Rationalizing Context-Dependent Preferences: Divisive Normalization and Neurobiological Constraints on Choice

Abstract

Biology places a resource constraint on the neural computations that ultimately characterize stochastic choice behaviour. We incorporate one such computation, divisive normalization, into a neuroeconomic choice model and predict that the composition and size of the choice set will adversely influence choice. Evidence for novel violations of the IIA axiom is provided from two behavioural experiments, and the model more accurately captures observed behaviour compared to existing econometric models. Finally, we demonstrate that normalization implements an efficient means for the brain to represent valuations given neurobiological constraints, yielding the fewest choice errors possible.

JEL Classification: D87