Intertemporal decision making

Many economic decisions are intertemporal in the sense that current decisions affect also the choices available in the future. Examples are saving and retirement decisions of households, and investment decisions of firms. In the case of saving, the saving decision made today affects not only the household's current consumption but also his future consumption possibilities. If someone saves more today, he can consume less today and hence his current utility declines, but he can consume more in the future, and his future utility increases.

As can be seen from the savings example, intertemporal decisions are characterized by some kind of intertemporal trade-off: If I give up something today, I want to be compensated for the resulting utility loss in the future. The optimal intertemporal decision requires that current and future changes of utility implied by current behavior correspond to the individual's intertemporal preferences – formally, that the rate of substitution be equal to the rate of time preference.

An number of studies have shown that the standard theory of intertemporal choice is frequently violated in experimental settings, just as standard (static) expected utility (EU) theory of choice is systematically violated (see Camerer, 1995). Intertemporal decisions are therefore an important area of research in behavioral economics.

See also: retirement, savings, time preference

Literature: Fishburn & Rubinstein (1982), Camerer (1995)

Entry by: Joachim Winter

June 17, 1999
Direct questions and comments to: Glossary master