Choice, Rationality and Welfare Measurement

Abstract:     
We present a method for evaluating the welfare of a decision maker, based on observed choice data. Unlike the standard economic theory of revealed preference, our method can be used whether or not the observed choices are rational. Paralleling the standard theory we present a model for choice such that the observations arise "as if" they were the result of a specific decision making process. However, in place of the usual preference relation whose maximization induces the observations, we explain choice as arising from a compromise among a set of simultaneously-held, conflicting preference relations. As in revealed preference theory, these simultaneously held preferences are inferred from the choice data and we use them as the basis to discuss the decision maker's welfare. In general our method does not yield a unique set of explanatory preferences and therefore we characterize all the explanatory sets of preferences. We use this set to compute bounds on welfare changes. We show that some standard results of rational choice theory can be extended to irrational decision makers. The theory can be used to explore a number of context-dependent choice patterns found in psychological experiments.

Keywords: welfare economics, behavioral economics, psychology and economics, voting

JEL Classifications: D01, D11, D60

Working Paper Series