Sunday, October 09, 2005

Drinking over time preferences

I was in the liquor store yesterday buying some beer, some wine, and a good vodka for making Martinis (or is that martinis?) -- just as you do on a Saturday -- and at the counter I found myself faced with a dilemma.

My chosen brand of beer was priced at a modest $16.95 a dozen today, but it was pointed out to me that it will be on special Tuesday for a very tempting $13.95 a dozen. The dilemma was resolved in a moment: far preferable to get outside a few beers now, I reasoned, than to sit around until Tuesday with only a dry old promissory note for a cheaper dozen to keep me company.

As I quite happily paid over the odds in order to begin consuming beer now instead of days later (without of course ruling out consuming it on Tuesday as well) I reflected that this is clearly an example of 'time preference' -- a phenomenon first identified by WS Jevons and Eugen von Bohm-Bawerk, and one seen every night in nightclubs across the globe, wherein people happily empty their pockets for a drink NOW rather than wait for satisfation on a later night.

It is a phenomenon that Ludwig von Mises called a universal (a 'categorial,' or a priori) element in human action; put simply, the theory of time preference reflects the overwhelming preference to have two drinks this moment rather than three drinks next week, and it is this universal desire, argues Mises, that explains the phenomeon of interest.

If, for example I borrow money from you today in order to buy a car this afternoon, I'm quite willing to pay extra in order to have the car now rather than next year; thus $1o,000 for that purpose put into my account now is worth more to me than my promise to pay, say, $12,000 over the course of the next two years. As Mises explains it in Human Action:
Time preference is a categorial requisite of human action. No mode of action can be thought of in which satisfaction within a nearer period of the future is not--other things being equal--preferred to that in a later period. The very act of gratifying a desire implies that gratification at the present instant is preferred to that at a later instant. He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction.
The theory is not without its critics, of course. Some critics still insist that interest simply reflects the productivity of capital, a notion that both Bohm-Bawerk and Mises effectively dismissed -- there is no evidence, Mises pointed out, of a "time-structure" in the capital stock of a society; further, the present valuation of income-producing capital will already have anticipated the future income stream. Brian Caplan rejects Mises' time-prefence theory for a different reason, in that he puts the origin of interest down to diminishing marginal utility:
You don't need time preference to get people to divide their consumption between today and tomorrow; all you need is diminishing marginal utility. If you are stuck on an island with two bananas for two days, a perfectly patient person would still want to eat one banana per day. Even though he disvalues hunger today and hunger tomorrow equally, eating one banana today assuages his hunger more effectively than saving that banana for tomorrow.
Lawrence White however argues that Caplan's criticism doesn't stack up. First off, Caplan talks about perishable rather than imperishable goods (contra Mises) and assumes too an ever-expanding economy; for another, diminishing marginal utility "doesn’t explain why, even when today and tomorrow are equally provisioned, the market characteristically values a dollar today higher than a dollar tomorrow. That’s a fact that we need time preference to explain." I'm with White on this one.

Israel Kirzner has another beef with Mises' theory, one I'm inclined to agree with; says Kirzner:
The pure-time-preference theory [that Kirzner has] written about is not based on a priori reasoning. I've merely concluded that time preference is a reasonably universal empirical phenomenon. I ask my students: do you know anybody who is indifferent between receiving a paycheck now and receiving it in ten years? The answer is no. To me, that is enough to provide the basis of the theory.
As I drank my beer, I reflected that he's probably correct. And if true, it means that bankers and nightclub owners have more in common than might otherwise be thought, for they both earn their money by trading on the basis of this universal phenomeon of time preference.
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11 Comments:

Blogger t selwyn said...

A serious post without Ayn bloody Rand mentioned at all. Great!

Another concept is propinquity. A preference/higher valuation for that in spatial proximity - but I think it works well with time too. Also, to throw in more economic concepts, there is a risk factor in not taking possession/using something now and waiting for it - an opportunity cost. Also the actor may not have perfect information about the object or situation that they are waiting for. Then there is game theory is more than one actor is involved. Fascinating stuff...

I remember Rodney Hide telling me that Mises was his favourite economist. Something about people making decisions to act. I haven't read anything by Mises so I can't comment further than that.

10/09/2005 05:23:00 pm  
Blogger Oswald Bastable said...

All true, except that vodka does not a martini make.

That requires Gin! ;-)

10/09/2005 06:32:00 pm  
Anonymous Sus said...

What about the effect of extraordinary external influences such as hyper-inflation upon decision-making? I wonder what Mises et al would make of the following:

In 1984 I was working in Israel, where inflation was running at about 300%. This meant that the local Israeli shekel was not the preference in most shops/businesses; hard currency (the US$ was particularly strong that year) was the goer. However, if not exactly welcome, the shekel was still grudgingly accepted.

