What is Hyperbolic Discounting?

What is hyperbolic discounting?

WHAT IS HYPERBOLIC DISCOUNTING AND WHY YOU SHOULD LIVE EACH DAY AS IF IT WERE YOUR LAST – BUT ONLY ON SUNDAYS  

You know the saying: ‘Live each day as if it were your last.’ It features at least three times in every lifestyle magazine, and has a slot in every self-help manual’s standard repertoire, too. For such a clever line, it makes you none the wiser. Just imagine what would happen if you followed it to the letter: you would no longer brush your teeth, wash your hair, clean the apartment, turn up for work, pay the bills?. . .?In no time, you would be broke, sick and perhaps even behind bars. And yet, its meaning is inherently noble. It expresses a deep longing, a desire for immediacy. We place huge value on immediacy – much more than is justifiable. ‘Enjoy each day to the fullest and don’t worry about tomorrow’ is simply not a smart way to live.

Would you rather receive $1,000 in a year or $1,100 in a year and a month? Most people will opt for the larger sum in thirteen months – where else will you find a monthly interest rate of 10% (or 120% per annum!). A wise choice, since the interest will compensate you generously for any risks you face by waiting the extra few weeks.

Second question: would you prefer $1,000 today cash on the table or $1,100 in a month? If you think like most people, you’ll take the $1,000 straight away. This is amazing. In both cases, if you hold out for just a month longer, you get $100 more. In the first case, it’s simple enough. You figure: ‘I’ve already waited twelve months; what’s one more?’ Not in the second case. The introduction of ‘now’ causes us to make inconsistent decisions. Science calls this phenomenon hyperbolic discounting. Put plainly, the closer a reward is, the higher our ‘emotional interest rate’ rises and the more we are willing to give up in exchange for it. The majority of economists have not yet grasped that we respond so subjectively and inconsistently to interest rates. Their models still depend on constant interest rates and are correspondingly questionable.

Hyperbolic discounting, the fact that immediacy magnetises us, is a remnant of our animal past. Animals will never turn down an instant reward in order to attain more in the future. You can train rats as much as you like; they’re never going to give up a piece of cheese today to get two pieces tomorrow. But wait a minute: don’t squirrels manage to gather food and save it for much later? Yes, but that’s pure instinct and – verifiably – has nothing to do with impulse control or learning.

And what about children? In the 60s, Walter Mischel conducted a famous experiment on delayed gratification. You can find a wonderful video of this on YouTube by typing in ‘marshmallow experiment’. In it, a group of four-year-olds were each given a marshmallow. They could either eat it straight away or wait a couple of minutes and receive a second. Amazingly, very few children could wait. Even more amazingly, Mischel found that the capacity for delayed gratification is a reliable indicator of future career success. Patience is indeed a virtue.

The older we get and the more self-control we build up, the more easily we can delay rewards. Instead of twelve months, we happily wait thirteen to take home an additional $100. However, if we are offered an instant reward, the incentive has to be very high for us to postpone the fulfilment. Case in point: the exorbitant interest rates banks charge on credit-card debt and other short-term personal loans, both of which exploit our must-have-now instincts. 

In conclusion: though instantaneous reward is incredibly tempting, hyperbolic discounting is still a flaw. The more power we gain over our impulses, the better we can avoid this trap. The less power we have over our impulses – for example when we are under the influence of alcohol – the more susceptible we are. Viewed from the other side, if you sell consumer products, give customers the option of getting their hands on the items straight away. Some people will be willing to pay extra just so they don’t have to wait. Amazon makes a bundle from this: a healthy chunk of the next-day delivery surcharge goes directly into its coffers. ‘Live each day as if it were your last’ is a good idea – once a week. 

Next:
‘Because’ Justification – ANY LAME EXCUSE

Similar Biases:
Decision Fatigue – DECIDE BETTER – DECIDE LESS
Simple Logic – SPEED TRAPS AHEAD!
Procrastination – WHY NEW YEAR’S RESOLUTIONS DON’T WORK

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The above article is from the book The Art of Thinking Clearly by Rolf Dobelli. The article is only for educational and informative purposes to explain and understand cognitive biases. It is a great book, definitely worth a read!