General Equilibrium Dynamics with Naive and Sophisticated Hyperbolic Consumers in an Overlapping Generations Economy

Using an overlapping generations model, this paper describes interactions between naive and sophisticated hyperbolic discounters in general equilibrium. The naifs, who overestimate their future propensity to save and hence over-forecast the future equilibrium asset prices, are exploited through capital transactions by sophisticates, who correctly forecast the future asset prices by incorporating the naifs' mis-forecasts. Due to the capital losses, the naifs fall into bankruptcy when they are highly present-biased, highly patient, and having a low population density. Under generous conditions, the equilibrium is shown to be globally stable and Pareto inefficient in the ex-post sense.