Academic journal article Economic Inquiry

How Many Paychecks? an Example of a Self-Imposed Constraint

Academic journal article Economic Inquiry

How Many Paychecks? an Example of a Self-Imposed Constraint

Article excerpt

I. INTRODUCTION

The case of Ulysses and the sirens is one of the most interesting puzzles for the model of rational behavior.(1) Ulysses knew enough about himself to know that he would not be able to control his behavior when under the spell of the sirens, so he had himself bound to the mast, had wax put into the ears of his crew, and instructed them to completely disregard any gestures he might make. It is reasonable to ask, if Ulysses knew enough to know that he would lose control when under the spell of the sirens, why didn't he know enough to maintain control? More generally, if you are rational enough to know you are going to be irrational, why can't you stop the irrationality? Apparently things are not so simple. Psychiatrist George Ainslie [1975; 1992] argues, based upon a large body of experimental evidence in psychology, that individuals have an inherent tendency to be myopic, and this leads them to have to develop rules of behavior which limit options. Given the story of Ulysses, the process of imposing such constraints on oneself is sometimes called binding.

The Christmas Club is the traditional example of a self-imposed constraint.(2) The local credit union offers an account which has all of the attributes of the normal savings account and the added characteristic that the account holder cannot make any withdrawals until a specified date close to Christmas. Given that the lack of flexibility inherent in the Christmas Club is combined with no compensating advantage of any sort (e.g. higher interest rates), standard analysis suggests the Christmas Club would have no takers. But in fact there are many Christmas Club members.(3) Apparently a large number of individuals feel they cannot trust themselves to save money for Christmas shopping in a normal savings account. The Christmas Club gives them a way of tying their hands. It is a self-imposed constraint.

In this paper, I examine behavior which might also be an example of a self-imposed constraint. At the College of William and Mary a full-time faculty member has the option of receiving her salary in eighteen equal payments over the nine-month academic year or in twenty-four equal payments over the entire year starting in September. The twenty-four month option has the look of a self-imposed constraint.(4) The faculty member who takes this option is foregoing interest earnings from a simple plan which deposits eighteen payments, earns interest, and finances the summer. Perhaps the faculty members who elect the twenty-four payment option are like Ulysses; they know enough to know that they will not follow the plan they know enough to make.

A preference for the twenty-four payment option is not necessarily evidence of a self-imposed constraint. Taking eighteen payments, squirreling away some of each payment, and financing one's summer expenditures from what had accumulated during the academic year is a costly endeavor. Therefore a standard economic model based on transactions costs could also explain a preference for the twenty-four payment option. The purpose of this paper is to present a test of these two models.

II. THEORETICAL ANALYSES OF THE CHOICE OF THE TWENTY-FOUR PAYMENT OPTION

A Standard Economic Model

The task at hand is to explain the demand for the twenty-four payment option as compared to the eighteen payment option. Since the total salary is the same in both cases, at any nonzero interest rate the present value of the eighteen payment option dominates the present value of the twenty-four payment option. This suggests that on a strict basis of economic rationality, there would be no takers for the twenty-four payment option. At William and Mary, however, over 67 percent of the faculty choose the twenty-four payment option. There is, however, a clear difficulty with simply comparing present values in this case. Such a comparison implicitly assumes that trips to the bank are costless. A complete model should consider transactions costs. …

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