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Can People Compute? An Experimental Test of the Life Cycle Consumption Model

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  • Stephen Johnson
  • Laurence J. Kotlikoff
  • William Samuelson

Abstract

This paper presents the results of an experimental study of the life cycle model in which subjects were asked to make preferred consumption choices under hypothetical life cycle economic conditions. The questions in the experiment are designed to test the model's assumption of rational choice and to elicit information about preferences. The subjects' responses suggest a widespread inability to make coherent and consistent consumption decisions. Errors in consumption decision-making appear to be very substantial and, in many cases, systematic. In addition, the experiment's data strongly reject the standard homothetic, time-separable life cycle model. The principal specific findings of the laboratory experiment are: (1) Subjects displayed significant inconsistencies in their consumption decisions; each of the subjects, in at least two pairs of economically identical situations, chose consumption values that differed by 20 percent or more. From the perspective of the standard life cycle model, error in decision-making accounts, on average, for roughly half of the variation in consumption. (2) A sizeable fraction of subjects undervalued future earnings relative to present assets; i.e., they systematically overdiscounted future earnings. (3) Almost all subjects exhibited oversaving behavior, apparently because they underestimated the power of compound interest. (4) The hypothesis that intertemporal consumption preferences are uniform across individuals is strongly rejected. Indeed, the demographic characteristics of subjects are significant determinants of consumption choice in the experiment.

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  • Stephen Johnson & Laurence J. Kotlikoff & William Samuelson, 1987. "Can People Compute? An Experimental Test of the Life Cycle Consumption Model," NBER Working Papers 2183, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2183
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    Cited by:

    1. Muller, Wieland, 2001. "Strategies, heuristics, and the relevance of risk-aversion in a dynamic decision problem," Journal of Economic Psychology, Elsevier, vol. 22(4), pages 493-522, August.
    2. Levy, Matthew & Tasoff, Joshua, 2016. "Exponential-growth bias and lifecycle consumption," LSE Research Online Documents on Economics 102087, London School of Economics and Political Science, LSE Library.
    3. Mohamed Bouzahzah & Frédéric Docquier & Oliver Paddison, 2002. "Retraites, croissance et inégalités en présence d'individus myopes," Économie et Prévision, Programme National Persée, vol. 155(4), pages 31-44.
    4. Pablo Mira, 2023. "Consumption and Fluctuations: What Role for Behavioral Economics?," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(82), pages 98-127, November.
    5. Levin, Laurence, 1995. "Demand for health insurance and precautionary motives for savings among the elderly," Journal of Public Economics, Elsevier, vol. 57(3), pages 337-367, July.
    6. Harald Uhlig & Martin Lettau, 1999. "Rules of Thumb versus Dynamic Programming," American Economic Review, American Economic Association, vol. 89(1), pages 148-174, March.
    7. Vital Anderhub & Werner Gäuth & Wieland Mäuller & Martin Strobel, 2000. "An Experimental Analysis of Intertemporal Allocation Behavior," Experimental Economics, Springer;Economic Science Association, vol. 3(2), pages 137-152, October.
    8. Francesco Cecchi & Tinka Koster & Robert Lensink, 2021. "Liquidity defaults and progressive lending in microfinance: A lab‐in‐the field experiment in Bolivia," Review of Development Economics, Wiley Blackwell, vol. 25(4), pages 2013-2030, November.
    9. Sheng-Cheng Hu, 1996. "Myopia and Social Security Financing," Public Finance Review, , vol. 24(3), pages 319-348, July.
    10. Tetsuo Yamamori & Kazuyuki Iwata & Akira Ogawa, 2020. "Effect of Longevity on Saving Behavior: An Experimental Study on the Simple Intertemporal Life-Cycle Problem," Working Papers e153, Tokyo Center for Economic Research.
    11. Yasufumi Gemma, 2016. "Money Illusion Matters for Consumption-Saving Decision-Making: An Experimental Investigation," IMES Discussion Paper Series 16-E-06, Institute for Monetary and Economic Studies, Bank of Japan.
    12. Tetsuo Yamamori & Kazuyuki Iwata & Akira Ogawa, 2014. "An Experimental Study of Money Illusion in Intertemporal Decision Making," Working Papers e085, Tokyo Center for Economic Research.
    13. Ballinger, T.P. & Palumbo, M.G. & Wilcox, N.T., 1998. "Precautionary Saving in the Laboratory," Papers 98-04, Houston - Department of Economics.
    14. Hermansson, Cecilia & Song, Han-Suck, 2016. "Financial advisory services meetings and their impact on saving behavior – A difference-in-difference analysis," Journal of Retailing and Consumer Services, Elsevier, vol. 30(C), pages 131-139.
    15. Dilip Soman & Amar Cheema, 2002. "The Effect of Credit on Spending Decisions: The Role of the Credit Limit and Credibility," Marketing Science, INFORMS, vol. 21(1), pages 32-53, September.
    16. Giles W Story & Ivo Vlaev & Peter Dayan & Ben Seymour & Ara Darzi & Raymond J Dolan, 2015. "Anticipation and Choice Heuristics in the Dynamic Consumption of Pain Relief," PLOS Computational Biology, Public Library of Science, vol. 11(3), pages 1-32, March.
    17. Feltovich, Nick & Ejebu, Ourega-Zoé, 2014. "Do positional goods inhibit saving? Evidence from a life-cycle experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PB), pages 440-454.
    18. Yamamori, Tetsuo & Iwata, Kazuyuki & Ogawa, Akira, 2018. "Does money illusion matter in intertemporal decision making?," Journal of Economic Behavior & Organization, Elsevier, vol. 145(C), pages 465-473.

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