Economics of Commitment: Why Giving Away Some Freedom Makes Sense

Abstract

In general, the more freedom we have, the better choices we can make, and thus, the better possible economic outcomes. However, in practice, people often artificially restrict their future options by making a commitment. At first glance, commitments make no economic sense, and so their ubiquity seems puzzling. Our more detailed analysis shows that commitment often makes perfect economic sense: namely, it is related to the way we take future gains and losses into account. With the traditionally assumed expo- nential discounting, commitment indeed makes no economic sense, but with the practically observed hyperbolic discounting, commitment is indeed often economically beneficial.

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