Extensions of the Analysis of Choice
Overview
So maybe the notion that people are simply calculators constantly weighing the costs and benefits of choices is a bit of a stretch. It turns out many choices people make are hard, if not impossible, to explain with the rational choice model. For example, one of the most obvious problems is people's decision to vote in presidential elections. The rational choice model suggests people will do things as long as the benefits from doing it outweigh the costs. In the case of voting, each person knows a single vote will not influence the election, so there should be no benefits from voting. Voting is not free, though, at least if you value your time. As a result people who vote consistently behave in such a way as to incur costs without any benefits - certainly a decision at odds with the rational choice model.
To better understand some of the limitations of the rational choice analysis, we are going to examine some choices situations, including those you looked at earlier in the semester. These choice situations are listed below. In this unit we will examine two extensions of the rational choice analysis. In the first extension, we will examine how incomplete information and uncertainty can affect choice decisions. This will be followed by a brief discussion of some of the common "irrational" behaviors of individuals - why people behave as they do, and how the decisions could be "improved." As we go through these questions you will undoubtedly be surprised at the extent of "irrational" behavior uncovered in the class' answers to an earlier set of questions. Before analyzing the results, let us look at the choice situations we will be discussing.
The Choices
Economics of Information
Let's return to our discussion of markets where the "model" is one of buyers and sellers coming together to exchange. In this model the only information ever mentioned was price, and that information was readily known to all participants. Unfortunately, this is not how things tend to work in the "real" world with "real" markets where market participants tend to have imperfect information. We will look at two differences. First, as a result of imperfect information, we may very well expect differences in behavior from what the "rational-choice" model would predict. Second, we can expect the existence of less than perfect information will alter the composition of the participants in any market.
In the world of imperfect information, a good starting point is to think of buyers and sellers as potential rivals prone to sending out erroneous information. Do you really want to let someone know how much you want that car? Do you really want to let the potential buyer know everything about the car you are trying to sell? How many times have you heard the ad promising the highest return combined with least risk and wondered how they could do this? How many times have you heard Best, Lowest, and Longest lasting in promotional material and realized it was a bunch of hot air? Probably you do not want to reveal all of your information [desire for car that you are considering buying, condition of used car that you are considering selling] and you have listened to so many inflated claims you have begun to discount the claims. This is the problem in markets where there is imperfect information, and we will talk about how this changes the operation of the markets and the behavior of the participants. To get a sense of the issues, return to the following questions.
I suspect you will agree all too often the answers will be 1. Rolex, 2. fancy suit, 3. No, 4. No, 5. No, and 6. Yes. Now you understand the problem of imperfect information, but you also are on the way to understanding how decision-makers deal with imperfect information. One way decision-makers deal with imperfect information is to look for signals. You looked to the fancy suit, the Rolex name, the 3.8 cum. You really were not in a position to find out all of the information to make the well-informed "rational" choice about the watch, the lawyer, or the student, so you looked for some short-cuts, some signals about the watch, the lawyer, and the student.
But why is it you believe some signals and not others. Why did you not believe the grandmother story, but accepted the fancy suit as a signal? If the signals are to be credible, if market participant are to convince others of their claims, then they must satisfy two criteria - the costly-to-fake and the full-disclosure principles.
Returning to the questions, why do people tend to pick the fancy suited lawyer? Why did they go with the expensive Rolex? The reasoning goes something like this: Rolex pays BIG bucks to advertise internationally and if their product did not live up to their claims, they would not be able to stay in business. It would be too costly-to-fake a good maintenance record. You can be sure the Korean auto companies were counting on this in 1998 when they began announcing 100,000 mile warranties on their autos. The value of this type of advertising had been shown earlier by Chrysler. Big ad budgets, great promises for refunds, service guarantees are all means by which companies signal that their claims are credible.
The lawyer, meanwhile, is signaling success with the wardrobe, just as the student is with the 3.8 cum. This is one of the forces behind conspicuous consumption, spending done to impress someone. This is the rationale for your career counselors' advice to "dress-for-success." When they tell you to dress up, it is because they believe your appearance will be sending a nonverbal message to prospective employers. The good news is dress-for-success pressure will tend to decline with age, since by then people will have an established track record and potential buyers will not need to rely as heavily on signals. If a lawyer has been practicing law in town for a number of years, prospective clients will know about the lawyer's success rate and this is likely to be more important than the clothes. For a new lawyer coming to town, however, the trappings of success will be very important since this may be all we know about the lawyer. The same would be true if you were working and living in a small town. Here the community would be more likely to have information on you than they would if you lived in New York City - which helps explain why people in large metropolitan areas tend to spend more on expensive clothing than people in smaller communities. As the amount of information falls, the importance of signals increases.
