Human Nature #16: Hyperbolic Discounting

Imagine that we are given the choice between receiving $100 today or $200 tomorrow. The answer seems obvious, we should wait a day and get that extra $100. But now imagine that the choice is between receiving $100 today or $200 in a year. The answer seems less obvious. As the waiting time increases, the importance of that extra $100 decreases.

Statistically, when people are given the second option, they overwhelmingly choose $100 today. When those same people are asked again to choose between $100 in five years or $200 in six years, their preferences flip again, preferring to wait the extra year for the extra $100. They assume that they will be fine waiting in the future even though they aren’t fine waiting today. In reality, when year five rolls around, they will probably want the immediate payoff as much as they want it today.

These conflicting preferences tell us something about the inherent irrationality in how we deal with the future.

Temporal Myopia

We tend to suffer from a type of temporal myopia – a decrease in clarity as time periods increase. This causes us to agree to commitments in the future that we would not commit to today, it causes us to disregard preventative health measures in the present that would benefit us tomorrow, and it causes us to sacrifice future monetary rewards for present gratification.

This time-inconsistent model of discounting the future is known as hyperbolic discounting – the farther away the awards or punishments are, the more we discount them. This can also be thought of as the “I’m going to die anyway” approach to planning. In evolutionary terms, the selection mechanism for traits is based on the ability to pass on genes from one generation to the next. If this can be done by your twenties, there’s little incentive to select for qualities that plan for your eighties.

Issues with Hyperbolic Discounting

There is an inherent conflict that we all face between short-term satisfaction and the achievement of long-term goals. When viewed through the lens of hyperbolic discounting, the weight of short-term satisfaction increases while the weight of the long-term goals decreases. As such, most people act in way that is not beneficial to their hyperbolically discounted long-term goals.

For example, when people are told that smoking will damage their ability to breathe in the future, most people see the short-term satisfaction of smoking as outweighing the long-term ability to breathe. Similarly, studies have found that when heart attack patients were told to make a lifestyle change or risk heart failure, only 10% of the patients sampled made any changes. If it’s in the future, what does it matter.

For another example, most people know that they need to save for retirement but still have difficulty sacrificing present consumption for future consumption. An extra TV today is nice, even if it wreaks havoc on the long-term. This is the business model of credit card companies. Benefits upfront, large costs deferred.

In both examples, a small benefit today is being exchanged for large cost tomorrow.  Rational behavior would suggest that people would not pay these out-sized costs for relatively small rewards, but they do. At the extreme, you can think of global warming. Sure the world might be inhabitable in 50 years, but that is in 50 years. What pay a dime today?

Conclusion

People disproportionately value the present over the future. This causes problems when we try to rationally compare the costs and benefits between time periods. A benefit might be huge on an absolute scale, but it will still be disproportionately punished the longer it takes to realize. Seinfeld summarized it best:

References:
https://en.wikipedia.org/wiki/Hyperbolic_discounting

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Author: David Shahrestani

"I have the strength of a bear, that has the strength of TWO bears."

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