Endogenous preferences

The conventional neoclassical view that consumers have rational preferences that maximize their utility is wrong, according to new experimental evidence.

Researchers got some students in Prague to taste an unpleasant mixture of Fanta, salt and vinegar and then to say how much they would need to be paid to drink a larger quantity of the concoction, with those who stated a below-median price being required to actually drink it. This exercise was repeated ten times.  

They found that subjects' offers were strongly influenced by the median price elicited in previous auctions. This is not necessarily irrational; someone wanting the money rather than the nasty taste would want to bid a penny less than the median. What is odd, though, is that those subjects who were told about the lowest offers offered lower prices themselves, which was against their own interests. "Preferences are endogenously determined by the market process themselves", they conclude.

This is more evidence that peer pressure matters; it influences our decisions to spend or save and our decisions on how to invest.

This experiment shows that these peer pressures matter even when people's choices are anonymous - that is, in the absence of social pressures to conform. They also matter even in purely private contexts, when people must weigh their idiosyncratic distaste for the drink against their desire for money.

Consumers' choices are shaped by the When Harry met Sally principle: "I'll have what she's having."

One reason for this might be that preferences are, within some range, indeterminant; this might also explain another anomaly from the perspective of conventional theory, that consumer choices are shaped by how they are framed. This point was classically made in a famous (though apocryphal) exchange between George Bernard Shaw and a socialite:  

'Would you sleep with me for... for a million pounds?' `Well,' she said, `maybe for a million I would, yes.' `Would you do it for ten shillings?' said Bernard Shaw. `Certainly not!' said the woman `What do you take me for? A prostitute?' `We've established that already,' said Bernard Shaw. `We're just trying to fix your price now!' "

In fact, though, Shaw was being a little harsh: his interlocutor's preferences were merely less well-defined than standard theory assumes.

This might explain a lot. It might contribute to the emergence of Adler superstars (pdf) - musicians and authors who make millions despite a lack of talent: as Andrew Hill says, people want to buy what others are buying. It might also explain the Steve Brookstein effect - the tendency for apparently popular X Factor winners to sink quickly into obscurity; it's because popular preferences might not be as strong as they seem.

You might think this is just yet another attack on orthodox neoclassical economics. I suspect, though, that the problem goes further. Political preferences might also be endogenous; other laboratory experiments show that our attitudes to inequality - to take just one example - are shaped by an anchoring effect or by simple resignation. It might, therefore, be that our political preferences are also endogenous and do not serve our interests. If so, the problem with democracy isn't (just) the politicians, but the voters. 

Comments

[David Landon Cole]

I can buy into this; it seems to describe me quite well. I'm a member of the Labour party, and I'm sure that shapes my views on things. I stay mostly out of some sort of inertia. I'm not sure that, if I wasn't a member, I would join.

[An Alien Visitor]

I don't believe that capitalism delivers what people want, I think it distorts what they want and perverts it. I think that under capitalism wants and priorities become distorted.

For example, health care is not keeping pace with social changes, yet we want to cut health provision in order to provide space for the private sector. We have an irrational system, how can we avoid irrational choices.

And even then how much is the choice if the consumer? I can't remember voting to turn analogue TV off and switch to digital, it just happened.

And maximising utility is a fuzzy concept, does it mean consuming in the best interests of your body or getting the best value for money or something else?

I am not against understanding consumers but behind every bourgeois concept lies bourgeois interest.

maybe in the next world we can really and honestly understand consumer preference but not in this world.

[Luis Enrique]

I don't think you mean rational preferences, I think you mean exogenous. Rationality is about how you take decisions given your preferences. There is nothing rational about preferring apples to oranges.

And I somewhat object to your phrasing. I don't think the neoclassical view is that consumers are like this, but rather that modelling them like that is useful. You make it sound like neoclassical economists really think people are like that.

