the loss in 1 week but also generates the gain of receiving it in 4 weeks (see the right flowchart). For two reasons, the cost in 1 week would have a higher impact in the present than would the benefit in 4 weeks, which leads to the delay premium. First, because the cost occurs 3 weeks earlier than the gain, the cost is discounted less than the benefit. Second, due to the aforementioned loss bias, a USD 1 cost is evaluated as having a greater magnitude than a USD 1 benefit. Since both of these effects jointly operate to make the delay cost larger relative to the benefit, people cannot accept the delay of the voucher’s arrival without a sufficiently large compensation.
This results in the delay premium.
In contrast, when the disk voucher is re-scheduled to be delivered 3 weeks earlier, from 4 weeks later (the reference case) to just 1 week later, one gets the value flow of the gain in 1 week followed by a loss in 4 weeks (i.e., see the right panel of Fig.2.2b). As the gain takes place 3 weeks earlier (hence, is discounted less) than the loss, the speed up of the voucher delivery produces a net gain and leads to the speed-up cost. However, the speed-up cost will not be as large as the delay premium because the gain is evaluated as smaller than the loss due to the loss bias. In sum, in the case of the speed-up cost, the effects of discounting and the loss bias cancel out each other, whereas the two enhance each other for the delay premium. It follows that the speed-up cost is much smaller than the delay premium.
As demonstrated in Sect.3.4, the interest rate for saving tends to be higher than that for borrowing. This phenomenon can be explained in terms of the delay/speed- up asymmetry. Although Fig.2.2ais used to illustrate the effect of delaying the disk voucher delivery in the previous example, it can also illustrate the effect of delaying the timing of consumption by saving. The right panel can represent the changes to the flow of consumption when people save money a week later and thereby consume an item 4 weeks later (from now). Similarly, the right panel of Fig.2.2b can illustrate the effect of accelerating the timing of consumption by borrowing. For the same reasons discussed in the voucher example, the savings interest rate (computed as the rate of the delay premium) will be higher than the borrowing interest rate (measured by the rate of the speed-up cost) due to the combined effects of discounting and the loss bias.
2.4 Choosing Improving Sequences
monkeys in the classical Chinese story discussed in Chap.1is a typical example.
The monkeys who were faced with the problem of choosing either “three chestnuts in the morning and four in the evening” or “four in the morning and three in the evening” have to compare the discounted sums of the two gratifications sequences.
Similarly, when an employee chooses a time schedule to be paid a lifetime income, he or she has to evaluate and compare alternative sequences of annual incomes from the current viewpoint. Assuming that the personal discount rate is positive, it is an easy matter to arrange the optimal sequence to receive the fixed lifetime amount;
the optimal choice is to receive the larger gratification at the earlier point in time.
With respect to the monkey example, those who chose “four chestnuts in the morning and three in the evening” behaved optimally. Unfortunately, however, people often do not behave in such a way.
2.4.2 Choosing the Smaller Lifetime Income
Consider the following question:
Q2-1 Suppose that the government provides you with what is required to live (e.g., residence, food, clothing, etc.) for 10 years. The sum of the value of the provided goods is fixed. From among the following three patterns, which would you choose?
(A) A gradually increasing standard of living from the lowest level (B) A constant standard of living
(C) A gradually decreasing standard of living from the highest level
In this scenario, because the total amount of goods provided is the same regardless of the pattern chosen, a decision-maker cannot consume more later by saving over the first few years. Thus, the real interest rate is 0. A decision-maker who has a positive discount rate should choose option (C), in which higher standard of living can be enjoyed earlier. However, research suggests that many people choose options (A) or (B). For example, in our 2005 survey, 30 % and 65 % of the respondents chose options (A) and (B), respectively. In other words, only 5 % of the respondents indicated that they would behave in accordance with the theory’s predictions.
George Loewenstein and Nachum Sicherman asked similar questions to 80 adults who visited the Museum of Science and Industry in Chicago, Illinois (Loewenstein and Sicherman 1991). The respondents were shown a figure similar to Fig.2.3and were asked to choose one of two wage-income profiles. Each profile covered a 6-year period, and the total wages earned were equated across the patterns (i.e., a 0 % interest rate). Pattern 1 depicted a decreasing wage profile, and pattern 2 depicted an increasing wage profile. If a respondent had a positive personal discount rate, then the discounted sum of wage flows in pattern 1 is larger than that in pattern 2. For example, with a 10 % discount rate, the discounted sum of wage flow is USD 120.8 thousand for pattern 1 and USD 118.7 thousand for
pattern 2.3Although the present value of pattern 2 was USD 210 smaller than that of pattern 1, more than 80 % of the respondents chose pattern 2.
People thus tend to choose the improving sequence of gratifications even when its total amount is somewhat smaller than in the alternative cases. For instance, in reference to the monkey example, if people had to choose the sequence of chestnut delivery for the monkeys in “Liezi,” they would choose “three in the morning and four in the evening” instead of “four in the morning and three in the evening.” With a positive discount rate, people would prefer a decreasing sequence of gratifications that is less discounted (i.e., one in which greater gratification comes earlier). Thus, the observed tendency for people to prefer the “improving sequence” suggests that the personal discount rate is negative. For this reason, I regard the issue as an intertemporal-choice anomaly.