The second criteria is full-disclosure. What if you were well aware of the fact that some sellers had made claims concerning the quality ratings of their products in their advertisements, and you are now considering a seller who has not made the claim. Would you assume the seller not making the claim could make the claim, but simply chooses not to? Probably you are no more likely to believe this than you would be to believe that Specific Motors cars matched up to those of the Big Three. For this reason people in a world of imperfect information tend to attribute value to warranties.
Now what about the pre-owned car salesperson's claim? You probably are not likely to believe it, but that does not keep people from using it. Just look at the Classified Ads where you will frequently see the phrase "Moving Sale" in a car ad or a yard sale ad? The problem is the sellers in the car market have more information than the buyers, so the buyers are forced to make some assumptions. They assume those selling a used car are getting rid of lemons, hence the name given to this concept - the Lemons principle. The concept was designed to answer the question: why do cars lose their value so quickly once they are driven off the lot? When you drive the car home from the showroom, you have certainly not created $3,000 or $4,000 of wear-and-tear on the car, but this is how much the price falls. The problem is people without the complete information, attach information value to the fact the car is being sold. The assumption is people with good cars do not sell them, so the pool of used cars is assumed to consist of cars that have problems.
The problem with the market is further compounded by the fact sellers of good cars recognize the problem and refuse to sell their cars because they cannot develop a credible message. In this situation you would say the market is characterized by adverse selection. When a group is presented with a transactions opportunity (potential sellers of a car), the group that takes the opportunity will be very different from the group that does not take the deal. Those with bad cars will sell, while those with good cars will not sell. This is a big issue in the insurance business.
The lemons principle has created problems for auto dealers. As a growing share of autos are being leased for a few years, auto dealers find themselves with an inventory of pre-leased vehicles they must attempt to resell. The lemons principle will assure these dealers they will not get their money's worth, so they will tend to look for ways to gain credibility for their claims the cars are reliable. One solution would be the certified programs for used cars that provide the buyer of a used car with a warranty comparable to a new car warranty. The expectation is thatpotential consumers will see that the car is not a lemon and pay a premium price.
We have now seen how rational decision-makers may choose to operate with less than perfect information, and when they do, their behavior takes on a new character and markets behave a bit differently. In a world of imperfect information, we find individuals tend to use signals to guide their decisions, the lemons principle explains how markets can produce the wrong market price, and adverse selection describes how the existence of imperfect information will prompt some potential market participants not to participate in a market.
Bikhchandani, Hirschleifer, and Welch (1998) have developed a framework for choice to explain what is sometimes explained as "wait-and-see" and herd behavior, to explain the tendency we have to experience fads. They note this tendency to imitation has long been noted by others. Machiavelli noticed the same tendency when he wrote in 1514: "Men nearly always follow the tracks made by others and proceed in their affairs by imitation." The philosopher Eric Hoffer writing in 1955 notes very much the same tendency when he states: "When people are free to do as they please, they usually imitate each other. . . . A society which gives unlimited freedom to the individual, more often than not attains a disconcerting sameness."
The answer can be found in the fact that in a world of imperfect information, individuals learn by observing the actions of others - what they refer to as observational learning or social learning. Armed with this framework they set out to explain why two management gurus would secretly purchase 50,000 copies of their book in 1995 from the stores monitored by the New York Times bestseller list, or why the revitalization of Times Square languished until Disney announced its plans to invest in the area. This certainly helps to explain the growth of a crowd on July 4th on a hill overlooking San Francisco Bay. These people had gathered to watch the fireworks over the Bay. The only problem was no one there actually knew whether you could see the fireworks. Someone had stopped and other simply stopped because they assumed the person was right.
At its simplest the model is based on the assumption there are two inputs into choice situations - information collected by the individual and the past choices of others. When choosing between A and B, an individual will collect information on each and also observe how many have chosen A and how many chose B. If you are indifferent between A and B, but note B was chosen by someone else, then you will tend to follow suit by buying B. The strength of this learning effect is also likely to depend upon the 'stature' of the initial adopter.