There was a large car dealership just outside the old city in Jerusalem. The exchange rates would be broadcast daily during the midday news. At 11.50am a staff member would remove the pricetags from under the wipers and return with the new (higher) pricetags about 12.15pm.

So in real terms you were virtually forced to do your shopping - be it for food or cars - as early as possible, because the later you left it, the higher the prices. Quite surreal.

When I left the country in Oct that year, the predictions were for inflation to reach 1000% which was reported to have occurred by the end of the year. Argentina was the only other country (of significance) that enjoyed that ignominious status at the time.

10/10/2005 11:04:00 am  
Blogger Duncan Bayne said...

t selwyn - if you've not read anything from Ludwig von Mises, check out the Ludwig von Mises Institute website.

10/10/2005 05:11:00 pm  
Blogger Oswald Bastable said...

But the real question that remains is:

Bombay Shapphire or Waterloo Gin?

10/10/2005 09:29:00 pm  
Blogger PC said...

"But the real question that remains is:

Bombay Shapphire or Waterloo Gin?"

Stolichnaya. :-)

10/10/2005 09:46:00 pm  
Blogger PC said...

Hi Sus,

Mises and his fellow Austrians wrote extensively on the phenomenon and destructive effects of inflation (see for example Inflation and Price Control, or you can try searching that online 'Human Action' if you like). Here's a few pieces that might interest you on the subject of Germany's 1923 hyperinflation:

Mises: The Great German Inflation
"From the early days of the war till the end of June 1922 the Reichsbank rate remained unchanged at 4 per cent.; it was raised to 6 per cent. in July, to 7 per cent. in August, 8 per cent. in September and 10 per cent. in November 1922, to 12 per cent. in January 1923, 19 per cent. in April, 30 per cent. in August and 90 per cent. in September. But these increases were as nothing when measured alongside the progressive lightening in the burden of a loan during the time for which it ran. Though, after September 1923, a bank or private individual had to pay at the rate of 900 per cent. per annum for a loan from the Reichsbank, this was no deterrent to borrowing. It would have been profitable to pay a so-called interest, in reality an insurance, charge, of thousands or even millions of per cents. per annum, since the money in which the loan would be repaid was depreciating at a speed which would have left even rates like these far in the rear. With a 900 per cent. interest rate in September 1923 the Reichsbank was practically giving money away and the same is true of the lower rates in the preceding months when the course of depreciation was not quite so headlong.

Richard Ebeling:
From the President: The Great German Inflation
During the last months of the Great Inflation, according to Gustav Stolper, “more than 30 paper mills worked at top speed and capacity to deliver notepaper to the Reichsbank, and 150 printing firms had 2,000 presses running day and night to print the Reichsbank notes.”

But these statistical figures do not tell the human impact of such a catastrophic collapse of a country’s monetary system. In his book, Before the Deluge: A Portrait of Berlin in the 1920s (1972), Otto Friedrich writes that “By the middle of 1923, the whole of Germany had become delirious. Whoever had a job got paid every day, usually at noon, and then ran to the nearest store, with a sack full of banknotes, to buy anything that he could get, at any price. In their frenzy, people paid millions and even billions of marks for cuckoo clocks, shoes that didn’t fit, anything that could be traded for anything else.” The price of a cup of coffee would double in the time that a customer took to drink it in a café.

Food supplies became both an obsession and a currency. The breakdown of the medium of exchange meant that the rural farmers became increasingly reluctant to sell their agricultural goods for worthless paper money in the cities. Urban dwellers streamed back to the countryside to live with relatives in order to have something to eat. Anything and everything was offered and traded directly for food to stave off the pangs of hunger.

The inflation generated a vast and illusionary economic boom. In his classic study, The Economics of Inflation (1931), Constantino Bresciani-Turroni detailed how the inflation distorted the structure of prices and wages, generating paper profits that created a false conception of wealth and prosperity. Austrian economist Ludwig von Mises was the first one to emphasize this aspect of the inflationary process...

10/10/2005 10:20:00 pm  
Blogger Neil said...

The real question is actually "which beer did you actually buy"?

10/11/2005 10:22:00 am  
Anonymous Jason Watson said...

I think the real question is, "If a butterfly flaps its wings in central park, will I be a teetotaller"? or maybe, "If drink a Martini in a plane at 30 000 feet, will I get drunk more quickly than if I was sitting in an inflattable deckchair, in the middle of the Pacific ocean sipping my vodka"? Alcohol content being equal.

10/11/2005 11:16:00 am  
Anonymous Sus said...

Cheers Peter. Fascinating and bizarre .. & not necessarily in that order.

I remember studying The Weimar Republic at high school and seeing pictures of Germans wheeling barrows of notes to buy one loaf of bread.

It's monetary insanity. Living it was truly weird.

10/11/2005 04:32:00 pm  
Blogger t selwyn said...

Thanks DB.

10/12/2005 12:35:00 am  

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