V Lecture Recursive relation between preferences and choices

Wrap up of the previous lecture Methodological problem of inferring from price-choice reversal data the phenomenon of preferences reversal. If the inference is incorrect, then the phenomenon at stake is an artifact and the explanatory hypothesis (preferences as a contingent for of information processing) is not testable. Triangulation method and lab-reality of preferences reversal. The truth-value of the explanatory hypothesis can be tested.

Introduction. Utility as the driving force of human behavior ECONOMICS: 1) Utility is a numerical representation of rational preferences (standard view); 2) utility is a hedonic measure that the brain assigns to states or events of the world (behavioral foundation). Implication: choices reveal and not shape utility (preferences). PSYCHOLOGY: utility is hedonic in character but it is ill-defined. Implication: choices shape utility through 1) sensitivity to situational factors; 2) memory of past behaviors that might be biased by situational factors.

The standard view Aim of RCT: providing a general concept of rationality and a measure of utility. The concept of rationality has to represent a class of entities, namely individuals. Preferences relations are reduced to logical ordering relations (Hollis and Sugden 1993). Rationality defined in terms of consistency between preferences and choices; utility is defined in notional terms (numerical representation of preferences). Representation theorem of expected utility theory: analytical equivalence between preferences consistency and utility maximization (Bermudez 2009). Definition of preferences in terms of choices. There is no gap between preferences and choices so that rational choices always reveal individual’s true preferences. (Hollis and Sugden 1993) There is no causal and substantive assumption on preferences and utility.

Examples A professional billiard player chooses the direction to of the white ball by following – most of the time - rules of thumbs. His behavior satisfies geometrical laws that he does not know. Football players – in aggregate – kick on the grounds of their experience. Their behavior is consistent with a mixed strategy in Nash equilibrium. Chess players chose their moves by following – explicitly – logical rules. We see how choices can satisfy theoretical predictions even if they are not necessarily caused by a deliberate use of rationality principles.

Interpretations of the standard view Normative interpretation: axioms of rationality are normative requirements and they describe how the subject should behave. Prescriptive interpretation: axioms of rationality are requirements that prescribe how the subject ought to behave. Positive interpretation: axioms of rationality are positive properties that describe the way people behave under the assumption of full rationality. In the first two cases deliberation is required while in the latter it is not. There is not a uniquely valid interpretation of RCT and the three interpretations do not necessarily imply each other. In the positive interpretation we notice the following asymmetry: all reasons are causes while not all causes are reasons.

Examples In a prisoner’s dilemma agents should exhibit preferences for defection. In this case, subjects apply axioms of rationality after deliberation. However this interpretation leaves open the possibility of having compelling reasons (may be ethical) for not being an utility maximizing agent (normative interpretation). In a prisoner’s dilemma subjects have compelling reasons to implement the rational strategy of defection. In this interpretation axioms of rationality are restrictions on our compelling reasons of choice (prescriptive interpretation). In a prisoner’s dilemma agents behave in an utility maximizing manner. In this case, axioms of rationality simply describe behaviors and they are compatible with a wide range of causes (positive interpretation).

Behavioral foundation Characterization of utility in hedonic terms. Utility is an universal feature of human nature. Utility is a real cause of behavior (Bruni and Sugden 2007). Axioms of rational consistency describe a real preferences structure. Positive interpretation of standard theory: deliberation is not a necessary condition for rationality. Unilateral causal relation between preferences and choices: preferences are causes of choice behaviors but the inverse does not holds (preferences exogeneity). Empirical hypothesis: rational actions are a reliable basis to infer hedonic utility and preferences. The behavioral foundation of RCT is consistent with a RPT’s interpretation of preferences.

Example In repeated pricing-choosing tasks subjects exhibiting preferences reversals can be turned into “money pumps” (Lichtenstein and Slovic 1971). Subjects learn from the bad consequences of their choices. If learning is allowed then preferences reversals disappears. i.e. second price auctions (Cox and Grether 1996). If subjects exhibit the same pattern of choices between pricing and choosing tasks, then their choices are a reliable basis to infer their hedonic utility.

Implications Actions do not influence rational preferences. This means that we always implement rational actions on the grounds of a given preferences ordering. Preferences are context-independent. Rational preferences are discovered rather than learnt (DPH). Preferences are path-independent. The way we come to implement rational choices is causally irrelevant for what concerns the structure of rational preferences: preferences are discovered and not learnt.

Problem We have evidence that in repeated interactions preferences reversals disappear (Cox and Grether 1996). The consistency between choosing and pricing confirms theoretical predictions. Considering choices as a reliable basis to always infer utility is a stronger assertion and it implies DPH. To falsify DPH we need evidence of consistent behavior that does not allow for a reliable inference of the subjects’ true utility: we need evidence of a recursive causal relationship between preferences and choices.

Coherent arbitrariness of preferences (Ariely et al. 2003) Experiment: 1) participants are asked to state if they would pay a given price for bottles of wine corresponding to the last two digits of their social security number; 2) participants are asked to bid for the bottles in an auction. Results: people with higher social security number bid more than people with a lower one. These patterns of behavior do not converge across market (anchoring effect). Arbitrariness: the value attribution is determined by the normatively irrelevant cue of social security number. Coherence: people start to choose in a consistent way bearing on their initial (arbitrary) valuation. Coherent arbitrariness is a long run phenomenon. In new situations choices are highly responsive to normatively irrelevant stimuli. This foundational choice exerts a normatively inappropriate influence on future choices so as to characterize the emergence of the orderly pattern. The orderly pattern of choice is market specific. We can identify a recursive relation between preferences and choices due to preferences responsiveness to the cue dimension of the external stimulus. Our coherent choices might reflect an arbitrary and biased set of preferences.

Original attribution of value The original attribution of value - the first time that you evaluate an object – is highly variable and malleable. Relative preferences provide the order of original valuations. Axioms of rationality apply only to relative preferences.

Relevance of original attribution of value Such variability of the original attribution of value might lead to the emergence of market specific patterns even in logically equivalent interactions. These patterns of behavior are a long run phenomenon (i.e. coherent arbitrariness). The variability of the original attribution of value is explainable through cognitive sciences. Therefore, cognitive science might integrate the explanation of economically relevant phenomena.

Memory and preferences formation Arbitrary determination of the value of wine bottles (Ibidem) and coherence of subsequent bids. Observation of past choices and inference of hedonic utility. Acting in accordance with the inferred utility. People ignore the possibility that their foundational choice might be determined by normatively irrelevant stimuli. Difference between reinforcement learning and learning by experience. Reinforcement learning: fine- tuning predictions of hedonic utility of different courses of actions. Learning by experience: past behavior is an arbitrary set point not necessarily related to hedonic utility: i.e. anchoring effect due to SSN.

Problems in measuring utility Do actions shape hedonic utility or do they bias the subjective estimation of utility? If individuals are not endowed with a well-defined structure of preferences, then both possibilities are allowed (PCH). If they do are endowed with a well defined structure of preferences, then actions can only bias utility in the short run (DPH). Inference problem: are choices due to biased or “shaped” preferences?

Conclusions The behavioral foundation of economic theory implies that 1) actions do not influence preferences; 2) preferences are context- independent; 3) Preferences are path-independent. Empirical analysis identifies a recursive causal relation between preferences and choices so as to falsify the mentioned implications. Metrical problem: do actions shape or bias hedonic utility?