Front Page Titles (by Subject) CHAPTER 21: RATE OF TIME-PREFERENCE - Economics, vol. 1: Economic Principles
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CHAPTER 21: RATE OF TIME-PREFERENCE - Frank A. Fetter, Economics, vol. 1: Economic Principles 
Economics, vol. 1: Economic Principles, (New York: The Century Co., 1915).
Part of: Economics, 2 vols.
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RATE OF TIME-PREFERENCE
§ 1. Subjective rate of time-preference. § 2. Time-preference showing in care and repairs. § 3. Time-preference showing in production of indirect agents. § 4. Time-preference rate pervading an economy. § 5. Time-preference and moral weakness. § 6. Beginnings of durative direct goods. § 7. Valuation of durative direct goods. § 8. Relation of technic to time. § 9. Examples of technical and time-differences. § 10. Degrees of roundaboutness ruled by time-preference.
§ 1. Subjective rate of time-preference. The fundamental ideas of value (developed in Part I) have application to the rate of time-preference. Wherever there is a good that offers a time-choice to its possessor, there arises valuation as regards time. One may eat the apple now (a typical direct good) or postpone its use, may shift it forward or backward in time. We know little of the absolute magnitudes of the desires that men may have for these things at the two different points of time. We infer only that if a man eats the apple now, his desire for its present use is greater than his present desire for its future use. The preference of the present may be due (case 1) to the prospect that apples which are scarce now will be much more plentiful in the future; there we feel almost warranted in saying that the absolute magnitude of the present value is greater than it will be at that future time. We at least feel that we can infer something as to this. But again (case 2) the present use is chosen when the prospect is that apples will be no more plentiful, indeed when it is certain that they will be less plentiful, but when our need and our desire for them will be greater. Again (case 3) when one eats a part and keeps a part of a large crop and the keeping involves no trouble or cost whatever, and no loss from decay, etc., there may be no difference whatever in the present values of the different units of the stock. The principle of indifference applies. But in almost every conceivable case the keeping of a good calls for some labor (thought and physical effort) and the use of agents valuable for other purposes (case 4). The present value of a future unit would have to be therefore at least enough greater than that of the present unit to make up this additional cost, otherwise it will not be kept. Present value plus estimated cost of keeping equals present value of future unit. There is time-preference for the future, exactly offset by costs. The marginal unit for each period would be in equilibrium with the marginal unit in the other period. (See Figure 32.)
In these cases, however, there is no element of pure timepreference, other than that offset by costs, no degree of preference for the present unit simply because it is present. The supposition involved is that of equality of value to the results of equal expenditures of labor and to equal amounts of other agents regardless of the time-distance at which various products would appear. Even in a Crusoe economy such a preference must exist. If Crusoe disregarded all time-differences he would take exactly the same thought of the products of fifty years distant as he did of present products and would put just as much of his labor and equipment upon them; that is, he would divide the year’s products into fifty (or more) parts, using only a fiftieth. Normally he uses all or nearly all of this year’s income, leaving to next year’s labor and equipment the task of providing for next year’s needs. Practical observation and all the considerations adduced above (Chapters 3, 10, and 20) regarding man’s nature, support the view that present desires will receive on the whole more attention than future desires. If any true time-preference whatever prevails, it must be at some rate, in each case, tho the rate may vary with the mood and the conditions in which Crusoe finds himself. One could, by watching different individuals working at their own affairs, form a general opinion, often a pretty accurate one, as to whether their rates of time-preference were high or low. It would show in many ways in their use of their own time and of their stocks of goods, in the qualities of thrift, industry, prudence, etc. But to express any general rate at all exactly would be most difficult so long as we observed only the choice among many objects, without any common standard of value in which to compare them.
