Most of classical economic theory is built on the foundation of revealed preference.  The guiding principle is that, whatever is going on inside her head, an individual’s choices can be summarized as the optimal choice given a single, coherent, system of preferences.  And as long as her choices are consistent with a few basic rationality postulates, axioms, this can be shown mathematically to be true.

Most of modern behavioral economics begins by observing that, oops, these axioms are fairly consistently violated.  You might say that economists came to grips with this reality rather late.  Indeed, just down the corridor there is a department which owes its very existence to that fact:  the marketing department.  Marketing research reveals counterexamples to revealed preference such as the attraction effect. Suppose that some people like calling plans with lots of free minutes but high fees (plan A) and others like plans with fewer free minutes but lower fees (plan B).  If you add a plan C which is worse on both dimensions than plan A, suddenly everybody likes plan A over plan B because it looks so much better by comparison to plan C.

The compromise effect is another documented violation.  Here, we add plan C which has even more free minutes and lower fees than B.  Again, everyone starts to prefer B over A but now because B is a compromise between the extreme plans A and C.

Do we throw away all of economic theory becuase this basic foundation is creaking?  No, there has been a flurry of research recently that is developing a replacement to revealed preference which posits not a single underlying preference, but a set of preferences and models individual choices as the outcome of some form of bargaining among these multiple motivations.  Schizonomics.

Kfir Eliaz and Geoffrey de Clippel have a new paper using this approach which provides a multiple-motivation explanation for the attraction and compromise effects.  Add this to papers by Feddersen and Sandroni, Rubinstein and Salant, Ambrus and Rosen, Manzini and Mariotti, and Masatilioglu-Nakajima-Ozbay and one could put together a really nice schizonomics reading list.

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