Intertemporal Choices

Posted in Finance, Accounting and Economics Terms, Total Reads: 489
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Definition: Intertemporal Choices

Intertemporal choice is the study of relative payoff that choices or decision provide at different point of time. It is a kind of cost benefit analysis to make healthy decisions. The decision pertained can vary from career choices to nutritional habits.


The model used by economist to analyze intertemporal choices was the Discount utility model. It draws parallel from the discounted cash flow model. It assumes that people make choices based on the cost and gains associated with it and also discounts them depending on the time when the benefits are realized. It has been used in understanding the way people make choices and have been used in the past to make policy choices.


Prior to the theory of intertemporal choices was the model of Keynesian consumption model. It was based on the hypothesis that thee marginal propensity to consume lied between 0 and 1 and the average propensity to consume declines with income. However post world war 2 it was observed that the increase in savings was not commensurate to the rise in income. The failure of Keynesian model led to the emergence of intertemporal model.


Some of the theories regarding intertemporal choices are the Fischer model of intertemporal consumption, Modigliani life cycle income hypothesis, Friedman permanent income hypothesis and others.


As per the Friedman permanent income hypothesis some consumption is permanent in nature and corresponds to the permanent income of the individual. However consumption also contain a variable or transient part.

CPt 2YPt

Ct = CPt + CTt

Yt = YPt + YTt

CP, is proportional to permanent income, YP. Actual consumption, C, and actual income, Y, consist of these permanent components plus unanticipated transitory components, CT and YT, respectively.


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