§ 2. Time-preference showing in care and repairs. If Crusoe’s time-preference (for the present) were very high it would show in his use both of his stock of enjoyable goods and of his stock of indirect durative agents. (See Chapter 11, section 11, on the economy of repairs.) When he landed in his canoe he would let it lie on the beach at the risk of its being filled with water or dashed against the rocks, or carried out to sea. This act necessarily implies that at that moment he values his own effort to pull it up more than he values the dimly seen necessity of bailing it out to-morrow, or of repairing the injury done by the rocks, or of making a new one when this is lost. When his house leaks he would do as the proverbial Arkansas farmer (not peculiar to that state), who couldn’t mend his roof when there was rain and saw no need to mend it when there wasn’t. Crusoe’s use and management of his garden, of his fowls, and of his goats, their feeding, breeding and care, all would involve and express a certain comparison between present and future vegetables, grain, eggs, milk, cheese, goat meat and skins, his own labor, etc. In every economy, whether in Crusoe’s or in a larger community, the practice of each individual as to repairs and the efforts made by him to offset depreciation, inevitably embody that individual’s rate of time-preference in a thousand ways, tho it varies more or less with his mood, health, fatigue, etc., and tho he is quite unconscious of any arithmetic expression of it.
A rate would show itself among other ways, in the need of more labor and more materials later, than would suffice now. A handful of earth may stop a hole in a dyke, whereas a trainload would be insufficient later. Whenever it is true that a stitch in time (now) saves nine (next year) and the stitch is not taken, then the neglect involves a rate of 800 per cent in terms of present stitches (one now, increment next year eight). If one day’s labor now on the canoe is found by experience to save two days’ labor a year later and it is not taken, then the rate is over 100 per cent a year (one now, two next year; increment one, or 100 per cent of quantity). Plainly, however, two greatly diverse rates if recognized, could not long continue to exist side by side. For if the rate were even 99 per cent, not only would the canoe be mended but the stitch would be taken in time wherever it would save two or more stitches next year. And so, it would be if there were a thousand different kinds of repairs to be done. There would not be a thousand different actual rates of physical increments; for so far as there is any normal habit or consistency in the individual’s conduct these different rates of increments will be brought more or less into conformity with a prevailing rate of time-preference. Whatever that rate be, there is good reason to make the possible repairs that involve a greater rate. But those repairs, the neglect of which involve a smaller increment, ought not to be made. The rate of time-preference, like an isothermal line, marks off the repairs that hypothetically would involve a greater increment (and which now are made) from those which involve a less rate (which now are left undone).
Repair is nothing but a particular case of production presenting the peculiar problems of complementary agents. Even where time-preference is very great, repairs will be promptly made when the whole agent with all its usance-value may be put back into running order by replacing a single part (as by mending a hole in a canoe, putting a new string on a bow, etc.). It is the anticipatory repairs, the ounce of prevention that is most likely to be neglected in an improvident economy. When many repairs are needed, the repair becomes as difficult as the making of a new agent, or more difficult, and presents practically the case of new production.
§ 3. Time-preference showing in production of indirect agents. A rate of time-preference is reflected in the physical increment of goods in many cases. Suppose one hundred days of labor this year will produce one thousand fish, caught by wading the streams or will make a canoe which will enable one hundred days of labor next year to yield 1100 fish; and suppose that one day’s labor will obtain one thousand apples in the wild forest, and will plant a tree that will yield 1100 apples next year; then the choice of the relatively direct method results in a physical excess of products at the rate of 10 per cent. But the direct method is chosen and will continue only when the rate of time-preference is over 10 per cent, and is abandoned as soon as the rate of time-preference is less than 10 per cent. Whenever a Crusoe “gets ahead far enough” in his equipment to have a canoe, he no longer gets his fish by wading the streams (except at unusually favorable moments), and when he has got to the point of having an orchard he no longer plans to gather fruits in the forest (tho he will pick the few that are easiest to get). He continues this choice among all the possible present and future uses of his present labor and resources, till he has included all the time-consuming methods, whether direct or indirect, that involve increments as great as his rate of time-preference. That rate, as it falls to 9, 8, 7, etc., dominates the choice of technical processes. A man’s prevailing attitude of mind and habit of choice between present and future, in the use he makes of his present economic agents (labor and goods) marks, so to speak, an isothermal line between those savings which he makes (all tending to the same rate by the marginal law) and those which he fails to make (the excluded choices). Time-preference (a purely psychological fact) involves a rate of discount or of premium which thus would show itself here and there in a certain quantitative surplus or increment each year over the yield possible by the alternative methods. When, however, a better technical method is in use, and is warranted by the rate of time-preference, it is possible only at a loss to go back to the older method. For lack of a saving that involves but 5 per cent discount on next year’s goods, one might reduce production to an amount involving 100 per cent discount. Evidently this would be a maladjusted economy, and would call for a new adjustment of agents for present and future uses.
