Eliciting Discount Functions when Baseline Consumption changes over Time

Many empirical studies on intertemporal choice report preference reversals in the sense that a preference between a small reward to be received soon and a larger reward to be received later reverses as both rewards are equally delayed. Such preference reversals are commonly interpreted as contradicting constant discounting. We show that this interpretation is correct only if baseline consumption to which the outcomes are added, remains constant over time. The difficulty with measuring discounting when baseline consumption changes over time, is that delaying an outcome has two simultaneous effects: (1) due to the change in baseline consumption, it changes the increase in utility from receiving the outcome, and (2) it changes the discount factor applied to this increase in utility. In order to draw conclusions about discounting one needs to disentangle these two effects which seems impossible at first sight (Noor, 2009). Yet, in this paper we propose a way to disentangle the two effects.