If the idea of temporal discounting can usefully be extended to effort, is there anything else it can be extended to? How about financial expenditure, for instance? Is the first penny is the hardest one?
Some friends are in the process of buying a house costing about a million dollars. There was some serious haggling over the final price, to which my friend finally replied “Forget about it, it’s just thirty thousand dollars, it’s not worth the conflict.” And after all, paying $1,100,000 vs. $1,130,000 doesn’t seem like an interesting difference.
I imagine that if they were haggling over a car that cost $20,000, they would move heaven and earth to avoid paying $30,000 more; $20,000 vs. $50,000 seems a major difference.
This seems a lot like hyperbolic discounting, where having to wait ten minutes makes a big difference if it’s ten minutes from now, but very little difference if it’s a year vs. a year + ten minutes. Spending $30,000 makes a big difference if it’s the first $30,000, but very little if it’s $1.1 million + $30,000.
The Kahneman & Tversky jacket-calculator study is the classic example of this, if you want to switch from thought experiment to actual experiment.
This topic also came up in another post; I left I comment about it there.
One view of what’s happening is that discounting just reflects people’s intuitive sense of magnitude, which is nonlinear. It may not be completely logarithmic, but it’s at least somewhere in between linear & logarithmic. So someone faced with a temporal discounting choice effectively thinks “9 years is farther away than 8 years, so I’ll demand more money to wait 9 years based on my intuitive sense of how much farther away it is.” Because of the nonlinear sense of magnitude, you can’t just subtract the two numbers and call it a 1 year gap, since it feels smaller than the gap between 1 year vs. 2 years from now. Similarly, the friend in your house example effectively thinks “$1,130,000 is more money than $1,100,000, so I’ll put in more effort (and put up with more conflict) to try to get $1,130,000 based on my intuitive sense of how much more it is.” But their intuitive sense of magnitude makes that gap seem relatively small, smaller than the gap between $50,000 and $20,000, so they don’t haggle. One gets called temporal discounting and the other gets called diminishing marginal utility, but they can both reflect this same nonlinear sense of magnitude.
The law of diminishing marginal utility is at the heart of the explanation of numerous economic phenomena, including time preference and the value of goods.
Diminishing marginal utility is a fundamentally rational process: I really do need my first $20,000 more than I need the next $100,000, because when spending the first $20,000 to increase my utility, I can knock off my low-hanging fruit preferences like food, water, and housing—but when spending the next $100,000 I come to more complicated preferences like social status and comfort that aren’t quite as important.
But the discounting I’m mentioning here is per item. I would be more likely to excuse a $50 cost overrun on a $200 item than on a $20 item, even if I am a millionaire and in the end $50 makes no difference to my total amount of money either way. Even if I know I’m going to buy both a $20 item and a $200 item, I’d still prefer getting the $50 surcharge attached to the $200 item, even though it doesn’t affect my total expenditure. That’s irrational, and so it’s got to be a bias rather than an instance of diminishing marginal utility.
Good call—I think. Diminishing marginal utility does seem like a rather nice name for phenomena such as temporal discounting, expenditure discounting and effort discounting, though—even if it is currently defined to mean something else. Is there a better name for these things? Or is some terminology hijacking required?
If the idea of temporal discounting can usefully be extended to effort, is there anything else it can be extended to? How about financial expenditure, for instance? Is the first penny is the hardest one?
Some friends are in the process of buying a house costing about a million dollars. There was some serious haggling over the final price, to which my friend finally replied “Forget about it, it’s just thirty thousand dollars, it’s not worth the conflict.” And after all, paying $1,100,000 vs. $1,130,000 doesn’t seem like an interesting difference.
I imagine that if they were haggling over a car that cost $20,000, they would move heaven and earth to avoid paying $30,000 more; $20,000 vs. $50,000 seems a major difference.
This seems a lot like hyperbolic discounting, where having to wait ten minutes makes a big difference if it’s ten minutes from now, but very little difference if it’s a year vs. a year + ten minutes. Spending $30,000 makes a big difference if it’s the first $30,000, but very little if it’s $1.1 million + $30,000.
See today’s post on prospect theory for more.
The Kahneman & Tversky jacket-calculator study is the classic example of this, if you want to switch from thought experiment to actual experiment.
This topic also came up in another post; I left I comment about it there.
One view of what’s happening is that discounting just reflects people’s intuitive sense of magnitude, which is nonlinear. It may not be completely logarithmic, but it’s at least somewhere in between linear & logarithmic. So someone faced with a temporal discounting choice effectively thinks “9 years is farther away than 8 years, so I’ll demand more money to wait 9 years based on my intuitive sense of how much farther away it is.” Because of the nonlinear sense of magnitude, you can’t just subtract the two numbers and call it a 1 year gap, since it feels smaller than the gap between 1 year vs. 2 years from now. Similarly, the friend in your house example effectively thinks “$1,130,000 is more money than $1,100,000, so I’ll put in more effort (and put up with more conflict) to try to get $1,130,000 based on my intuitive sense of how much more it is.” But their intuitive sense of magnitude makes that gap seem relatively small, smaller than the gap between $50,000 and $20,000, so they don’t haggle. One gets called temporal discounting and the other gets called diminishing marginal utility, but they can both reflect this same nonlinear sense of magnitude.
It seems as though this idea is closely related to “diminishing marginal utility”:
I don’t think so.
Diminishing marginal utility is a fundamentally rational process: I really do need my first $20,000 more than I need the next $100,000, because when spending the first $20,000 to increase my utility, I can knock off my low-hanging fruit preferences like food, water, and housing—but when spending the next $100,000 I come to more complicated preferences like social status and comfort that aren’t quite as important.
But the discounting I’m mentioning here is per item. I would be more likely to excuse a $50 cost overrun on a $200 item than on a $20 item, even if I am a millionaire and in the end $50 makes no difference to my total amount of money either way. Even if I know I’m going to buy both a $20 item and a $200 item, I’d still prefer getting the $50 surcharge attached to the $200 item, even though it doesn’t affect my total expenditure. That’s irrational, and so it’s got to be a bias rather than an instance of diminishing marginal utility.
Good call—I think. Diminishing marginal utility does seem like a rather nice name for phenomena such as temporal discounting, expenditure discounting and effort discounting, though—even if it is currently defined to mean something else. Is there a better name for these things? Or is some terminology hijacking required?
You are correct, timtyler is wrong.