Why do people choose a small reward now over a large reward in the future?

Behavioral economist Thaler’s experiments showed that people tend to prefer a large payoff in the distant future, but when the actual moment of choice arrives, they choose a small payoff in the present. This shows that human preferences change over time and are not consistent. Self-binding promises and counter-inducements are proposed as ways to overcome this.

 

An experiment by behavioral economist Thaler illustrates how human choices change over time. If you were to receive an apple from someone, would you rather receive one apple a year later or two apples the next day? And if you were given a choice between receiving one apple today and two apples tomorrow, nearly a year later, which would you choose? When Thaler conducted an experiment with these two questions, most participants chose the two apples in the first question. However, in the second question, many participants chose one apple in the moment.
The reason people preferred to receive two apples a year and a day later to one apple a year later is that they thought the utility of a large future gain was greater than the utility of a small future gain. However, as the time approaches when the future benefit becomes a reality, the magnitude of the utility reverses. This means that people’s preferences are not always constant and unchanging, but change over time. Thaler noted that many people in the experiment gave inconsistent answers. Contrary to the traditional view of economics, which assumes that people are rational and will make consistent choices, Thaler analyzed that inconsistent choices are closer to human nature. Based on this analysis, Thaler proposes to eliminate one future option so that people can make consistently rational choices, which he calls “self-binding commitments.
Self-binding promises are made by giving people a “carrot” that’s too good to refuse or a “stick” that’s too bad to accept and reducing or eliminating their options so that they have no choice but to keep their promise. Imagine a person who knows that saving will benefit them in the long run, but is swayed by the immediate temptation of spending when it comes time to make a choice. This person might be incentivized to make a rational choice by offering a significant additional interest rate on top of the promised rate if they keep their savings to maturity, or by deducting a significant amount of money when they close the savings product early.
These self-binding commitments aren’t just limited to financial behavior, but can be applied in many areas of life. For example, if someone decides to exercise to get fit, they might bet a friend a certain amount of money and promise to exercise every day. If you fail to fulfill this promise, the money goes to your friend. This way, you’re motivated because the loss of not exercising is too great.
Self-binding commitments can also be used effectively in organizations. For example, instead of paying employees a bonus if they meet a certain goal, a company can penalize them if they don’t. This can be an incentive for employees to work harder to achieve their goals. Self-binding commitments are a useful concept that can be applied in many different areas, from personal habits to how organizations operate.
Of course, traditional economics also uses the concept of carrots and sticks. The stick is used to deter irrational behavior by imposing fines, and the carrot is used to encourage rational behavior by subsidizing it. Behavioral economists, on the other hand, see the need for carrots that are too good to miss and sticks that are too harsh. Traditional incentives may not be strong enough to get people with inconsistent preferences to overcome their present-focused impatience.
In addition, behavioral economists have proposed a concept that is distinct from traditional inducements: counter-inducements. The traditional notion of enticement involves dangling a carrot or stick about A in order to get someone to choose it. However, in counter-inducement, the carrot or stick is about B, which is the opposite of A, in order to get people to choose A. When people are presented with a strong carrot or stick against A, they tend to reject the carrot or stick and choose A over B. This is called counter-inducement. Countervailing incentives are used effectively by governments and businesses.
Governments can use countervailing incentives when pushing policies to get citizens to behave in a desired way. For example, to encourage recycling, a government might introduce a policy that provides tax incentives for households that recycle more than a certain amount, but fines households that don’t recycle. This can be an effective way to get citizens to recognize the importance of recycling and actively participate.
Businesses can also use counter-incentives to drive consumer behavior. For example, they can offer discounts to consumers who buy environmentally friendly products and charge extra for those who buy non-environmentally friendly products. This is a way for consumers to contribute to environmental protection and reap economic benefits at the same time.
Thaler’s work emphasizes that human choices are not solely based on economic interests, but are heavily influenced by psychological and social factors. This opens up the possibility for behavioral economics to understand human behavior in a different way than traditional economics, and to come up with more realistic and effective policies and strategies.