead of saving for retirement, even though saving for retirement would provide a greater benefit in the long run.
The Traditional Economic View
In traditional economics, time discounting is not considered a significant factor in decision-making. The rational economic agent is assumed to have a consistent discount rate for future rewards. This means that they would value a reward received in one year the same as a reward received today, as long as the amount is the same. However, research has shown that this is not how most people behave.In fact, studies have found that individuals tend to have a higher discount rate for future rewards. This means that they would value a reward received in one year less than a reward received today, even if the amount is the same.
The Role of Emotions
Behavioural economists argue that emotions play a significant role in time discounting. Emotions such as impatience, fear, and excitement can influence how individuals value future rewards. For example, someone who is feeling impatient might be more likely to choose a smaller immediate reward over a larger future reward. Moreover, emotions can also affect how individuals perceive the time horizon for a particular reward.For instance, someone who is feeling anxious about their financial situation might have a shorter time horizon and be more likely to choose immediate rewards over future ones.
Bias and Social Norms
Bias and social norms can also impact time discounting. For instance, the availability bias can lead individuals to overvalue immediate rewards because they are more easily accessible in their minds. Similarly, social norms can influence how individuals perceive the value of future rewards. If society places a high value on instant gratification, individuals may be more likely to discount future rewards.The Hyperbolic Discounting Model
The hyperbolic discounting model is a popular model used in behavioural economics to explain time discounting.It suggests that individuals have a higher discount rate for rewards that are closer in time compared to those that are further away. In other words, the value of a reward decreases at a faster rate as the time to receive it gets closer. This model explains why individuals might choose immediate rewards over future ones, even if the future reward is significantly larger. For example, someone might choose to receive $100 today instead of $200 in one year because the $100 has a higher present value due to the individual's high discount rate for future rewards.
Implications for Policy-Making
The concept of time discounting has significant implications for policy-making. Traditional economic policies assume that individuals will make rational decisions that maximize their long-term well-being.However, behavioural economics suggests that this is not always the case. For instance, policies that require individuals to save for retirement may not be effective if individuals have a high discount rate for future rewards. In this case, policymakers may need to consider alternative approaches, such as automatic enrollment in retirement savings plans or providing incentives for saving.