PROJECTION BIAS INPREDICTING FUTUREUTILITY* GEORGE LOEWENSTEIN TED O’DONOGHUE MATTHEW RABIN Peopleexaggerate the degree to which their future tastes will resemble their current tastes.We present evidence from a varietyof domains which demon- stratesthe prevalence of such projectionbias, developa formalmodel of it,and use thismodel to demonstrate its importance in economic environments. We show that,when people exhibit habit formation, projection bias leads people to consume toomuch early in life,and to decide, as time passes, to consume more— and save less—than originally planned. Projection bias can also lead to misguided pur- chasesof durable goods. We discuss a numberof additional applications and implications. Thegreat source of both the misery and disordersof human life,seems to arise from over-rating the difference between onepermanent situation and another.Avarice over-rates the differencebetween poverty and riches:ambition, that be- tweena private and apublic station:vain-glory, that between obscurityand extensivereputation— Adam Smith, The The- oryof Moral Sentiments [2002, p. 173; III,iii,31]. I. INTRODUCTION Optimal decision-makingoften requires a predictionof fu- turetastes, and futuretastes may differ fromcurrent tastes due tosuch factors as habit formation,day-to-day mood uctuations, socialin uences, maturation, and changesin theenvironment. *Forhelpful comments, we are grateful to Erik Eyster, ChristopherHarris, andmembers of theRussell Sage Foundation Behavioral Economics Roundtable; seminarparticipants at Cornell University, Yale University, Harvard University, Universityof Michigan,University of Texas,Syracuse University, London School ofEconomics, University of Zurich, the Toulouse Conference on Psychology and Economics,and the Jerome Levy Institute;and Lawrence Katz, Edward Glaeser, andan anonymousreferee. We especiallythank Colin Camerer and Drazen Prelec forvery helpfuldiscussions at theformative stages of this project. Forresearch assistance,we thank Kitt Carpenter,Erik Eyster, JeffreyHolman, David Huff- man,Christopher Meissner, and Mandar Oak. For nancialsupport, Loewenstein thanksthe Center for the Study ofHuman Dimensions of Global Change at CarnegieMellon University (NSF Grant SBR-9521914),O’ Donoghueand Rabin thankthe National Science Foundation (Awards SBR-9709485,SES-0078796, andSES-0079266), and Rabin thanks the Russell Sage, MacArthur, andSloan Foundations.This research was started while Loewenstein and Rabin were Fel- lowsat theCenter for Advanced Study inthe Behavioral Sciences, supported by NSF Grant SBR-960123,and they are very gratefulfor the Center’ s hospitality andthe National Science Foundation’ s support. © 2003by thePresident and Fellowsof Harvard Collegeand theMassachusetts Institute of Technology. The Quarterly Journal ofEconomics, November2003 1209 1210 QUARTERLY JOURNALOF ECONOMICS Whenmaking summer vacation plans during thecold of winter, peoplemust predict what vacationswill bemost enjoyable during theheat of summer. When ordering food at thebeginning of a meal,people must predict howhungry they will beat theend of themeal. When contemplating smoking cigarettes or indulging in otherhabit-forming substances,people must predict howthis consumptionwill affect theirfuture desire for and enjoymentof thesesubstances. In this paper weprovide evidence for, formalize, and explore theimplications of a generalbias in theprediction of future tastes:people tend tounderstand qualitatively thedirections in whichtheir tastes will change,but systematicallyunderestimate themagnitudes of thesechanges. Hence, they tend toexaggerate thedegree to which their future tastes will resembletheir current tastes.Such projectionbias maycause people making summer vacationplans in thewinter to chooseoverly warm destinations, dinersto order too much food at thebeginning of meals, and peopleunaddicted tocigarettes to underestimate the power of and drawbacks ofaddiction. In SectionII wereview evidence from a varietyof domains supporting theexistence of projectionbias. Peopleunderappreci- atethe effects of long-term changes in tastes,such as thosethat resultfrom adaptation toa shifting standard ofliving.People also underappreciatethe effects of frequently uctuating tastes,such as uctuating hunger.Indeed, virtually all evidencewe are fa- miliarwith onmisprediction of future tastes is consistentwith projectionbias. In SectionIII wedevelop a formalmodel of projectionbias. To xideas,suppose that aperson ’sinstantaneousutility can be written as u(c,s), where c is herconsumption and s is a “state” that parameterizesher tastes. Suppose furtherthat theperson with currentstate s9 mustpredict hertastes at atimein the futurewhen her state will be s.Consistentwith evidencethat peopletend tounderstand thequalitative