§ 4. Time-preference rate pervading an economy. The mere physical increments that result from any process or method of production are not necessarily value increments of the same magnitude. Indeed, we have no absolute standard by which to measure the magnitude of a person’s valuations in two different periods, any more than we have to measure the magnitude of values in the minds of two different persons at the same time. If one values 100 present fruit now as much as he values 110 next year, we can not say that the 110 when they come will have a value 10 per cent greater than they have now. This year there may be an unusually small crop, next year there may be reason to expect an unusually large crop. Under the conditions one hundred present fruit may have a present worth of two hundred future fruit at the same time that many other choices indicate a time-preference rate of not over 10 per cent. Again we must confess that we have no absolute standard of values that can be carried over from one time period to another.
However, when we stand outside of an individual economy, overlooking the seasonal variations within the years and the changes in productive methods due to science and invention, and we see how on the average, year after year, choice is made, we could form some judgment of the person’s prevailing or pervading rate of time-preference. Such a rate each individual has; and these rates of individuals unite into a time-price when two or more persons trade present for future possession of goods. Just as the subjective, individual choices between any two commodities (Chapter 7, sections 3-7) enter into a market-price of objective goods, so the rates of time-preferences of individuals trading in a market are adjusted to each other and result in a market-rate of time-preference.
§ 5. Time-preference and moral weakness. Economics touches frequently upon the borders of ethics, and it is well to observe here that abstinence is but an aspect of choice and will-power which has effects in the realm of moral as well as of economic values. If there were to be formulated an economics of personal conduct, it surely would give a large place to the comparison between present and future enjoyments.
The problems of abstinence and time-value appear in prodigality, in much heedless pleasure, and in many forms of vice. Prudence, always included among the virtues, is the faculty of recognizing not only future costs and dangers to be avoided, but the greater future joys that may be gained at the price of present sacrifice. It is not without reason that in the discipline of youth in civil and military life, the cultivation of thrift, order, and promptness are in every land deemed to be fitting means, when wisely employed, of developing moral virtues. Shiftlessness in the performance of tasks for one’s own good is almost certain to show itself in failure to fulfil agreements with others, resulting in excuses, falsehood, and degeneration of character.
Time-value is involved in prodigality. Often the estimate of the present good is unduly high, viewed in the light of wider experience. Goods that meet momentary desires make an exaggerated appeal to untrained minds. The child, the spendthrift, the savage, can not properly estimate the relative values of present and future. The drinker exchanges the hopes of a worthy life for the exhilaration of the spree. The reckless, underestimating the future penalties of disease, insanity, and death, barter health and happiness to gratify the moment’s impulse. Indulgence in social pleasures, if secured at the price of lost sleep, weakened health, and debauched character, are loans from the future made by youthful prodigals at usurious cost. If no one ever paid more than a moderate premium for the gratification of his present whims and impulses, most hospitals, drug-stores, and medical colleges would close, and half, if not all, the prisons would be empty.
