Sizing Up Categories
Theoretical Inquiries in Law (2021, Forthcoming)
25 Pages Posted: 1 May 2020 Last revised: 4 May 2020
Date Written: May 1, 2020
Categories intentionally create discontinuities. By breaking the world into cognizable chunks, they serve as shortcuts that simplify the information environment. But the signals they provide may be inaccurate or scrambled by strategic behavior. This essay considers how law might approach the problem of optimal categorization, given the role of categories in managing and transmitting information. It proceeds from the observation that high categorization costs can be addressed through two opposite strategies—making classification more fine-grained (splitting), and making classifications more encompassing (lumping). Although continuizing and other forms of splitting offer intuitive answers to inaccurate classification and gaming along category lines, lumping is sometimes a better solution. If category membership carries multiple and offsetting implications, the incentive to manipulate the classification system is dampened. To take a simple example, insurance that covers only one risk is more vulnerable to adverse selection than is an insurance arrangement that covers two inversely correlated risks. Making categories larger, more durable, and more heterogeneous can help to produce such offsets. These and other forms of bundling can help to arrest damaging instabilities in categorization.
Keywords: adverse selection, mechanism design, categorization, information, strategic behavior, coalitions
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