“I would gladly pay you Tuesday for a hamburger today.”
-J. Wellington Wimpy
Economists used to not get this joke. We all knew that Wimpy was simply a glutton fueling his eating disorder with more hamburgers than he could afford. But in their world, such a man didn't exist. We were laughing. They'd just blink.
You see, all economists since Adam Smith worked under the rational "economic man" theory, namely, that every potential transaction is judged according to an internal cost-benefit analysis against available means. Meaning, "Can I afford the hamburger at the listed price?" Anything extra, like psychology and emotions, might have an effect on an individual basis, but have negligible effect on the whole of the economy. Plus, those things are really, really complex, and they're economists, not psychologists.
In fact, under this model, the average American household debt in 2001 should have been around $900. It was actually around $5000, with credit card debt interest rates around 18% and investment income around 10%. Clearly this was not a nation of Smiths, but of Wimpys. What model could account for this?
David Laibson is a professor of economics at Harvard who has undertaken some behavioral economics to try and account for the missing factors. He built on work by Richard Herrnstein, who in 1967 developed and tested the theory with pigeons and food. Around 2001 Laibson wrote a series of papers that try and explain what's happening with people and debt. He didn't identify the whats, but the hows. In short: he figured out the discount curve. It works something like this: Sitting down to lunch, most people would prefer to have a hamburger right now than two hamburgers tomorrow at the same price. (I'm actually a vegetarian, but sticking with the Wimpy lede...)
But at some point in the future, this switches, e.g. people would prefer to have 2 hamburgers in 100 days than 1 hamburger in 99 days at the same price. The difference is time. The value we assign to the burger (discount in economics-speak) is higher now, and slowly decreases in time. Push the decision far enough out in the future, and we begin to act like rational actors.
For the mathematically inclined, there's a formula:
Little v is the discounted value of the burger, big V is the full value of the burger, D is the time between now and the burger delivery, and k is the "degree of discounting". The degree is a fairly big variable, as it's different for younger people than for older, different for wealthy than for poor, different for those addicted to the burger, and different depending on how long it takes to consume the good. (A burger versus a college scholorship, for instance.)
What informs our "irrationality" is all the stuff economists used to wave off: emotions, instant gratification, impulse purchasing. Turns out the curve is more hyperbolic than exponential, and thus the term hyperbolic discounting. Through him economists now have mathematical models that better predict what's actually happening in the real world. (Insert scary that's-how-they-get-you theory here.)
The interesting takeaway is what successfully saves people from the effect, other than simple self-control, which we all know isn't so simple.
The first tactic is to make decisions early enough, such that we're acting on rationality and not impulse, and finding a way of locking the decision in. In economics this might be investing in bonds. In life this might be giving the keys to the snack cabinet to your partner right after you unpack your groceries rather than when you're hungry. This is tied to the second tactic...
The second is that when we invest in "illiquid assets," meaning things that can't be affected by a lack of self control, like a home, we simply don't have the option to act against it on impulse. The process of home buying is too cumbersome for someone to just get rid of on a whim. This is the economic solution for the economic problem, but it begs extending to other areas of our lives...where we're wimpy.
Hyperbolic Discounting and Consumption (with Christopher Harris), February 2001, Eighth World Congress of the Econometric Society.
Gorgonzola says re hyperbolic discounting: I suggest to you that a lot of the foreclosure crisis was generated from people buying "too much" house on impulse.