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Intertemporal Choice in Economic
What is Intertemporal Choice in Economics?
Intertemporal choices refer to present choices that may affect what becomes available in the future. In other words, it shows how current decisions impact the availability of options in the future. Therefore, it becomes very desirable to understand the limits of current consumption because if the availability of resources gets too scarce in the future, it may create problems in life.
Intertemporal choices are often needed to be made in life.
For example, people’s choices of current savings and investments are intertemporal choices. People often need to decide how much to spend now and how much to save for later. This pattern of savings and spending affects the quality of life in a holistic manner.
Intertemporal choices are also an important part of the business. Corporate and other business organizations often need to take present decisions that have an impact on profitability in the future. Therefore, like individuals, intertemporal choices are an important topic in business environments too.
It is often seen that saving in present by consuming less increases the wealth. When wealth increases the individual consumes more in the future. So, while the utility was less in the present, it increases in the future. In other words, if individuals consume less in the present, they have less current utility, but it increases the future utility in general.
Usually, consumption is directly related to budget constraints. Therefore, individuals are limited by budget constraints while making intertemporal choices in the present.
However, it is a common tendency of individuals to consume more in the present irrespective of the impact it might have in the future.
Example of intertemporal choice in economics
Examples of intertemporal choices are many. For example, let us take the example of an individual who wants to build his house. The individual has different choices in front regarding the finances he would like to spend to build his house. He may be tied up with budget constraints while making the decision on financing.
However, he has the opportunity to go beyond his budget constraint and build a house that costs a lot more than what could be the ideal spending regarding his budget. In such a case, the individual will have to face constraints in the future. He may have to take a personal loan, use the maximum limit of his credit card or spend some money from his retirement fund as well.
In this case, making huge spending would lead to a decrease in the current assets of the individual. He may now have to add supplemental income to cover the lack of assets, especially in his salary from which the retirement funds are deducted.
Unforeseen expenses are also a factor in intertemporal choices because it is related to the future. In the example at hand, if some unforeseen activities occur, such as the loss of a job, the person may find it tough to provide enough contributions to his retirement fund. Moreover, if the unforeseen occurrence happens after the sizeable expenditure, the intertemporal choices along with external factors can impact his future opportunities. Such a decline in assets could mean the person to opt for a second mortgage or postpone the retirement plan which was already on cards.
Models of Intertemporal Choice
Theory of Discounted Utility
In economic terms, discounted desirability or utility is the satisfaction derived from some future event that is applied to the present environment. Instead of expressing the utility in the future for the consumption of a good, the discounted utility theory offers the experience in present terms. So, the discounted utility is not a practical assumption as future events are modeled in the present in this theory.
In a perfect intertemporal model, the utilities of the future are added with their maximum value, discounting them to the present value. It is subject to budget constraints which state that the current value of present and future consumption cannot exceed the budget of the individual who will consume the goods in the future as well as in the present.
In the theory of discounted utility, the interpretation of the discounting factor is not straightforward. In some instances, it is expressed as the degree of the patience of an individual. If the economic agents are considered rational, the theory exempts time valuations from the judgments of rationality. So, the individuals who spend hugely by borrowing money, those who spend but save for the future, and those who show wealth but do not spend have the same nationality. This means that different people have different rates of time preferences.
Normative Intertemporal Choice
Normative intertemporal choices are often viewed through the present-biased theory which states that common individuals prefer to choose the present for the consumption of a good rather than a future opportunity. There are however varieties of points of view about the extent of observed preferences that should be linked to normative choices.
Some economists argue that normative preferences should be linked to choice. On the other hand, some others argue that normative preferences can be different from revealed preferences. The latter point of view is especially related to individuals whose preferences represent actual interests that can be used for analysis. There is a tradition in economics to not use revealed preferences as normative ones. So, it is argued that social discount rates should be different from individual discount rates in an analysis. So, one must know well how to discern between an individual and a group while using normative choices for analysis.
Intertemporal choices represent a very interesting and important face of consumption patterns and their future implications. While individuals consuming less in the present tend to increase their consumption in the future, the general individual who splurges in the present is tamed by burdens that limit their future spending. We can understand from the theory of intertemporal choices that making informed savings and expenditures should be a habit to maintain a balanced life. Without a conscious effort to balance intertemporal choices, people may face enough burdens in life.
Qns 1. Why is the concept of intertemporal choices important?
Ans. The concept of intertemporal choices is important because it shows how present consumption can limit future expenditures. This helps individuals in limiting and saving their expenditures for a better lifestyle in the future.
Qns 2. Are intertemporal choices consumer choices?
Ans. Although the concepts are different, intertemporal choices are consumer choices in practice. Only the contexts of use of the terms are different.
Qns 3. Do intertemporal choices impact consumer demand?
Ans. Yes. When individuals know the concept of intertemporal choices, they may curtail some of their expenditures to prepare for a better future lifestyle. This impacts the consumer demands in the markets.
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