§ 6. Beginnings of durative direct goods. The illustrations of time-value thus far have been of consumptive direct use of goods. (See the analysis in Chapter 11, section 1.) These are the nearest to psychic income, and in this class of cases time-value appears in its simplest form. Historically viewed, likewise, this is the starting point of time-value. The animals (with few exceptions) live only in the realm of value that contains present, direct, consuptive uses. The savage’s range of vision and choice is wider, but still is limited mainly to direct present uses gained with such aid as his simple tools and weapons afford. He leads necessarily “a hand to mouth” existence. He has no surplus stock except by lucky chance. Lack of success for a few days in the everlasting search for food means hunger, then famine, and the diseases which always follow in its train. The increase of wealth in early times, therefore, took largely the form of larger stocks of direct goods. Some of these were of a kind that could be kept, such as stores of vegetable food, flocks and herds of animals kept to be eaten, hoards of precious ornaments, more and better clothing and shelter, weapons of the chase, horses, dogs, etc., which were valued also as direct agents in sport, not merely as means of getting food.
§ 7. Valuation of durative direct goods. Let us now extend our study of time-value to more durative direct goods. (See numerous illustrations, Chapter 11, sections 2 and 3.) Take a dwelling as an example. Literally every moment’s use of a house is a separate use, but for convenience these infinitesimal uses are grouped into conventional units, as one day’s or month’s or year’s use, evaluated all at one date. The uses of a house for the next ten years may be practically the same in a physical sense but they are distributed in time. But it is not a stock of present, non-perishable goods which may be all treated as present uses or all as future uses subject to the leveling influence of time-preference. Each use is fixed in time and must be valued there or not at all. (See Figure 34.) If every future use were valued now without discount, the present values of the units would be represented by the top line. If this occurred in the case of a durable house that should last a hundred years, the total present value of future uses would be one hundred times this year’s use. A piece of real-estate kept up under the renting contract has an indefinite series of uses, which if not discounted would have an incredibly large present value, a thousand times, or an infinite number of times, the value of the annual use. But if the future uses (as usually happens) are discounted in the present, this might be represented by the descending line. Such regularity results, however, only in a market where the great variety of individual differences of conditions have been combined into a market-rate of time-preference. A (Figure 35) has a growing family and the uses of the house will steadily increase for the next six years, and then, as his children leave home, will decline. B is expecting to be away for a time, and the house will first yield uses of smaller, then of larger, value. If each of these persons or families were in a Crusoe economy such differences would affect the amount of labor and materials put upon a house, the year in which it would be built or improved, etc. But in a market for house uses many other adjustments are possible, through moving out and moving in, buying and selling, sub-letting, etc., by which these differences of individuals’ circumstances largely disappear, and only the general and persistent discount, reflecting a market-rate of time-preference, remains. A diamond necklace is a good example of an absolutely durative series of uses. If each year the value of the use is expected to mature as one hundred dollars, the necklace would have an infinite value if the future uses were not discounted.
§ 8. Relation of technic to time. Directness of use (technical) and timeliness are not the same. (See Chapter 10.) Of the thousands of forms of matter in the world, only a comparatively few ever will make an immediate impression on man’s senses. But many of them are in his life so connected with uses by instinct, association, and reasoning that he attaches an importance to them. In most cases it would require close thought to see that the service attributed directly to them is but a reflection of that performed by some other thing. To include indirect uses in choice, calls for something the same kind of wider vision that is needed to include future uses. Indirectness and futurity may be, and often are, united in a single concrete good. Indeed, these two qualities of goods are very commonly confused in thought, whereas their gradations are in different planes of thought; they are, so to speak, at right angles with each other but having a single point in common. This may be graphically represented as in Figure 36.
