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Revealed Preferences

July 4, 2008 in Economics - General, Experimental | Permalink

Generally, economists believe that individuals are rational and make choices to maximize utility. How do you reconcile the fact that most people would prefer to own a Ferrari, but actually own a car like a Toyota Matrix? Once you take into account all aspects of this choice (including price) then the Toyota Matrix doesn’t look so bad.

However, an NBER working paper by Beshears Choi, Laibson and Madrian (2008) claims that sometimes, people’s revealed preferences may not coincide with their true preferences:

  1. Passive choice. If individuals do not actively make a choice, such as would be the case for a default 401(k) enrollment at work, people may not be choosing optimally (at least initially).
  2. Complexity. It is often difficult for individuals to act rationally in complex situations. For instance, when one is faced with a large number of choices or faced significant uncertainty regarding future prospects, individuals may act suboptimally.
  3. Limited Personal Experience. “Human learning is often generated by feedback.” Thus, the more experience an individual has, the more rational they will act. You probably get a better deal buying groceries than buying a used car, because you have much more experience with the former.
  4. Third Party Marketing. “Tom Sawyer tricked his friends into paying him for the privilege of painting his family’s fence. A great deal of real behavior is also influenced by marketing.”
  5. Intertemporal Choice. How should people discount future utility? The authors claim that “Only discounting due to mortality risk is easily defended philosophically.”

How can we correct for these “incorrect” revealed preferences? Beshears and co-authors give some suggestions:

Structural estimation specifies a positive model with a precise set of economic and psychological motives (perhaps including non-Bayesian thinking and other decision-making errors). This model is then estimated using data, and the resulting positive preferences are mapped into normative preferences using normative axioms.

Active decisions …[require individuals] to explicitly state their preference without beinginfluenced by (or being able to rely on) a default option.

In most stationary economic environments, initial choices are likely to be further from normative optimality than choices made after many periods of experience. One should therefore give more weight to asymptotic choices [preferences revealed after having experience with the choices] when attempting to infer normative preferences.

When homogeneous individuals make noisy, error-prone decisions, their individualdecisions do not reflect normative preferences, but their aggregate behavior can …

Self-reported preferences reveal something about an agent’s goals and values. Normative economics should allow self-reports to have some standing.

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Therapeutic non-adherence: a rational behavior revealing patient preferences?

October 29, 2007 in Academic Articles, Pharmaceuticals | Permalink

Many studies have revealed patient non-compliance with medical prescriptions (e.g.: not taking prescribed drugs, not visiting the doctor) at around 50%. Most medical researchers believe that non-adherence is either due to 1) irrationality or 2) misinformation. Yet a Health Economics article by Lamiraud and Geoffard (2007) tests the hypothesis of whether or not this behavior may in fact be rational.

Most medical treatments have costs. There are monetary costs, time costs, inconvenience costs, and physical costs from any side affects which occur. Physicians often focus on the benefits of medication without fully taking into account the discomfort patients experience from medication.

To solve this problem the authors used a data from a randomized controlled trial (RCT) of HIV-1 infected patients. The trial aimed to test the safety and efficacy of two HAART therapies. The authors use the following system of equations to estimate factors associated with compliance.

  • θ*it=x1itβ1+ε1it
  • h*it=x2itβ2+ θitγ +ε2it
  • εjit=νjt+ηjit

The variable θ* represents a latent variable as to the level of adherence (θ=1 for full adherence and 0 otherwise) and h* is a latent variable representing the health status of the individual (h=1 if the individual is an a good health status and 0 otherwise). The model is estimated using a panel non-linear simultaneous two-equation system.

The authors find that higher adherence levels are associate with higher patient welfare. Thus, if two drugs are equally effective, the authors recommend that policy-makers, insurance companies, and government should select the pharmaceutical with higher compliance levels. “To the contrary, the clinicians of the trial were tempted to support the treatment in which the adherence level was smaller, based on the rationale that a higher adherence would have pushed the efficacy to upper levels in that group.”

Realizing that adherence is an endogenous behavior made by rational individuals may change the way in which the benefits of prescription drugs are measured in the future.

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