I reckon even the most hardcore mainstream economist accepts preferences are probably endogenous to an extent (although let's not exaggerate that extent, we can only be influenced so far) but regards the problem of explaining where preferences come from as too difficult and so preferes to proceed by taking them as given and going from there.
I am not sure about this experiment. It sounds to me like bidding prices that are influenced by others is a different thing from saying preferences regarding drinking horrible fanta based potions have been changed.
Buying things that other people like is a different thing too. Prior to reading Harry Potter I did not know whether I'd like it. I read it because everybody else had but that doesn't mean I liked it an more because of that.

[UnlearningEcon]

@ luis

The problem with the "we don't really believe that but it's useful" refrain is that it just becomes an empty catch-all that you can use whenever utility is questioned. The question is *how* utility is useful (making theory mathematically tractable doesn't qualify because that says nothing about its realism).

[Luis Enrique]

Yes. And you appear to have managed to complete an economics degree without gaining any insight into why utility functions are useful.

[Chris Mealy]

Chris, have you read Elster's "Sour Grapes"? It's really great. As you might guess from the title, it's about how people want what they can have.

[Peter Dorman]

First, the issue here is not the positive side of economics (OK, a bit on the stability of preferences), but on the normative. It's really about whether the notion of people maximizing well-being/utility is viable. And there's a ton of evidence that it isn't. To put it differently, the problem isn't neoclassical economics in general but welfare economics in particular.

Second, I hate to get all biologically deterministic, but.....people are, first and foremost, mammals. The mechanisms of their learning (obviously not the content) is rooted in biology. And as any ethologist will say (I think), mimesis is central. I'm not surprised by any study that says we gravitate toward the behavior we observe.

A favorite quote from (this is showing my age) the Firesign Theater:

"What will you do when you grow up?"

"Find some people, dress like them, and follow them around."

[Luis Enrique]

personally (and I recognise my views are of little interest) I am completely open to social-biological stories about preference formation, which sound right to me. At the same time I think it makes sense to treat preferences as given in many applications (I reckon my preferences are pretty dyed in the wool by now) and that in some sense our nature as human beings in this moment in history is exogenous to us, plus there is obviously some individual variation in tastes that is not completely explained by peer groups etc. (my three-year old son dislikes chocolate). And whilst I'd be delighted to see economics take steps in these directions (I am confident some are) I think it's still worth asking what approach is appropriate for economists to take, and personally I like the fact they start by thinking people know what they like and approach welfare by asking whether they get it, rather than thinking that people are blank slates that to be written on. Despite me thinking the truth is somewhere in the middle, I'd rather err on the side of respecting people's preferences. I don't like to think what economics would look like if we started from the premise that people's preferences are there to be shaped.

[Icarus Green]

Research on herd behaviour is very interesting to me. It raises philosophical questions about whether human beings are actually individuals in terms of what they want and live for.

The neoliberal canard that there is no such thing as society just isn't true. Even our deepest desires and dreams are socially conditioned to an extent.

If preferences aren't anchored in anything individually originated it opens the question about who sets these preferences for goods, services, political parties...fashion, hairstyle etc.

As Chris points out they aren't rational decisions.

You can go too far with this line of thought though and say everything, including biological gender preferences and aspects of certain groups are completely socially constructed.

[Dave Timoney]

"What is odd, though, is that those subjects who were told about the lowest offers offered lower prices themselves, which was against their own interests."

But this presumes that their interests are understood, whether because they are exogenous or conform to some objective "rationality". Just as there is peer pressure, there is also the awkward squad. Some participants might bid a low price simply to show contempt for the process.

[ZC]

I always find these sorts of elicitation methods pretty non-credible, and this case is even worse. Although the researchers are trying to set it up as a one-shot game, if I were a participant I might think that there was a possibility it'd be repeated. So I want to set a high price for my suffering (possibly above my 'true' WTA), but I think I wouldn't be called back if I set too high a price.

With this experimental setup and the quirk above, you'd get these results even with fixed, exogenous preferences. Since I have some uncertainty about the experimenter's preference, I get a signal from other people's offers. Or, I think that the experimenter will choose a certain number of people so I don't want to be the highest price.

The Hawthorne effect is pretty powerful.

