TAILIEUCHUNG - A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption Between Paydays

An alternative conception of consumer choice has recently gained the attention of economists, which allows for two closely related departures from the standard model. First, consumers may have dynamically inconsistent preferences. Second, as a rational response to this dynamic inconsistency, the consumer may use external commitment devices or personal rules in an attempt to limit overspending. We use data from a large, representative sample of households in the UK to test the relevance of these twin predictions in the field. We find evidence that consumption spending declines between paydays, and jumps back to its initial level on the next payday. The decline is too steep to be explained. | A Monthly Struggle for Self-Control Hyperbolic Discounting Mental Accounting and the Fall in Consumption Between Paydays David Huffman IZA Bonn Matias Barenstein US Federal Trade Commission First draft November 2002 This version December 2005 Abstract An alternative conception of consumer choice has recently gained the attention of economists which allows for two closely related departures from the standard model. First consumers may have dynamically inconsistent preferences. Second as a rational response to this dynamic inconsistency the consumer may use external commitment devices or personal rules in an attempt to limit overspending. We use data from a large representative sample of households in the UK to test the relevance of these twin predictions in the field. We find evidence that consumption spending declines between paydays and jumps back to its initial level on the next payday. The decline is too steep to be explained by dynamically consistent exponential impatience and does not appear to be driven by stockpiling or other rational motives. On the other hand a model with dynamically inconsistent quasi-hyperbolic time preference can explain the decline for reasonable short-term and long-term discount rates. We also investigate whether households in our sample appear to make an effort at self-control using a strategy emphasized in the literature a mental accounting rule that limits borrowing during the pay period and thus puts a cap on overspending. We find that households who are able to borrow in the sense that they own a credit card nevertheless exhibit the spending profile characteristic of credit constraints. Investigating their behavior in more detail we find that these households treat funds from the current and future income accounts very differently during the pay period. In combination these facts suggest the use of a mental accounting rule limiting borrowing. Overall our findings are difficult to explain in the standard economic framework whereas

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