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Definition of Discount Factor


Definition: In a multi-period model, agents may have different utility functions for consumption (or other experiences) in different time periods. Usually in such models they value future experiences, but to a lesser degree than present ones. For simplicity the factor by which they discount next period's utility may be a constant between zero and one, and if so it is called a discount factor. One might interpret the discount factor not as a reduction in the appreciation of future events but as a subjective probability that the agent will die before the next period, and so discounts the future experiences not because they aren't valued, but because they may not occur.

A present-oriented agents discounts the future heavily and so has a LOW discount factor. Contrast discount rate and future-oriented.

In a discrete time model where agents discount the future by a factor of b, one usually lets b=1/(1+r) where r is the discount rate.

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