Choices

Sendhil MullainathanFall 2009

Economics 2030

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Psychology of choice

• Choice overload vs. choice conflict• Importance of dimensions- construal• Inference from choice set

– Rational (Kamenica?) or heuristic? – What’s the difference?

• Choice set can change very nature of preferences

• Irwin et al. (1993) found that, in JE, people were willing to pay more for improving the air quality in Denver than for improving a consumer product such as a VCR, but in SE, WTP values were higher for improving the consumer product.

• Kahneman and Ritov (1994) found that, in JE, people would contribute more to programs that save human lives (e.g., farmers with skin cancers), but in SE, they would contribute more to programs that save endangered animals (e.g., dolphins)

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

A Simple Example

• Suppose there is a good with a price and a characteristic (megapixels): x = 10, 11.

• No choice set effects: u(10)- u(11) < c (cost) determines choice and competitive provision

• Choice set effects– u(11,{11})-u(10,{10}) < u(11,{11,10})-u(10,{11,10})– How do you think about these two cases:

• Case A: u(10,{11,10}) > u(10,{10}) • Case B: u(10,{11,10}) < u(10,{10})

Competition in Government Services

• Social security, Mutual funds, Schools• Two benefits of choice:

– Tastes & circumstances differ• Choices lets people choose what they want• Choice allows people to self-sort to those services self-

sorts to plans that best match preferences

– Competition facilitates cost efficiency• Choice places pressures on plan to be on efficiency frontier• Private provision & competition yield innovation

Implicit Assumption: Consumers Choose Well

• Some examples of difficulty in choosing:• Failure to minimize fund fees (Choi, Laibson, and Madrian, 2007)• Emphasize annual fees for credit cards, not rates (Ausubel 1991)• Pay more for identical goods when costs are shifted into add-ons shipping, hotel

phone calls, re-stocking fees, etc.

• Can reduce or reverse benefits of competition– Matching benefits mitigated– Firms compete along contour of revealed preference not necessarily hedonic

preference

• Recent experiments about choice:– School choice (Hastings and Weinstein 2007).

• Powerful impact of making it much easier to acquire information about school quality

– Mexico social security (Hastings and Tejeda-Ashton, 2008)

Distribution of Plan CostsMedications as of 2006

0-3 4-6 7-10 11+

Share of sample .36 .33 .20 .10

Least expensive plan $623 $1417 $2580 $3556

Median plan $1053 $2019 $3383 $4788

Average cost of $958 $1932 $3303 $4540plan selected

Experimental Challenge

• How do we evaluate quality of choice?– In other contexts, people use objective metric– High late fees, quality of mutual fund portfolio

• Objective metric unclear here– Cost minimization need not be consumer’s goal.

• Our insight: choice instability• Does subtle changes to decision environment

(C) affect choice significantly? • Notice the welfare problem here

Information Intervention• Both groups:

– Letter on university stationery– Standard introductory and concluding paragraphs– Brochure on using the Medicare website (& 800

number)

• Comparison group: – Address of Medicare website (& 800 number) only

Impact• 28% of intervention group switched plans

– Vs. 17% of comparison group– Difference .12**– Regression adjusted .10**– 9% of intervention group switched to lowest cost plan

• Vs. 2% of comparison group• Difference .07*

– Amongst switchers:• 31% in intervention group switched to the lowest cost plan• 12% in the comparison group switched to the lowest cost plan

• Predicted savings (all)– Intervention: $132– Comparison $16– Difference $116**– Regression-adjusted $90**– Regression-adjusted ln (Y 07/Y 06)=.058**

Impact

• Regression-adjusted effect on total savings: $90**– Effect on premiums: $14– Effect on out-of pocket costs: $76**

• Out-of-pocket costs as share of total– Costs in 2006 plan: 81%– Potential savings from changing to least expensive plan: 80%– Predicted savings by comparison group from actual switches: 31%– Predicted savings by intervention group from actual switches: 84%

Broader Implications

• Structure of choice in various contexts– UI training systems– School– Privatizing social security

• Not just about choice quality but about competition.

• Choice platforms

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Choice of Choice Sets

• Fundamental Question– Retailers– Choice platforms

• Orbitz

• Little is known about this topic

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Thought Experiment

• The new health care bill tries to deal with ballooning costs and abuses by insurers. Critics charge though that the new health care bill would cost X. Do you support it?– X = 900 billion– X = 100 billion– X = 900 million– X = 100 million

Valuations

• Desvousges et al. (1992) asked separate groups of participants how much they would donate to save 2,000, 20,000, or 200,000 migrating birds from drowning in uncovered oil ponds. The mean responses were $80, $78, and $88 respectively.

Deeper Points about Scale

• Many times we are required to make choices where scale is hard to assess

• Example: School test scores

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Disclosures

• Often create meaningless scales• APR meaningful? • Environmental ratings?• MPG?

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

More Fundamental Issues of Choice

• Darley and Batson• Recruited seminary students to deliver

practice sermon on the parable of Good Samaritan

• After completing surveys, told to go to another building for the sermon

• Half (“Rushed”) were led to believe they were running late

Psychology: Power of Context

• On the way to give talk, all participants passed an ostensibly injured man slumped in a doorway, coughing and groaning.

• Key DV: Would individual stop?

Psychology: Power of Context

• Outcome: – No hurry 63% helped, – Medium hurry 45%– High hurry 10%

• Notice: – These are priests…ironically giving a lecture on the

good samaritan• Key insight:

– Channel factors. Facilitate good behaviors

Channel Factors (Lewin)

• Contrary to major interventions that prove ineffectual, apparently minor situational details can have a large impact…

• Leventhal, Singer and Jones:– Students receive persuasive messages about tetanus

inoculation. Offered tetanus shot– Only 3% showed up later at shot– If given map and urged to decide particular time, 28%

showed up. • Did students “want” tetanus shot? Revealed

preference

Some Other Issues

• Are many choices actual choices?• Thought experiment: Do high school dropouts

choose to dropout or just to skip a few days of school?

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Measurement Issues

• Problem of anchor– “How cold was it yesterday?”

• People in Miami and Boston in December

– Kahneman and Krueger: moment by moment readings

• Problem of what is being maximized– Sum of momentary utility?

• “utility” a convenient construct?

Overview of Lecture

• Choice sets– Some observations about the psychology– Competition and markets– Choice of choice sets– Structural estimation

• Scale issues– Contingent valuation and Jury awards– Disclosure

• More fundamental issues of “choice”• Hedonics

– Measurement issues– Use as a dependent variable

Use as a Dependent Variable

• To gauge progress– Does wealth matter? Does inequality matter?– Cross-country, cross-individual

• To create relative weights– Inflation vs. unemployment

• To evaluate outcomes– Oreopolous: dropouts– Gruber and Mullainathan: cigarette taxes

Next Lecture

• Laibson guest lecture. I would read• Akerlof, George (1991). “Procrastination and

Obedience,” The Richard T. Ely Lecture, American Economic Review, Papers and Proceedings, May.

• Laibson, David. (1997) “Golden Eggs and Hyperbolic Discounting.” Quarterly Journal of Economics, 62, May, 443–77.

• O’Donoghue, Ted and Matthew Rabin (1999). “Doing it now or doing it later.” American Economic Review, 89(1), 103–124, March.

Following Lecture

• Will do arbitrage (readings announced)