Example Of Dynamic Inconsistency

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Papers motivated by dynamic inconsistency

As explained in the introduction to this chapter, dynamic inconsistency poses a difficulty for welfare analysis, since the individual reveals different preferences at different points in time and it is unclear which of these set of preferences, if any, should be regarded as representing his welfare. An early approach to welfare evaluation in the presence of dynamic inconsistency is called the multi-selves Pareto criterion (e.g., Laibson et al. <cite>laibson1998self</cite>). This criterion is rationalized by regarding the individual as a collection of different selves. It asserts that a change in consumption is a welfare improvement if and only if it is acceptable by all selves; that is, increases
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</footnote> it is readily verified that applying it to the infinitely many periods version of the β, δ model, would result in the long-run criterion. In point of fact, the same conclusion holds even when postponing the consumption plans only by one period. As pointed by BR (p. 57-58), the arm 's length perspective might, in some cases, provide a better guidance for welfare because it does not trigger the psychological processes responsible for apparent lapses of self-control but in other cases it provides poor guidance for welfare due to various reasons such as imperfect imagination and indecisiveness.
<footnote>We believe that when it is a lack of self-control that makes us suspicious about whether particular choices are a good guidance for welfare, this should be modeled explicitly (as we do in Chapter 4).
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In a novel approach, Kahneman et al. <cite>kahneman1997back</cite> cast doubts on the revealed preference methodology in the intertemporal setting: "Systematic errors in the evaluation of past events and decisions that do not maximize future experienced utility... raise doubts about a methodology in which observed choices provide the only measure of the utility of outcomes" (p. 376). Kahneman et al. therefore suggest, instead of revealing preferences from choice, to measure the agent 's instant utilities directly and to regard the agent 's total utility (welfare) according to a "time natural perspective," that is, with no

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