The Normalization of Consumer Valuations: Context-Dependent Preferences from Neurobiological Constraints

Abstract

A long line of empirical research documents that consumer valuations are shaped by choice sets, yielding patterns of substitution between alternatives as choice sets are varied. Building on recent neuroeconomic evidence that valuations are transformed during the choice process, we incorporate the canonical divisive normalization computation into a discrete choice model and characterize its implications for consumer choice. We find that divisive normalization predicts choice behaviour that depends on both the size and composition of the choice set and examine evidence for such behaviour from two experiments. Divisive normalization more accurately captures observed behaviour compared to alternative models, including a range normalization model, and is robust across experimental paradigms. Finally, we demonstrate that divisive normalization implements an efficient means for the brain to represent valuations given neurobiological constraints, yielding the fewest choice errors possible.

JEL Classification: D87