Self-Control : Theory and some applications

1. June, the 27th 2003 Jan Peuckert, Jörn Block Self-Control : Theory and some applications • Table of Contents: • An Economic Theory of Self-Control (Thaler et al. [1981]) • Willpower and Personal Rules (Bénabou et al. [2001]) • Self-Control in Peer Groups (Bénabou et al. [2002]) • Literature 1

2. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • Introductory examples: • Christmas Clubs • Smoking Clinics • Economic theory as an explication (Stigler 1966): • introduction of another item of preference into utility theory : protection against future lack of willpower • Demand model for institutions of self-control developed by Thaler et al. : application of theory of agency rather than other explanations like income effects 2

3. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • The model: • Individual has two sets of preferences that are in conflict at a single point in time (short-run vs. long-run) • Individual has a fixed income stream: • Individual has a consumption plan: • Conflict between short-run and long-run preferences is introduced by viewing the individual as an organization: Organization consists of a „planner“ and a „doer“ • Planner is concerned with lifetime utility • Doer is selfish and his thinking is short term 3

4. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • Doer‘s utility function: Zt (.) Zt is independent of all components of c except ct Zt is strictly increasing and concave in ct • Planner‘s utility function: V (Z1, Z2, ....., ZT) Budget constraint: Plan which maximizes V subject to budget constraint is optimal from planners point of view • Problem: Without some method to control doer‘s actions plan cannot be implemented Individual would borrow on perfect capital market and consume all income in 1‘st period 4

5. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • Consequence: planner requires psychic technology to affect doer‘s behaviour 2 main techniques: 1) doer can get discretion preferences modified or incentives altered 2) doer‘s set of choices can be limited by imposing rules • 3 cases possible: • Pure discretion for doer : • Zt depends on a preference modification parameter selected by the planer. • with planner can alter Zt such that it posseses an internal maximum any desired ct may be obtained. • the lower the desired ct the more modification will be required. • marginal cost of modification increases with . 5

6. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • solution: modification is increased until the marginal utility derived from additional consumption in last period (T) equals the marginal inutility in earlier periods due to modification. • Direct control by planner : • would be set equal to zero for all t and c would be selected to maximize V subject to the budget constraint. • however: monitoring costs arise • Both rules and preference modification are permitted : trade off between monitoring costs and costs for modification • Techniques to reduce conflicts in individuals: • Methods to alter doer‘s incentives • Direct modification of preferences • Explicit monitoring of consumptional behaviour • Explicit altering of incentives (-> introducing a punishment) 6

7. 1. An Economic Theory of Self-Control (Thaler et al. [1981]) • methods to alter opportunities: Rules • Extreme case: all doer discretion can be eleminated: strategy of precommitment • Limit the range of doer discretion through self imposed rules of thumb: • ban on borrowing (debt ethic) • prohibit borrowing except for specific purchases • Eleminate discretion over a specific class of decisions for which the conflict is particularly acute 7