Economic decisions are not just about whether to buy, but when to. If I’m impatient, I may borrow money to buy a television today. If I’m patient, however, I will wait until I have earned the money myself. Economists call people’s level of impatience their time preference. Although some are more patient than others, in general people prefer a television today to a television in a month. People are said to ‘discount’ the future.
The time preference that an individual exhibits at any given moment is determined solely by their personal preferences. One of the factors that may determine an individual’s time preference is how long that individual has lived. An older individual may have a lower time preference (relative to what he had earlier in life) due to a higher income and to the fact that he has had more time to acquire durable commodities (such as a college education or a house).
A practical example is if Jim and Bob go out for a drink and Jim has no money so Bob lends Jim $10. The next day Bob comes back to Jim, and Jim says, “Bob, you can have $10 now, or at the end of the month when I get paid I will give you $15.” Bob’s time preference would change depending on if he trusted Jim and how much he needs the money now, thinks he can wait or would prefer to have $15 at the end of the month than $10 now. Present and expected needs, present and expected income affect the time preference.
People who discount at a high rate are likely to save less and consume more today. This is related to the idea of an interest rate. $100 in a year’s time is viewed as worth less than $100 today, so if I lend someone $100, I will ask for more than $100 to be returned to me in a year. If I expect to receive $100 in one year, then I would want to know the ‘present value’ of this amount. This would be the amount that I would have to lend out at interest today to be paid back $100 in a year, and would be less than $100.