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Better may be worse: Some monotonicity results and paradoxes in discrete choice

Author

Listed:
  • Mattsson, Lars-Göran

    () (Department of Infrastructure)

  • Voorneveld, Mark

    () (Dept. of Economics, Stockholm School of Economics)

  • Weibull, Jörgen W.

    () (Department of Economics)

Abstract

It 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.

Suggested Citation

  • Mattsson, Lars-Göran & Voorneveld, Mark & Weibull, Jörgen W., 2004. "Better may be worse: Some monotonicity results and paradoxes in discrete choice," SSE/EFI Working Paper Series in Economics and Finance 558, Stockholm School of Economics, revised 13 Sep 2006.
  • Handle: RePEc:hhs:hastef:0558
    as

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    References listed on IDEAS

    as
    1. Mirrlees, James A., 1987. "Economic Policy and Nonrational Behavior," Department of Economics, Working Paper Series qt9tw447ws, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    2. Kihlstrom, Richard E, 1974. "A Bayesian Model of Demand for Information About Product Quality," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(1), pages 99-118, February.
    3. Sheshinski, Eytan, 2000. "Bounded Rationality and Socially Optimal Limits on Choice in A Self-Selection Model," MPRA Paper 56141, University Library of Munich, Germany, revised Nov 2002.
    4. Kihlstrom, Richard, 1974. "A general theory of demand for information about product quality," Journal of Economic Theory, Elsevier, vol. 8(4), pages 413-439, August.
    5. Chade, Hector & Schlee, Edward, 2002. "Another Look at the Radner-Stiglitz Nonconcavity in the Value of Information," Journal of Economic Theory, Elsevier, vol. 107(2), pages 421-452, December.
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    Cited by:

    1. Filip Matêjka & Alisdair McKay, 2015. "Rational Inattention to Discrete Choices: A New Foundation for the Multinomial Logit Model," American Economic Review, American Economic Association, vol. 105(1), pages 272-298, January.
    2. Hautsch, Nikolaus & Hess, Dieter & Müller, Christoph, 2012. "Price adjustment to news with uncertain precision," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 337-355.

    More about this item

    Keywords

    decision theory; discrete choice; uncertainty; monotonicity.;

    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 - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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