Wednesday, December 28, 2011

Time Preference

Time preference is an economic term for the degree to which we prefer present to future satisfaction (consumption). It relates to how much money we want to spend now, and relates that to how much we're willing to invest to consume at a future date.

But it doesn't just apply to our capital, but how we spend our time as well.  How much time we spend in leisure (consumption) compared to the labor we're willing to work in order to have future leisure in the conditions we want.

Now, how is this important?  The first implications are that time preference affects how much is saved and invested for future use.  The lower time preference is willing to save more and consume less.  The saved funds become potential capital to be invested, and make the individual richer.  The more capital a society as a whole invests, the faster that society will advance due to capital investment's positive effects on production.

Now another important implication of time preference builds on the first implication, that capital investment builds and lengthens the structure of production.  The Austrian Business Cycle Theory states that when banks print new money and loan it to businesses it lengthens the structure of production.  It tricks businesses into thinking there's new savings available to fund new business ventures, for there is new money to invest.

The problem arrives when this money filters down to individuals through wages and purchased goods, where these individuals, based on their otherwise unhampered time preferences, rush to reestablish their old savings/consumption ratios.  This bids investment away from capital goods back to consumer goods, causing a crisis to occur when businesses who've invested in longer capital structures to realize these were malinvestments.

And so, that's a very simplified version of the Austrian Business Cycle Theory and why the time preference axiom is important to economics.

Thanks for reading, and like always - questions and comments are welcome and appreciated.

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