Note that I have used the term “improving sequences” instead of “increasing” or
“upward-sloping” sequences. The reason is that when choosing sequences of displeasures such as physical pains and dissatisfactions, the same tendency to choose the sequence that improves the situation should be observed. Thus, the term “improving sequence” can accommodate both increasing and decreasing trends. For example, Chapman asked respondents to consider the unpleasant situ- ation of having to contend with a headache for a period of time (Chapman 2000).
The respondents were asked to choose between two options: one that involved a downward-sloping sequence (i.e., a gradual reduction in pain) and one that involved an upward-sloping sequence (i.e., a gradual increase in pain). For both options, the total duration and level of pain were equated. The results indicated that more than 80 % of the respondents preferred the downward-sloping sequence across a wide range of periods (e.g., an hour, a year, 5 years, or 20 years). If future headaches were discounted at a positive rate, then they should have preferred an upward-sloping sequence in which the stronger headache is experienced later. Thus, these results also imply that the respondents have negative personal discount rates.
23.0 23.8
24.6 25.4
26.2 27.0
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Pattern 2 27.0
26.2 25.4
24.6 23.8
23.0
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Pattern 1
Wage (thausand USD) Wage (thausand USD)
Fig. 2.3 Choice of wage-income profiles (thousand USD). Note: Illustrated using the same data as in Loewenstein and Sicherman (1991)
3The present values are computed as 27þ126þ0:2:1þð1þ250::41Þ2þ þð1þ230:1Þ5¼120:9 for pattern 1 and 23þ1þ0:123:8 þ þð1þ270:1Þ5¼118:7 for pattern 2.
2.4.3 The Seniority-Based Wage Puzzle
The tendency to prefer improving sequences of gratification is important in under- standing why the seniority-based wage contract is widespread. In the seniority- based wage contract, the employee’s wage is contracted to go up as seniority at the firm increases, regardless of whether labor productivity increases. From the view- point of economic rationality, the wage rate should be equal to the value of the work produced. Thus, the seniority-based contract seems to contradict economic ratio- nality. However, the use of this contract makes sense if considered from the perspective that employees prefer improving sequences related to their standard of living.
Economics researchers have explained the prevalence of the seniority-based wage contract in two ways. The first is based on the firm-specific human capital hypothesis. By adopting the seniority-based wage contract, a firm can provide workers with an incentive to remain with the same firm long enough to learn the technologies of production and administration and thereby accumulates human capital that is specific to the firm’s activities. In this case, the human capital is firm-specific such that it does not benefit the employee to leave the firm. In contrast, general human capital can be applied non-exclusively to activities at other firms, giving workers an incentive to accumulate such human capital at their own costs. In this case, the firm cannot hold workers at the firm by offering the upward-wage profile. Only when the required human capital is firm-specific do firms have an incentive to incur the training cost for workers and find ways to keep them in their employ so as to recoup the initial training costs.
The second explanation can be described as the agency-cost hypothesis. If young workers fail to produce a sufficient work product while under a seniority-based wage contract, they would lose their opportunity for higher future wages. By creating a contract in which senior workers can be paid higher than what produc- tivity would dictate, firms can discourage junior workers from shirking their responsibilities.
Although these two hypotheses have face validity, they cannot completely explain the widespread occurrence of the seniority-based wage contract. Robert Frank and Robert Hitchens used commercial airline pilots and intercity bus drivers as examples (Frank and Hutchens 1993). In these professions, the wage profiles are upward sloping but cannot be explained by either the firm-specific human capital hypothesis or the agency-cost hypothesis. The former does not apply because the human capital required to be pilots and bus drivers is not firm-specific. The latter also does not apply because carelessness (i.e., low productivity) has serious risks for pilots and bus drivers; in other words, even without an increasing-wage contract, they have an incentive to operate airplanes and buses safely. It follows that in these professions, the preference for the improving sequence of gratifications would be a predominant explanation of the seniority-based wage contract.
2.4.4 Improvements Yield Gratification
Why do people prefer improving sequences? One reason may be that people savor the anticipation of future pleasure and avoid the anxiety associated with future displeasure. By scheduling an event associated with larger gratification at a delay, people can enjoy the happy feeling of anticipation. For instance, according to this idea, when planning a travel vacation, people would schedule a pleasurable event at a later part in the vacation rather than at the beginning. In contrast, for events associated with displeasure or pain, people would reduce their anxiety by schedul- ing the event earlier rather than later. The anticipation effects of future pleasure and anxiety on intertemporal choices have been considered by classical economists. In the seminal bookTheory of Political Economy, William S. Jevons discusses why humans consider future outcomes even though they tend to be selfish and myopic in the present. He attributes this tendency to people’s inclination to pursue “pleasures from anticipation.”
