Can People Compute? an Experimental Test of the Life Cycle Consumption Model

60 Pages Posted: 10 Feb 2001 Last revised: 4 Apr 2010

See all articles by Stephen Johnson

Stephen Johnson

Decision Research

Laurence J. Kotlikoff

Boston University - Department of Economics; National Bureau of Economic Research (NBER); Gaidar Institute for Economic Policy

William F. Samuelson

Boston University - Department of Finance & Economics; National Bureau of Economic Research (NBER)

Date Written: March 1987

Abstract

This paper presents the results of an experimental study of the life cycle model in which subjects were asked to make preferred consumption choices under hypothetical life cycle economic conditions. The questions in the experiment are designed to test the model's assumption of rational choice and to elicit information about preferences. The subjects' responses suggest a widespread inability to make coherent and consistent consumption decisions. Errors in consumption decision-making appear to be very substantial and, in many cases, systematic. In addition, the experiment's data strongly reject the standard homothetic, time-separable life cycle model. The principal specific findings of the laboratory experiment are: (1) Subjects displayed significant inconsistencies in their consumption decisions; each of the subjects, in at least two pairs of economically identical situations, chose consumption values that differed by 20 percent or more. From the perspective of the standard life cycle model, error in decision-making accounts, on average, for roughly half of the variation in consumption. (2) A sizeable fraction of subjects undervalued future earnings relative to present assets; i.e., they systematically overdiscounted future earnings. (3) Almost all subjects exhibited oversaving behavior, apparently because they underestimated the power of compound interest. (4) The hypothesis that intertemporal consumption preferences are uniform across individuals is strongly rejected. Indeed, the demographic characteristics of subjects are significant determinants of consumption choice in the experiment.

Suggested Citation

Johnson, Stephen and Kotlikoff, Laurence J. and Samuelson, William F., Can People Compute? an Experimental Test of the Life Cycle Consumption Model (March 1987). NBER Working Paper No. w2183. Available at SSRN: https://ssrn.com/abstract=228009

Stephen Johnson (Contact Author)

Decision Research

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Laurence J. Kotlikoff

Boston University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Gaidar Institute for Economic Policy

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William F. Samuelson

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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