ECON 406

U NIVERSITY OF M ARYLAND
E CONOMICS D EPARTMENT

HW 3
Yusufcan Masatlioglu

1. (Immediate cost and delayed reward) Today is Friday and you must write a paper before
Monday. However, it is a mid-November weekend with plenty of sports on TV–pro-
basketball on Friday night, college football on Saturday, and pro-football on Sunday.
You prefer watching pro football to college football, and prefer college football to pro
basketball. The attractiveness of the sports are 3, 8, 13, respectively, and they are im-
mediate. Writing the paper costs you to miss one of these events. You know the paper
will be better if written on either Saturday or Sunday (when you have an entire day).
While the reward of the paper written on Friday is 12, it is 18 if it is written on Saturday
or Sunday. The reward is delayed: you get the reward next day.
For example, if you do the paper on Saturday, you get an additional benefit of 18 on Sun-
day, but you miss the game which costs you 8 (Saturday Event). Hence, from todayÕs
point of view, if you do it on Saturday, your payoff stream will be (3, 8 − 8, 13 + 18, 0) =
(3, 0, 31, 0). Assume β = 1/2 and δ = 1.

a) Show that a sophisticate works on the term paper before a time-consistent agent
does.
b) Show that a sophisticate works on the term paper before a naif does.
c) Intuitively explain the results of part (a) and part (b).

2. Kaya can work on two unpleasant tasks, A and B, during the next three days (t ∈ {1, 2, 3}).
Each task needs two days of work to be completed(need not to be consecutive days), a
starting period and a finishing period. If he has completed a task within the first three
days, he will receive a reward at day four. On each day t ∈ {1, 2, 3} he can take one of
the following three actions: working on task A, working on task B, or not working. Not
working costs zero. The immediate costs for working on project A in period t = 1, 2, 3
are 4, 22, 45, respectively, and the delayed reward is 40. Similarly, for project B, costs are
8, 4, 15 and the reward is 25:

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 Project Costs Reward
t =1 t =2 t =3 t =4
A 4 22 45 40
B 8 4 15 25

It is assumed that Kaya does not discount future utilities, i.e. δ = 1. Furthermore, as-
sume that if Kaya is a hyperbolic discounter, β is equal to 1/2.

a) Assume Kaya is time consistent. If he decides to work on one of the two projects,
A or B, when does he do it? Does he ever do any project? If he does, which one?
b) Now assume Kaya is a sophisticated hyperbolic discounter.
i. Assume Kaya started project A in one of the first two periods but did not finish
it. In period 3, does he complete the project? Similar, will he complete project
B if he has worked on it in one of the previous period?
ii. In period 2, does Kaya complete a project if he has worked on it in the first
period?
iii. When does this person work and on which task?
c) Describe the original plan of a naive hyperbolic discounter and what actually he
does.
d) Compare the behavior of sophisticates and naifs. Give a brief intuitive explana-
tion for the different behavior of these two types of hyperbolic discounters.

3. Assume that you were lucky enough to acquire a coupon to see one sneak preview over
the next four Fridays. You are crazy about sneak previews since you want to see the
movies before everyone. In addition, you cannot get them from other sources. Every
Friday, you decide whether to go to the movie if you have not yet used the coupon.
Utility values (reward) of movies are 100, 150, 250 and 400, respectively. The schedule
of next four movies, and utilities are given in the next table.

Movie Sherlock Holmes We Bought a Zoo A Separation The Devil Inside

t=0 t=1 t=2 t=3
utility 100 150 250 400

a) Consider a time consistent individual (TC) with δ = 1. Which movie does TC see?
b) Now consider a naive hyperbolic person (N) with β = 1/2 and δ = 1. What is N’s
plan? Which movie does N see?
c) Now consider a sophisticated hyperbolic person (S) with β = 1/2 and δ = 1. What
is S’s plan? Which movie does S see?

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 Assume that you have a nephew who is crazy about the wrestler called “Rey Myste-
rio” of WWE (World Wrestling Entertainment). WWE’s shows are on every Friday.
You like your nephew, but you hate WWE. Hence, your overall utility from watch-
ing a WWE show with your nephew is zero. Since each ticket costs money, your
overall utility will be the cost of two tickets (one for you and one for your nephew).
Assume that your utility for money is u(m) = m.
You are now (t = 0) whether to promise your nephew to take him to WWE show
for a certain date (for example the show on t = 2). If so, you need to buy (and pay
for) the tickets right away because of the popularity of WWE. Once you promise,
you must take him to WWE and cannot attend the sneak preview for that week.
d) If you are N, what is the maximum total amount of money that you are willing to
pay for each WWE show?
e) If you are S, what is the maximum total amount of money that you are willing to
pay for each WWE show?