Economic Perspectives on Addiction: Hyperbolic Discounting and Internalities

Abstract

This paper provides an introduction, with critical interpretations, to the use of hyperbolic discounting as a model of behavior for the consumption of addictive goods. The exponential and hyperbolic discounting models are carefully reviewed, with particular emphasis on the implications for time consistency. We then present a simple explanation of the logic of market failure resulting from internalities and the economic inefficiency that can result when time inconsistent choices have inter-temporal impacts. We then briefly review, with commentary, key work, from the experimental and broader empirical literature, that can be used to assess and critique the hyperbolic discounting model.