Every day we all go about our lives, making plans for our actions in the future, but how often do we follow through with them?
Simply put, dynamic or time inconsistency occurs when the preferences you plan at a point in time (t) for say, n periods ahead in the future do not match your preferences when the period (t+n) actually arrives. We also often play little tricks on ourselves to make us do things we ought to do and to keep us from doing things we normally avoid.
These "self-control" methods provide ways in which an individual can bind him/herself to stick to the globally optimal plan and are, in a way, solutions to the time inconsistency problem. In this presentation, the students extensively covered the two kinds of dynamic inconsistency and also explain the notable economic models of self-control as proposed by Strotz (1955) and Thaler (1980) in detail.
Finally, this aspect of self-regulation has major implications for economic decisions involving intertemporal tradeoffs, and thus has a lot of relevance for important decisions like consumption v/s saving, taking a mortgage, saving and investing for retirement, etc. taken at an individual or household level.
Assuming uniform preferences in an individual tends to ignore a variety of behaviours that we observe in everyday life. A person who has decided to quit smoking, giving in to the temptation to smoke is just one of the examples of an individual having non-uniform preferences over time. The essential problem here is of time inconsistency, where preferences change and become inconsistent over time. This is what calls for self control. Time inconsistency can occur both under certainty, where the preferences over certain outcomes change and also under uncertainty, where preferences over uncertain outcomes (lotteries) violate the traditional Expected Utility theory.
Strotz, gave a model which incorporated this inconsistency in the form of a variable discount function, back in his seminal paper in 1955. One of the limitations of the paper was that while talking of inconsistency, it did not give any way to model "Self Control" as such. Then, Thaler gave a two self model in which he modelled an individual as an organisation with two basic drives (Planner and a Doer). The idea is that the techniques of self-control used by an organisation to reduce conflict of interest costs are similar to those used by individuals. A mix of such techniques, like rules, discretion and combined strategies was given and Incorporated into the mathematical model. To conclude, we studied some of the real life implications of bringing this idea of self control into our daily lives. Two specific domains of pension plans and tax policy were discussed in detail.
Author: Ashwin K, Shreya Bhandari and Divya Purohit | Mentored by: Jyotsana Kala| Access link to presentation files