Another reason people prefer improving sequences may be that they incorporate the future effect of habituation. When an individual has habituated to a past pleasure or displeasure, a newly experienced pleasure or displeasure is felt at the habituated level. Thus, people may arrange the gratification time schedule by incorporating the effects of habituation. For example, in the case of the downward-sloping wage profile of pattern 1 in Fig.2.3, each year, workers expe- rience smaller gratifications than the habituation level that was formed by higher incomes in the previous years. By choosing pattern 2, more than 80 % of Loewenstein and Sicherman’s respondents indicated that they would prefer larger gratifications than the habituated reference level that was formed by lower wages in the previous years (Loewenstein and Sicherman 1991). Similarly, in Chapman’s survey (Chapman 2000), more than 80 % of the respondents indicated that they would reduce a headache each day by incorporating the habituation effect of the experiences of a stronger headache on the previous days.
2.4.5 Savoring and Habituation
To check whether the factors described above actually account for people’s pref- erences for improving sequences, we asked survey respondents how often they liked to delay gratification so as to savor it and whether they were aware of the future habituating effect of their current standard of living. The survey respondents were asked to respond on a 5-point scale to indicate how precisely the following two statements described them:
Q2-2 I like to keep pleasures for later enjoyment.
Q2-3 Once I have experienced a high standard of living, it is painful to reduce it.
Q2-2 was meant to elicit the respondents’preference for savoring, and Q2-3 was used to estimate their level of awareness of habituation.
Panels (a) and (b) in Fig.2.4illustrate how the proportion of those who choose improving sequences in Question Q2-1 of Sect.4.2varies as the degree of prefer- ence for savoring rises and as the degree of awareness of habituation rises, respec- tively. The respondents who had stronger preferences for savoring and those who had higher awareness of the habituation effect were more likely to prefer the improving sequence, as predicted by the theory. Although these data indicate a simple association between the two variables, the results are robust even when the effects of other factors (e.g., age, the discount rate, and income) are considered (see the line graphs).
Fig. 2.4 Savoring, habituation, and preference for improving sequences. Note: (a) Savoring and preference for improving sequences. (b) Awareness of habituating effect and preference for improv- ing sequences. Source: TheJapan Household Survey on Consumer Preferences and Satisfaction, 2005
2.4.6 Sequence as Context
The preference for improving sequences implies that people apparently have negative discount rates. However, as seen from the discussions regarding Fig.2.4, a more plausible account may be that although people have positive discount rates, they prefer improving sequences in order to savor anticipated gratifications and/or to enjoy increments in gratifications above the habituated level. If so, people should more strongly prefer earlier gratifications due to positive discounting in situations in which the decision is an independent choice between outcomes at two points in time and so that neither the effect of savoring nor habituation can operate. In this sense, the intertemporal choice will depend on whether the choice is framed over the sequence of outcomes or over outcomes at two independent points of time. For example, suppose an individual wants to watch a movie but has to return the DVD in 3 days. When will he or she watch it? If this person has nothing else to do, he or she may watch it today. However, if the person has to finish a task within 3 days, he or she is likely to first finish the task and then watch the movie.
The choices could be described as follows. When the person considers only the timing of watching the movie, he or she can obtain greater gratification by sched- uling it sooner (i.e., that day) because the effect of positive discounting will dominate the preference for savoring. In contrast, if the person has to complete an onerous task, the choices would be made over the sequence of watching the movie and finishing the onerous task. Then, by incorporating the habituation effect (as well as the savoring effect), he or she would watch the movie after finishing the task. In this way, the person can enjoy increments in gratification from the (nega- tive) gratification of finishing the task (e.g., on day 1) to the (positive) gratification of watching the movie (e.g., on day 2). This causes the preference for improving sequences. Therefore, people are more likely to delay gratifications when making choices over sequences of gratifications compared to independent gratifications.
An interesting questionnaire study by Loewenstein and Prelec provided empir- ical support for this hypothesis (Loewenstein and Prelec 1991). The respondents were Harvard University undergraduates who reported preferring a free dinner at a fancy French restaurant to one at a fancy Greek restaurant. The respondents were asked the following two questions:
Q2-4 Which would you prefer if both were free?
(A) A dinner at a fancy French restaurant in 1 month (B) A dinner at a fancy French restaurant in 2 months Q2-5 Which would you prefer if both were free?
(C) A dinner at a fancy French restaurant on Friday in 1 month and a dinner at a Greek restaurant on Friday in 2 months
(D) A dinner at a fancy Greek restaurant on Friday in 1 month and a dinner at a French restaurant on Friday in 2 months
For Question Q2-4, 80 % of the respondents reported preferring the French dinner in 1 month rather than in 2 months, whereas for Question Q2-5, more than 50 % reported preferring the French dinner in 2 months (with the Greek dinner in 1 month) to the French dinner in 1 month (with the Greek dinner in 2 months). That is, as hypothesized, the students tended to prefer earlier gratification when the decision was framed as a separate intertemporal-choice problem, whereas they tended to delay greater gratification to after a smaller one when the decision was framed as a choice of sequences. By incorporating the habituation effect, they seemed to prefer increments in gratification from early but small gratifications (the Greek dinner) up to later but larger gratifications.