Discounting Principle: A Review
The Discounting Principle, also known as the Principle of Discounting, is a theoretical concept of economics that attempts to explain how people value future rewards. The principle states that people will prefer a reward that is received sooner rather than later, even if it is of lesser value. This principle is used to analyze a wide range of economic decisions, from consumer purchases to investment decisions. This review will examine the Discounting Principle, discuss its implications, and explore the relevant literature.
Definition and History
The Discounting Principle was first developed by John von Neumann and Oskar Morgenstern in their 1944 book, Theory of Games and Economic Behavior. It states that people will prefer a smaller, immediate reward over a larger, delayed reward. This anticipation of future rewards is referred to as “discounting” since the value of a future reward is discounted by the rate of time preference. The Discounting Principle has since been applied to a variety of economic decisions, from consumer purchasing decisions to public policy decisions.
The Discounting Principle has a wide range of implications, both for individual decision-making and public policy. On the individual level, the Discounting Principle can be used to explain why people may choose to purchase items now rather than save for a larger purchase in the future. It can also help explain why people may be willing to take on debt to purchase items, even if it means paying more over time.
On the public policy level, the Discounting Principle can be used to explain why governments may choose to invest in projects that have a short-term payoff rather than those that may take longer to pay off. For instance, governments may be more likely to invest in infrastructure projects that will generate immediate economic benefits than those that may only pay off in the long term.
The Discounting Principle has been studied extensively in the literature. For instance, Bernheim and Rangel (2004) provided a comprehensive review of the literature on the Discounting Principle and its implications for decision-making. Their review found that the Discounting Principle plays an important role in a wide range of economic decisions, from consumer purchases to public policy decisions.
In a more recent study, Güth and Kliemt (2008) examined the implications of the Discounting Principle for investment decisions. Specifically, they looked at how investors can use the Discounting Principle to make more effective investment decisions. Their findings suggest that investors can use the Discounting Principle to make more informed decisions about when to invest in certain assets.
In conclusion, the Discounting Principle is a theoretical concept of economics that attempts to explain how people value future rewards. It states that people will prefer a smaller, immediate reward over a larger, delayed reward. The Discounting Principle has a wide range of implications, both for individual decision-making and public policy. It has been studied extensively in the literature, with research demonstrating its importance in a wide range of economic decisions.
Bernheim, B. D., & Rangel, A. (2004). Addiction and cue-triggered decision processes. American Economic Review, 94(5), 1558-1590.
Güth, W., & Kliemt, H. (2008). The discounting principle: An analysis of investment decisions. Economics Letters, 100(2), 169-172.
von Neumann, J., & Morgenstern, O. (1944). Theory of games and economic behavior. Princeton University Press.