Question

What are "time preferences"? How is discounting commonly modeled? (Explain the terms in the model.) What are some examples of how discounting can be irrational? What are some example of how discounting can be rational?

Please write one page. ( also please dont copy paste a google answer i can do it too)

Answer 1

Time Preference is the intesity of desire to satisfy our wants now over satisfying our wants in future. High time preference means we desire to satisfy our wants immediately. Whereas low time preference means that we're willing to sacrifice our consumption now in order to consume more in the future. An example to explain it's practical implication in Economy:

If people have low time preference i.e they prefer to save, interest rates will fall which will lead to availibility of cheap capital for entrepreneurs which will motivate them to invest in longer term investments and they start to increase their demand for the factors of production the prices of capital goods start to rise ( Cheap capital means that capital is available at low inerest rates therefore return on investment is greater than interest on capital ) . And the entrepreneurs are able to prepare for higher future consumption as indicated by people. When people start spending their savings on higher consumption in future the deposits in banks start decreasing and as a result interest rates increase, which in turn encourages the consumers for saving and discourages the entrepreneurs from borrowing.

Discounting is the process of determining the present value of a future payment or stream of payments. A dollar is always worth more today than it would be in future, according to the concept of time vallue of money.

Discounting is Irrational on following grounds:

• It's highly addictive for both seller and buyer as the seller enjoys higher sales volume and the buyer the relative cheapness of goods.
• This trains the customers to expect discount, in absence of which they won't spend.
• Moreover,it erodes the value of brand in the eyes of yourprospects and customers.

Rationality of discounting

The best justification is that it is rational to care less about your distant future because of it's uncertainity.

• Preference towards immediately available money over it's future availabilty is rational.
• As interest rates are always going to be positive.
• But marginal utility of money declines with passage of time.
• And most importantly the uncertainity of our very own existance.