Economists and Choice – Part 1: Quantity

Yes, another two-parter. As the title implies, these posts are going to look at the way economists view choice and some of the assumptions underpinning them. This post looks at the standard economic assumption that more choice is always better and the next one will look at economist's ambivalence to the quality of choices given to people due to assumptions about rationality.

It's a standard assumption in economics that increasing the number of choices available to people increases wellbeing. This is based on a primary economic assumption that people are rational and secondary assumptions that individual tastes are endogenously generated (ie primarily influenced by internal factors) and heterogeneous among the population. Thus, imagine that there are only two variables in car design – speed and safety – and that these variables are competing (increasing one decreases the other). Also imagine that there are two car makers, one which concentrates primarily on speed and one on safety. In this situation it is assumed, not unreasonably, that the population has a variety of preferences for combinations of speed and safety and the combinations selected by the car manufacturers will only match with the exact preferences of a small section of the population. Everyone else needs to make a compromise in their exact preferences when they buy a car.

So here it is assumed that an increase in choice would increase welfare. If a third manufacturer comes in with a compromise between speed and safety then some people's preferences will be more closely met and welfare will increase. To economists this insight is universal and never ending. There is a widely used formula, which I have forgotten, which basically says that more choice = more welfare.

The major problem with all this is that it rests on a whole bunch of assumptions. It assumes that people both know their preferences and know the properties of each of the choices in front of them so they can analyse how closely they meet their preferences. It then assumes that they are rational and are able to choose the one which most closely meets their preferences. Needless to say, in the real world not all of these conditions are likely to be met.

Just to take an anecdotal example, think about the last time you went to buy toothpaste (assuming, like me, you don't simply buy the same one every time out of habit). The multiplicity of choice here consistenly annoys me. I want something which will clean my teeth. But there's like 15,000 flavours and half a dozen brands and they're all different prices and claim to have different properties and to do your teeth better than the other one and I have no way of telling what my actual preferences are let alone which one will meet my tastes better. So I just pick fairly randomly. This choice does not enhance my wellbeing.

Actually, my wife lived in Norway for a while and they have very limited choice in their shops thanks to government subsidies for certain providers. After the initial shock of not having 17 different brands of jam to pick from her family found they actually liked it. You just went to the shop and got what you wanted, you didn't have to make much of a choice and didn't have to worry you'd gotten a bad deal.

But these example isn't going to convince economists that more choice is bad. However, behavioural economics strikes again here. A number of behavioural economists have researched how our lack of rationality means choice can be bad in certain circumstances and their findings are quite interesting. A recent Slate article summarises the research:

Befuddled seniors are clutching their heads and asking someone, anyone (their pharmacists, their kids, AARP) for help. Some of them will end up avoiding the plans entirely—and missing out on big drug savings—because they can't figure out which plan to pick.

This reaction to the drug plan was completely predictable based on modern research in the psychology of decision-making, sometimes called "behavioral economics." There is now ample evidence that when you increase choice by offering more and more options, a point is reached at which paralysis rather than "freedom" is the result. This is true of trivial consumer choices, such as which flavor of jam to buy, and of extremely consequential choices, such as which 401(k) funds to put your retirement money in.
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Columbia University social scientists Sheena Iyengar and Wei Jiang found that as companies did their employees a "favor" by offering more and more mutual-fund options for their 401(k) contributions, fewer and fewer people elected to participate. Participation dropped 2 percent for every 10 options offered. And, analogous to the Medicare drug plan, by not participating, employees were giving up "free money" in the form of an employer match. It was so hard to decide which funds that employees chose "none of the above." Employees were so worried they would make a bad choice that they made the worst choice—opting out. And even among those employees who realized that it was foolish to opt out, Iyengar and Jiang found another interesting result: As the number of mutual-fund options increased, the percentage of employees choosing ultraconservative money-market funds rather than equity funds also increased. Any investment adviser will tell you that this is the worst choice you can make for your retirement plan, unless you are old enough to be nearing retirement. So, as the number of options increases, fewer people opt in at all, and more who opt in make poor decisions.

This is fairly intuitive. Professionals need to train for many years to pratice in complicated areas like health and financial affairs for a reason. You simply can't expect lay people to be able to make informed judgements about such things and in fact forcing them to make choices based on their uninformed judgements reduces their wellbeing. Either, as was described in that article, they make poor choices (opting out, using inefficient rules of thumb) or are forced to undertake time-consuming learning and searching in order to make an informed judgement. These circumstances are also ripe for abuse, non-professionals searching for information in a complicated area are succeptible to being fed plausible sounding but unsound advice and then acting on that to their detriment (eg. get rich quick schemes and a lot of alternative medicine).

As with so many things, human's lack of rationality and real world information imperfections undermine the neat theoretical predictions of economists with respect to choice and welfare. Simply increasing the number of available choices is far from guaranteed to increase people's welfare.