Information-Constrained Dynamic Models of Choice Behavior


Michael Woodford
John Bates Clark Professor of Political Economy


This project will explore models of the cognitive processes underlying human choice behavior in economic contexts. The models to be explored allow for departures from fully-informed optimal choice. Rather than positing that behavior is simply "irrational," they will explain departures from optimal decision-making as resulting from the (generally pre-conscious) use of choice algorithms that are well-suited to mostly achieving decision makers' objectives. The choice algoritms also would not require greater information-processing capacity. If successful, the research will have broad implications for the development of economic theory by showing how research findings in other disciplines, such as psychology, vision science and neuroscience, can be integrated into economic analysis. It should also have broad implications for the design of economic policies, if accurate perception of the incentives of policies changes individuals' behavior.

The project will explore the ability of the proposed theory to explain anomalies of economic choice in a variety of contexts. Applications to be considered include processing errors as a source of randomness in observed choices; delays in the adjustment of behavior to changing market conditions and differential degrees of delay in the response to differing types of news; excess volatility of asset prices as a result of inattentiveness on the part of some traders to current market conditions; "focusing illusions" in which certain attributes of alternatives are disproportionately influential in determining choice; context effects in consumer choice, such as those that allow manipulation of purchasing behavior by the addition of additional alternatives to the set with which consumers are presented; and aspects of choice with regard to risky outcomes that are inconsistent with the theory of expected utility maximization.