Can economists predict how you spend your money?

Can economists predict how you spend your money?

Most financial decisions have consequences that will impact us over time.

How much should I spend today, and how much should I save? How many hours should I work tonight, and what work should I leave it for tomorrow?

Should I provide feedback to an under-performing colleague or delay the awkward interaction? Is it worth getting out of bed to take my medicine, or is it OK to skip a night? Should I exercise this afternoon, or check all of my social media accounts today and exercise tomorrow?

Be it in the workplace, the marketplace, on vacation, or at home, almost all decisions have an intertemporal dimension. If one makes these decisions with any foresight at all, it is necessary to somehow weigh costs and benefits that occur at different points in time.

These questions also dominate many of our government policy questions. How much to invest in the future is at the heart of policymaking, including education, health, retirement, energy, and the environment.

All animals, including humans, tend to pursue instant gratification. This is true even when such immediate rewards are obtained by giving up a more substantial amount of delayed gratification.

Our attention is limited. When choosing a bottle of wine for dinner, we think about just a few considerations: the price and the quality of the wine. We usually do not consider minor components like future income, the interest rate, the potential learning value from drinking this wine.

Traditional rational economics assumes that we process all the information that is freely available to us. This is the single most significant reason most traditional economic theories fail to accurately depict reality.

Tradicional economics cannot predict how we spend our money because we are humans, and as such, our decisions are not perfect.

Modifying this classical assumption is desirable and doable. Moreover, it is necessary to attain greater psychological realism in economic modeling, and ultimately to improve our understanding of markets and to design better policies.

For example. Traditional economics states that there is no money illusion. A behavioral model predicts that there is money illusion. When the budget and prices are both increased by 5%, people will consume less expensive goods, as they are perceived to be relatively more costly.

Research shows that individuals want to limit their options not merely to change their outcome but to reduce their costs of exercising self-control.

Ultimately, there probably isn’t a right answer to all economic decisions. Progress will likely come from many different methods that jointly create a more complete and compelling picture of our intertemporal preferences.

Are individuals well-equipped to make financial decisions? Do they possess adequate financial literacy and knowledge?


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About the author:

Personal Finance Made Easy

Hi, I am Leblon Blue. Mid-thirties senior manager on a large corporation. Happily married for seven years and waiting for my first kid. I have dedicated my past 15 years to build an engineering background and a stable career. After working in Europe, Scandinavia, and Latina America, I am now based in the Persian Gulf, where I manage the performance of a large corporation that operates in the region.

Find more about Leblon Blue.


Sources:

Bernheim BD, DellaVigna S, Laibson D. Handbook of Behavioral Economics – Foundations and Applications 2, Volume 2 [Internet]. Elsevier; 2019.

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