As we discovered last time, for traditional economics relies upon economic agents being consistent and thus rational. Today we will uncover a common phenomenon: preference reversal.
Let’s start with a little experiment...
You have a choice. There are two options of differing payoff and probability. Imagine that you, the subject, will get to keep any payoff you get. I, the experimenter, will pick a ball at random from a bag (a la bingo) to decide whether you are awarded any payoff. If you choose Option A I will use a set of balls that give you a 70% chance of getting the payoff (of £24), if you choose Option B I will use a set of balls that give you a 25% chance of getting the payoff (of £80).
Probability
|
Payoff
| |
Option A
|
0.7
|
£24
|
Option B
|
0.25
|
£80
|
- If you had to choose between them, which option would you rather have?
- Now think about how much each option is worth to you: what amount of money would be of equal value as each option? (What would you deem a fair price for each option to be?)
If you’re anything like me you will have chosen Option A. You may also have valued Option A at something like £17 and Option B at around £20.
And if you did, you were irrational.
Why? Because you said you prefer the Option A in the straight choice, but value Option B higher. This is inconsistent. We can infer that you both prefer Option A and Option B (because you valued it at a greater sum of money). You have ‘reversed’ your preferences. This is ‘standard preference reversal’ (‘non-standard’ is where someone chooses Option B, but values Option A higher). PR is asymmetric; the overwhelming majority of preference reversals are the standard type.
If you were inconsistent, don’t worry, you are not alone. If you were consistent you are probably smug, well done.
Preference reversal (PR) is the phenomenon where individuals change what they say they prefer, purely because the way they were asked was different. Interestingly, people change their preferences in a highly predictable, yet irrational, way.
The psychologists Lichtenstein and Slovic (1971) first demonstrated PR using their, now famous, experiment design (as roughly replicated above). They called Option A the ‘P-bet’ and Option B the ‘$-bet’.
The first economists to take notice of PR were David Grether and Charles Plott in 1979. They set out to ‘discredit’ the psychologists findings. They failed. Badly. After testing 13 theories they were forced to conclude that PR was not caused by flawed research. My favourite of their theories include:
Theory 12: The original experiments were done on psychology students who are ‘unsophisticated subjects’.
Theory 13: The original experiments were done by psychologists ‘who have a reputation for deceiving subjects’.
Alas, it turns out that PR is real and here to stay. We will explore the causes of PR in later blogs, but the debate is basically between economists and psychologists over whether it is inherently daft to assume that people have underlying preferences. Psychologists argue that we only ‘construct’ preferences when we face decisions, while economists argue that our preferences already exist and we just refer to them.
I will finish by giving an example of PR in the real world (controversial, I know)...
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| http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2012/1/31/1328027920111/high-speed-train-Eurostar-007.jpg |
Imagine you own a sheep farm in the Chiltons. However, the Government wants to build a high-speed rail link right through your land. The new line can either go straight past your delightful little cottage (causing you a big headache), or it can take a longer route going through your fields (taking up more of your prime sheep farming land). The Government wants to know which route you’d prefer. They can either ask you which option you would chose in a straight choice, or they can ask you how much compensation you will demand for each option (and choose the cheapest). Governments worldwide use both methods of asking people all the time, assuming they yield the same preference.
PR would suggest that they might not...
Recommended listening:
I Need A Dollar by Aloe Blacc
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