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Who's Irrational?

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Like Russ Roberts [2], I’m skeptical of claims that, in general, a person’s welfare is reduced if he or she is offered more choices rather than fewer.  More precisely, I’m skeptical of reading too much into experimental findings in which subjects seem to react negatively to increases, beyond some point, in the sizes of their choice sets.

But discard my (and your?) skepticism for the moment.  The typical conclusion that scholars and pundits draw from behavioral-economics findings (such as the "excessive-choice effect," mentioned above) is that markets are weaker and less trustworthy than they would be if people acted more like textbook homo economicus and, therefore, the case for regulation by government is stronger than it would otherwise be.

Neither of these conclusions follow.  In an interesting paper entitled "Less Choice is Better, Sometimes," Oklahoma State University economist Franklin Norwood builds a model in which consumers are harmed by having available to them too many product varieties among which to choose.  But his model

also illustrates market incentives for recognizing and avoiding the excessive-choice effect.  The use of advertising to raise industry costs can limit variety, leading to greater consumer and societal welfare.  This is true even if advertising is associated with higher product prices.  Perhaps the most effective method of providing the optimal number of varieties lies in the retailer.  While any firm may produce and try to sell additional varieties, retailers have complete control over which varieties they sell.  It is in the retailer’s incentive to provide the optimal number and type of varieties….  [T]here are many incentives and methods for markets to use to avoid the excessive-choice effect.

(Norwood’s article appears in the Journal of Agricultural & Food Industrial Organization, Vol. 4, 2006.  Here’s the abstract [3].)

And in the current issue of Regulation, Harvard economist Ed Glaeser argues [4] — powerfully, in my opinion — that "flaws in human cognition should make us more, not less, wary about trusting government decisionmaking."

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