Imperfect Memory and the Preference for Increasing Payments

We show how imperfect memory can imply a preference for increasing payments. We model an agent making a decision regarding effort in two periods. Before the first decision, the agent receives a signal related to the cost of effort, which is subsequently forgotten. Before the second decision, the agent makes an inference regarding the signal based on the publicly available information: the action taken and the wage paid. A preference for increasing payments naturally emerges. We show that this preference will only occur when the wage payments are neither very likely nor very unlikely to cover the cost of effort.