Six Contradicting Deviations From Rational Choice, and the Possibility of Aggregation Gain

Abstract

To help predict choice behavior, behavioral economics research tries to identify robust deviations from rational choice, and explain them by assuming distinct biases. Our analysis questions the value of this convention and proposes an alternative. First, we demonstrate that six known deviations from rationality that emerge when people gain experience are not robust; they can be reversed by small changes in the incentive structure. For example, published research shows that experience triggers underweighting of rare outcomes, and our study shows that experience can also trigger oversensitivity to rare outcomes. Then, we show that it is not necessary to assume situation specific biases. Simple models, assuming reliance on small samples of memories, capture all 12 contradicting deviations, and provide useful ex-ante predictions. The practical implications of our analysis include the clarification of the conditions that trigger rational choice. One example involves individual choice tasks in which the payoff maximizing option also maximizes the probability of success. The paper’s methodological contributions include the elucidation of conditions that elicit aggregation gain (Grunfeld & Griliches (1960)). When people use a wide set of rules that imply reliance on small samples of similar past experiences, it is easy to develop a usefully specified model of the aggregate behavior, even when it is difficult to correctly specify the factors that impact individual decisions. We believe that part of the popularity of situation-specific explanations, to the deviations that we capture with a single model, reflects the incorrect belief that aggregation is always bad.