[An Alien Visitor]

"I don't like to think what economics would look like if we started from the premise that people's preferences are there to be shaped."

Jesus, this guy Luis Enrique always promotes himself as a know it all on economics and he can say this out loud for others to see! Has this guy not heard of advertising, of the millions spent on shaping peoples preferences? We live in an economy where shaping preferences is fundamental AND RAISED TO AN ART FORM. Didn't they teach you anything? How has all this passed you by? What planet are you on? Seriously, are you A robot that has been created in order to provide the optimum level of apology for the system? i can imagine the designers, let us make the robot a sniveling little apologist but with a tone of being critical.

If you want a sense of what a mad economic system looks like, look no further than the news today that Tesco's market price recovered after news of their plan to abolish the company pension! I guess the employees preferences are about to change to cut price meals and holidays in the garden!

[Luis Enrique]

That final sentence you quote is open to misinterpretation if read in isolation, but you could only so completely miss my meaning if you completely ignore the rest of my comment, which of course you did, in your eagerness to prove yourself as unpleasant as you are stupid.

Incidentally, thinking it makes sense for economists to treat preferences as given in most applications in no way constitues an apologia for the current system, which, given people's preferences not to be unemployed or badly paid, isn't doing such a great job.

Now why don't you go away and come back when you're nicer.

[UnlearningEcon]

@luis

See, someone from a discipline which was more secure about its empirical record wouldn't have responded with a petty dig; they'd have (a) given some examples and (b) asked themselves exactly how someone could complete an economics degree without having the usefulness of utility demonstrated to them.

By the way, I'm now half way through a Master's, and it still hasn't happened. If anything, the more I learn the sillier utility becomes.

[Luis Enrique]

UE,

Yes, it was a cheap dig. Although I think youre wrong that a 'real scientist' wouldn't have made it.

Of course other explanations are available, but I was getting at the idea you didn't learn anything because you are so intent on unlearning. You're like somebody doing cost benefit analysis who only considers costs. It doesn't matter how smart you are, that way your conclusions are worthless.

I have tried before to explain the merits of mainstream econ to you. It was a waste of time.

[An Alien Visitor]

I have re-read the rest of your comment and it doesn't invalidate the point i am making. I don't accept the arguments in your response, any economist should understand that shaping preferences is a fundamental part of what capitalism is and not attempt to abstract it away, this is for one thing missing a very important piece of the narrative and secondly acts as apologia, as it misses important and possibly disturbing aspects of the system. Apologists would like to eradicate this from the story, just as they have done with exploitation. Reading your constant defence of the subject, the way you defend I think i am correct to label you an apologist. I think all the points made in my comment stand.

But let me put it another way,

"I don't like to think what economics would look like if we started from the premise that people's preferences are there to be shaped."

I know what it would look like, a damn sight nearer the truth! But according to our resident economics expert and know it all, economics should discard the truth and base its models on a fantasy.

[Luis Enrique]

Did you see the bits where I said I think social-biological stories about preference formations are true and that 'the truth is somewhere in the middle' between preference being completely fixed and completely malleable? That means I think preference can be shaped and I do not need to have the concept of advertising explained to me. Yet you re-read my comment and don't want to take anything back.

The reason that last sentence is open to misinterpretation, as I said, is because I should have written "people's preferences are there to be *entirely* shaped" because, as I said earlier, I was talking about two possible extremes assumptions that economists could make (preferences are entirely exogenous, entirely endogenous) and saying I prefer to err towards the exogenous. Notice the use of "err" also indicates I think it's not whole truth? Notice how I said I'd like to see economics take steps in direction of endogenous preferences?

What I meant is that I'd be more worried by economists thinking people don't know what's good for them and coming up with policies designed to deliver what they think people 'ought' to want, than I am by economists thinking people do know what's good for them and coming up with policies designed to deliver that.

"according to our resident economics expert and know it all, economics should discard the truth and base its models on a fantasy."

still stupid and unpleasant, then

[Luis Enrique]

on topic:

http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10004