Momentous Choices: Testing nonstandard decision models in health and housing markets

Abstract

During more than half a century, several strands of research contributed to the development of decision theory. The standard normative model for choice under uncertainty – expected utility – was given a foundation by von Neumann and Morgenstern (1944) and Savage (1954). It advised – and expected – reasonable actors to evaluate the consequences of their actions by the weighted sum of their utility, using probabilities of these consequences as weights. Utilities were derived from the choices made by actors themselves, and together with probabilities should be evaluated in a simple linear fashion. It can be shown that under certain reasonable conditions, behavior resulting from the theory is rational. Economists traditionally assumed that the standard model is also valid descriptively (Arrow, 1951). They assumed that, even though individual human beings can err and deviate from the theory, these deviations are not systematic, and the theory’s predictions for the consequences of economics action hold well (e. g., the as-if hypothesis, Friedman, 1953). However, with the advent of decision research in psychology, the building began to crack. Allais (1953) showed that reasonable people could make a series of choices violating expected utility. And, interestingly, stick with them even after the violations are pointed out. Even more fundamentally, Ellsberg (1961) showed that people may not be able to assign subjective probabilities to events.