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Limits on Individual Choice

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  • Eytan Sheshinski

Abstract

Individuals behave with choice probabilities defined by a multinomial logit (MNL) probability distribution over a finite number of alternatives which includes utilities as parameters. The salient feature of the model is that probabilities depend on the choice-set, or domain. Expanding the choice-set decreases the probabilities of alternatives included in the original set, providing positive probabilities to the added alternatives. The wider probability 'spread' causes some individuals to fur- ther deviate from their higher valued alternatives, while others find the added alternatives highly valuable. For a population with diverse preferences, there ex- ists a subset of alternatives, called the optimum choice-set, which balances these considerations to maximize social welfare. The paper analyses the dependence of the optimum choice-set on a parameter which specifies the precision of individuals' choice ('degree of rationality'). It is proved that for high values of this parame- ter the optimum choice-set includes all alternatives, while for low values it is a singleton. Numerical examples demonstrate that for intermediate values, the size and possible nesting of the optimum choice-sets is complex. Governments have various means (defaults, tax/subsidy) to directly a¤ect choice probabilities. This is modelled by 'probability weight'parameters. The paper analyses the structure of the optimum weights, focusing on the possible exclusion of alternatives. A binary example explores the level of 'type one'and 'type two'errors which justify the imposition of early eligibility for retirement benefits, common to social security systems. Finally, the e¤ects of heterogeneous degrees of rationality among individuals are briefly discussed.

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File URL: http://ratio.huji.ac.il/sites/default/files/publications/dp554.pdf
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Bibliographic Info

Paper provided by The Center for the Study of Rationality, Hebrew University, Jerusalem in its series Discussion Paper Series with number dp554.

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Length: 28 pages
Date of creation: Jun 2010
Date of revision:
Handle: RePEc:huj:dispap:dp554

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