Working Paper: NBER ID: w26258
Authors: Michael Woodford
Abstract: Traditional decision theory assumes that people respond to the exact features of the options available to them, but observed behavior seems much less precise. This review considers ways of introducing imprecision into models of economic decision making, and stresses the usefulness of analogies with the way that imprecise perceptual judgments are modeled in psychophysics — the branch of experimental psychology concerned with the quantitative relationship between objective features of an observer's environment and elicited reports about their subjective appearance. It reviews key ideas from psychophysics, provides examples of the kinds of data that motivate them, and proposes lessons for economic modeling. Applications include stochastic choice, choice under risk, decoy effects in marketing, global game models of strategic interaction, and delayed adjustment of prices in response to monetary disturbances.
Keywords: Imprecision; Perception; Valuation; Choice; Psychophysics
JEL Codes: C25; C91; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| imprecise perception (D80) | biased economic choices (D91) |
| noise in internal representations (C45) | biased valuations (D91) |
| biased valuations (D91) | choice behavior (D01) |
| context (Y60) | internal representation (C59) |
| internal representation (C59) | choice (Y60) |