Better may be worse: Some monotonicity results and paradoxes in discrete choice
AbstractIt is not unusual in real-life that one has to choose among finitely many alternatives when the merit of each alternative is not perfectly known. This may be the case when an individual chooses school, doctor or pension plan, or when a firm chooses between alternative R&D projects. Instead of observing the actual utilities of the alternatives at hand, one typically observes more or less precise signals that are positively correlated with these utilities. In addition, the decision-maker may, at some cost or disutility of effort, choose to increase the precision of these signals, for example by way of a careful study or the hiring of expertise. We here develop a model of such decision problems. We begin by showing that a version of the monotone likelihood-ratio property is sufficient, and also essentially necessary, for the optimality of the heuristic decision rule to always choose the alternative with the highest signal. Secondly, we show that it is not always advantageous to face alternatives with higher utilities, a non-monotonicity result that holds even if the decision-maker optimally chooses the signal precision. We finally establish an operational first-order condition for the optimal precision level in a canonical class of decision-problems, and we show that the optimal precision level may be discontinuous in the precision cost.
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Bibliographic InfoPaper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 558.
Length: 22 pages
Date of creation: 09 Mar 2004
Date of revision: 21 Apr 2004
Publication status: Published in Theory and Decision , 2007, pages 121-151.
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More information through EDIRC
decision theory; discrete choice; uncertainty; monotonicity.;
Find related papers by JEL classification:
- C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
- D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
- D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
- D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-03-14 (All new papers)
- NEP-DCM-2004-03-14 (Discrete Choice Models)
- NEP-MIC-2004-03-14 (Microeconomics)
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