natureof changes in tastes,but underestimatethe degree of change, we assume that the person’spredictionof her own future preferences, u˜ (c,sus9), liessomewhere “in between” hertrue future tastes u(c,s) and her currenttastes u(c,s9).Ourformal analysis in this paper assumes that u˜ (c,sus9)is asimplelinear combination of u(c,s) and u(c,s9), whichwe refer to as simple projectionbias. Becauseprojection bias leads todiscrepancies between pre- dicted and subsequentlyrealized utilities,it impliesthat aper- son’sbehaviorneed not correspond to correct intertemporal util- PROJECTION BIAS 1211 ity maximization.For instance, if currentconsumption has dele- teriouseffects on futurewell-being, and projectionbias leads the personto underappreciate these effects, she may overconsume relativeto what would maximizeher true intertemporal utility. Moreover,as tasteschange over time in ways shedoes not pre- dict, apersonmakes plans that shemay end up notcarrying out; that is,projection bias can lead todynamic inconsistency.A stressedundergraduate who underappreciates the addictiveness ofcigarettes, for instance, might start smokingwith theplan of quitting upongraduation, only to continue smoking after gradu- ationonce she becomes addicted. Todemonstratethe potential economic importance of projec- tionbias, in SectionsIV and Vweformallyanalyze twoeconomic environments.Section IV exploresthe implications of projection bias in alife-cycleconsumption model with habit formation. Whenconsumption is habit-forming,a personshould rationally pursuean increasingconsumption pro le,so that sheis always consumingmore than sheis accustomedto. Projection bias leads apersonto underappreciate the impact ofcurrent consumption onfuture utility, and henceto consume too much early in life and toolittle late in life relativeto what would beoptimal. More interesting,as timepasses and theperson habituates tohigher consumptionlevels, she may decide to consume more than she had earlierplanned; henceprojection bias cancause saving tofall shortof intentions. Finally, as theperson gets accustomed to higherconsumption levels, she also values income more highly, and hencemight decide to work more (or retire later) than she had earlierplanned. In SectionV weshow how projection bias can causemis- guided purchasesof durable goods.The satisfaction that aperson derivesfrom a durable goodoften uctuatesfrom day today, and projectionbias leads apersonto underappreciate how much her futurevaluations maydiffer fromher current valuation. As a result,people will overvaluethe good on high-value days and undervalueit onlow-value days. Apersonmaking a one-time buying decisionis thereforeequally likelyto buy whenshe should notor not to buy whenshe should. However, if theperson has multipleopportunities to buy, and (as is typically thecase) un- buying is moredif cultthan buying,projection bias will lead on averageto overpurchasing of durable goods. Webelieve that projectionbias is importantfor many eco- nomicapplications, and that it can providean intuitiveand parsimoniousaccount for many phenomena that areotherwise 1212 QUARTERLY JOURNALOF ECONOMICS difcultto explain. In SectionVI weextrapolate from our formal analysis in SectionsIV and Vand discuss someof these addi- tionalimplications. We conclude in SectionVII. II. EVIDENCE OF PROJECTION BIAS In this sectionwe review evidence from a varietyof domains supporting theexistence of projection bias. 1 Acommontype of tastechange is adaptation: peoplehave a remarkableability to adapt tomajor changes in theirlife circumstances,such as ac- quiring seriousmedical conditions, moving to different climates, and changingoccupations (see Helson [1964] and Frederickand Loewenstein[1999] fora recentreview). 2 Moreover,there is a greatdeal ofevidence that peopleunderappreciate the extent of suchadaptation. Speci cally,by comparinga “control” group’s predictionsfor how some major change would affect theirlives to theself-reports of people who have actually experiencedthat change,a numberof studies suggestthat peopleoverestimate the impact ofmajor changes on their long-run level of happiness. In themedical domain, cross-sectional studies haveconsis- tentlyfound that nonpatients ’ predictionsof the quality oflife associatedwith seriousmedical conditions are lower than actual patients’ self-reportedquality oflife. For instance, Sackett and Torrance[1978] ndthat nonpatientspredict that chronicdialy- sis would yield aquality oflife of0.39,whereas dialysis patients reporta quality oflife of0.56 (ona 0to1 scaleon which0 means as bad as death and 1meansperfect health). Boyd etal. [1990] nd analogouscross-sectional results with regardto colostomies. Thesame pattern alsoshows up in longitudinal studies.Jepson, Loewenstein,and Ubel[2001] askedpeople