Question

What is the present value of 500,000 fifteen years from now at a 4% interest rate with exponential discounting? With hyperbolic discounting? When would you choose to use hyperbolic discounting instead of exponential discounting?

Answer 1

N = 15 years

R = 4%

A = 500,000

Exponential Discounting:

PV = A * e-RN

PV = 500000 * e-4*15/100

PV = 274,405.818

Hyberbolic Discounting:

PV = A * (1/(1+RN))

PV = 500000/(1+4*15/100)

PV = 312,500

Hyperbolic discounting is when people value the immediacy of time over higher value of money. This is when people look for a immediate reward rather than a higher delayed reward.

Hypebolic discounting is used to lure the people. For examples:

1. Buy Now & Pay Later (Marketing Strategy): This is givign a immediate reward to the customer of the product but he has to pay the price later. The price might be a hiked price.

2. Referral Strategy: When a company gives incentives to referr a friend, they are rewarding the person on immediate basis but extract the value new customer over a period of time which is much higher than the referral price.

Thus, hyberbolic discounting is used to set the value of immediate reward instead of higher delayed reward which is mainly used in marketing activities.