1. Self-Control : Theory and some applications Table of Contents: 1.An Economic Theory of Self-Control (Thaler et al. [1981]) 2.Willpower and Personal Rules (Bénabou et al. [2001]) 3.Self-Control in Peer Groups (Bénabou et al. [2002]) 4.Literature June, the 27th 2003 Jan Peuckert, Jörn Block 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: Z t (. ) Z t is independent of all components of c except c t Z t is strictly increasing and concave in c t −Planner‘s utility function: V (Z 1, Z 2,....., Z T ) 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: (1) Pure discretion for doer : - Z t depends on a preference modification parameter selected by the planer. - with planner can alter Z t such that it posseses an internal maximum any desired c t may be obtained. - the lower the desired c t 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. (2)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 (3)Both rules and preference modification are permitted : trade off between monitoring costs and costs for modification −Techniques to reduce conflicts in individuals: a)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]) b)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