CHOICE – What Can Go Wrong?

The elegant economic picture of rational consumers achieving Pareto optimality through trade in decentralized self-organized markets is blurred by market imperfections and choices inconsistent with consumer self-interest. Behavioral economics has documented these errors in choice, and considered interventions that can mitigate harm to individuals from bad choices. This essay considers more broadly market distortions that arise when sellers design and market products to exploit consumer errors, and suggests market management policies to mitigate these distortions. I give examples in which consumers’ lack of attention and diligence in collecting, filtering, and processing information has an outsize effect on market outcomes. I discuss identification and estimation of a two-stage model of decision-making, with attention determined in the first stage, and choice among alternatives described in the second stage. The stages in this model are linked by unobservable factors and identified by available information specific to each. I use this model to quantify the effects of inattention in a market for health insurance.