Social Time Preference (STP) refers to the value society places on present consumption as compared to future consumption. This concept is crucial in economics and finance, particularly in cost-benefit analysis where future benefits and costs need to be discounted to present values. In an ideal competitive market with no failures, the rate of social time preference equates to the equilibrium interest rate.
Historical Context
The notion of time preference has roots in classical economics, with early discussions by economists like Adam Smith and David Ricardo. The formalization of time preference into a systematic theory is attributed to Eugen von Böhm-Bawerk in the late 19th century. Over time, this concept has been refined and integrated into modern economic analysis, influencing theories of investment, consumption, and public policy.
Types/Categories
1. Pure Time Preference
Pure time preference is the degree to which society prefers present consumption over future consumption purely because it is available sooner.
2. Utility Discount Rate
This incorporates not just the pure time preference but also the expected changes in the utility of consumption over time.
Key Events
- 1871: Eugen von Böhm-Bawerk introduces the concept of time preference in his work “Capital and Interest.”
- 1930s: John Maynard Keynes discusses the implications of time preference in his seminal work “The General Theory of Employment, Interest, and Money.”
Detailed Explanations
Mathematical Representation
The social time preference rate (STPR) can be represented as:
where:
- \( r \) = rate of social time preference
- \( t \) = time period
Cost-Benefit Analysis
In cost-benefit analysis, future benefits and costs are discounted back to the present value using the social time preference rate:
where:
- \( PV \) = Present Value
- \( B_t \) = Benefits in time period \( t \)
- \( C_t \) = Costs in time period \( t \)
Equilibrium Interest Rate
In a perfectly competitive equilibrium without market failures, the social time preference rate equates to the equilibrium interest rate. This rate reflects society’s intertemporal preference for consumption.
Charts and Diagrams
graph TB
A[Present Value] -->|Discounting| B[Future Value]
A -->|Present Consumption| C[Utility]
B -->|Future Consumption| C
D[Social Time Preference Rate] --> A
D --> B
Importance
Understanding social time preference is vital for:
- Policy Making: Helps governments evaluate the long-term impacts of policies.
- Investment Decisions: Assists businesses in evaluating the profitability of future projects.
- Environmental Economics: Key in valuing future environmental benefits and costs.
Applicability
Examples
- Public Infrastructure Projects: Discounting future benefits of a new highway to determine its present value.
- Climate Change Policy: Valuing long-term environmental benefits from reducing emissions.
Considerations
- Risk and Uncertainty: The future is uncertain, making it crucial to adjust the STPR for risk.
- Intergenerational Equity: Balancing the needs of current versus future generations.
Related Terms with Definitions
- Discount Rate: The rate used to discount future cash flows to their present value.
- Interest Rate: The cost of borrowing money, which can reflect the time value of money.
- Cost-Benefit Analysis (CBA): A systematic approach to calculating the strengths and weaknesses of alternatives used in decision making.
Comparisons
- Private vs. Social Time Preference: Private time preference pertains to individual consumption decisions, whereas social time preference considers society as a whole.
Interesting Facts
- Some studies suggest that younger societies with more children may have a lower social time preference rate, indicating a higher value placed on future consumption.
Inspirational Stories
A story of how innovative discounting approaches based on social time preference helped a city modernize its infrastructure while maintaining fiscal responsibility could highlight the practical impact of this concept.
Famous Quotes
“Economics is the study of mankind in the ordinary business of life.” — Alfred Marshall
Proverbs and Clichés
- “A stitch in time saves nine.”
Jargon and Slang
- NPV (Net Present Value): The difference between the present value of cash inflows and outflows.
- DCF (Discounted Cash Flow): A valuation method used to estimate the value of an investment based on its future cash flows.
FAQs
What is social time preference?
Why is the social time preference rate important in cost-benefit analysis?
How is social time preference related to the equilibrium interest rate?
References
- Böhm-Bawerk, Eugen von. “Capital and Interest.” 1884.
- Keynes, John Maynard. “The General Theory of Employment, Interest, and Money.” 1936.
- Dasgupta, Partha. “Human Well-Being and the Natural Environment.” 2001.
Final Summary
Social Time Preference is a critical concept in economics that addresses how society values present consumption compared to future consumption. It plays a fundamental role in cost-benefit analysis, investment decisions, and public policy by helping to discount future values to present terms. The rate of social time preference, often aligning with the equilibrium interest rate in ideal markets, is essential for balanced economic planning and intergenerational equity.