§ 9. Examples of technical and time differences. Mere technical indirectness per se has nothing to do with time-value. If a technical process involving a half-dozen or more steps is completed within an instant, then the most indirect agent must have all the value reflected to it from the product, subject to no discount on account of the lapse of time. The man can get the nuts by climbing the tree, or by taking a stick and knocking the nuts to the ground. The difference in the time of the two processes is negligible, the indirect method securing the product as soon as the direct method. Hence there is no choice between the two as to the time-remoteness of the product, but only as to the amount of the product per unit of labor (or ease of labor to get the same product). If sticks are free goods, the whole amount of the additional product is attributed to the labor; if sticks are scarce, a part of the product must be attributed to the usance of the stick. But that is a usance-problem, not a time-value-problem. But if the same amount of labor will plant another tree which will yield a much larger and better crop annually after twenty years, then time is an element. Or again: the coal heats the iron tubes, the tubes heat the water, the steam moves the piston rod, the piston rod turns the wheel, the wheel a belt, the belt turns a dynamo, the dynamo generates electricity, the electricity is carried through a wire to a filament in a glass bulb, and you are enjoying artificial daylight in your home. The coal is the first link in a chain of indirect uses the last link of which is at the same instant yielding a direct use. Whatever part of the value of the use is imputable to the coal on value-principles, as one of the various complementary agents, is, so to speak, payable on the instant. When, however, the roundaboutness of the process is necessarily time-consuming, then time-preference operates. For an interval of time divides the indirect use of the agent and the final psychic income from which its value must be reflected. If the coal has been mined for some time, time-value is involved in the relation between the present worth of the coal when it was mined and the time when it is turned into illumination. Various possible ultimate uses, at various degrees of distance in time from the present, some a year, some five years, some twenty years, may compete for some indirect agents. The various products are located at different points in the line of time, and because of this difference (besides other differences) appeal with varying degrees of force to desires. If this were not so time-preference would have a zero magnitude.1
§ 10. Degrees of roundaboutness ruled by time-preference. Nearly the whole of the great mass of indirect goods applied to making stuff-, form-, and time-changes require more or less the lapse of time to yield their uses. True, the indirect uses as well as the direct uses of goods (see Chapters 9 and 10) may be more or less hastened or delayed, but that is a time-change that involves the sacrifice of other agents. There is in each economy a certain normal time-point, a point of maximum economy for a product to appear. Rush orders are always costly. If a horse is worked beyond a certain point, the present use shortens the horse’s working life. If, to save another trip, a wagon is too heavily loaded it is strained or broken. If a machine is geared to run beyond a certain speed, it does poorer work or goes to pieces. A sudden rise in the value of the product may warrant the sacrifice of agents. To warn the inhabitants of the valley that the dam has broken, the rider may ride his horse to death. To keep from freezing, a man will use mahogany furniture as firewood. A war vessel going into action throws overboard the piano and other cabin fittings. The outbreak of war sets all the armories to working overtime.
What is the psychological change that happens in these cases? The present use suddenly becomes so much more valuable than the future use, is so much preferred, that the mode of use, or intensity of use, is altered. Time-preference dominates the technical processes. And this is so in normal as in abnormal times. The normal time-point, the point of maximum economy, at any period, is one where the uses of indirect agents are distributed along the path of time in accord with an existing rate of time-preference. If next year’s uses are now valued just as much as this year’s uses, there would be one choice of roundabout processes, if they are valued one tenth less, there will be a very different application of indirect agents. There is thus a relation between roundaboutness and time-preference, but it is one in which the mere mechanical method is passive and subordinate to human choice, time-preference.
[* ]The bars of different length represent repairs involving different rates of time-preference. If the rate is nine per cent, all the kinds of repairs here shown would be made. The same illustration applies to the choice of indirect processes, discussed in sec. 3.
[* ]The block A represents the comparatively small area of present psychic income. Over the threshold at B flow the direct uses of goods at each present moment. The rectangle A-Z represents all present goods, ranging from most to least direct. Their technical uses are being transmitted along the line, from Z to A. At the same instant man and all his possessions are being swept along by the stream of time. The indirect uses of goods thus are like swimmers moving toward an opposite shore and being carried along by the time-stream. They move across at different angles, for while time moves at the same rate for all, the swimmers move forward at very different rates. Some uses that are very indirect technically, are causing psychic income almost at once (line Z-B); other uses but slightly indirect, the slow swimmers, are not to attain the shore of direct use for a long time as they move through the successive technical stages. The course they describe would be represented by the straight line Z y 6; or if the early indirect steps are faster or slower than the later ones, the agents describe courses represented by Z x N and Z z N.
[1 ]This distinction between timeliness and roundaboutness must be kept clearly in mind, for confusion at this point betrays one into a false notion of the nature of interest.