Where do we find evidence of this behavior or attempts by decision makers to capitalize on it? One candidate would be Nike who has tried to tap into this demonstration effect with its high profile athlete endorsement program. Another would be network television programming where we see a remarkable amount of 'sameness' despite the traditional values of product differentiation, and branch banking which tends too often to locate branches in close proximity to other branches. The decisions to enter a market with a low price to build up excitement, to buy up the 50,000 copies of a book, and to fight serious crime by reducing minor crimes can all be viewed s examples of decisions linked to this behavior.
Choice under Uncertainty
When you decide to go on a winter vacation to the sun, are you guaranteed sun? When you buy a car, are you certain that it will run to your expectations? When you spend money getting a college education, are you absolutely certain that it will get you a good job when you graduate? In each case there is no certainty. These choices are made under uncertainty, and economists trying to make sense of situations where there is uncertainty, have extended their analysis and developed the expected-utility model. In the traditional model of choice under certainty, individuals were assumed to end up with the highest level of satisfaction (utility). In the uncertain world, the assumption is people choose the option with highest expected utility.
The first step toward understanding this model is an understanding of expected value. As an example, what is the expected value of a gamble / deal where there is a 50 percent chance you will win $1,000 and an 50% chance that you will lose $500? The answer is calculated below.
Expected value = .5*$1,000 + .5*(-$500) = $500 - $250 = $250
What this formula tells us is that on average we could expect to win $250 on the deal. At any one time you may win $1,000 or lose $500, but if you played it often enough you would tend to win an average of $250 per gamble.
The expected utility model specifies the expected utility of a gamble as the expected value of the utility over all possible outcomes. In the situation above we would calculate the expected utility as
Expected utility = .5*U($1,000) + .5*U(-$50)
Expected utility of the deal is .5 times the utility of $1,000 and .5 times the utility of losing $50. But now there is a new question. Is the expected utility of the gamble worth more or less than the utility of $250. It turns out the key insight is the expected values of the outcomes of a set of alternatives need not have the same rankings as the expected utilities of the alternatives. There are three possibilities.
A graphical version of the situation for a risk averse person appears below. Here we have a person given a choice of $5,000 or a 50/50 chance of $10,000 and $0. The expected value of the gamble is $5,000 [Expected value = .5*$10000 + .5*0 = $5,000]. The utility this person derives from $5,000 can be found on the blue utility curve. The value of the weighted sum of the utilities of $0 and $10,000 can be found on the red line (chord) joining the two points ($10,000 and $0) on the utility line. Given the blue utility line lies everywhere above the red line, this person is risk averse and will never take a fair deal.
What is the implication of this feature of risk aversion? The fact that risk averse people will not take a fair gamble means they will consistently choose options with lower expected values. This can be seen when people buy insurance, which by necessity, is an unfair gamble. The insurance company provides you with a deal where they can make enough extra money to pay for their costs and profits, even after they have paid off all their losses. One of the reasons the insurance companies' risks are likely to be larger than yours, and therefore your costs of buying insurance will be too high if you are a careful driver, is called moral hazard. When people get insurance they tend to be less careful when driving so the likelihood of an accident will increase, driving up the cost of insurance. The recognition of this fact has prompted some individuals and companies to self insure when the potential losses are not LARGE. You might do this with the deductible on your car insurance. When you get a $500 deductible you are in essence self insuring for small losses - you are betting the cost of the insurance on the $500 loss will be more than the expected cost of any small accidents. In this case you will end up with a higher level of expected income if you accept the uncertainty and not insure against small losses.
Risk aversion may also prompt individuals to make choices that appear on the surface to be irrational, or more specifically, choices that seem inconsistent. People tend to weight certainty more highly than uncertainty so they will actually make choices favoring certainty more often than expected.
Some Peculiarities in Consumer Choice
We have now looked at a number of situations. In some we have found people make choices that provide them with less, which seems to be at odds with the belief that more is better. This could be explained, however, by the way people deal with uncertainty when they are risk averse - which most people seem to be. We have also seen how people tend to make questionable decisions when information is limited and how they devise strategies of dealing with the limited information.
Now we are going to look at a few additional problems with the economists' model of choice. The problems raised here have to do with difficulties in applying the model, not limitations of the model. In earlier situations you found yourself saying, I understand what you are saying, but I am comfortable with my decision. There were also some choices made with imperfect information because assembly of all the relevant information made no economic sense. Here you are more likely to end up uncomfortable with some of your choices. Here you are likely to see "irrational" choices being made when there is no real difficulty in assembling the necessary information. In the remainder of this unit we will examine behavior that violates the "laws" of rational choice and discuss some alternative models of choice that have been devised to explain the behavior. We will look at situations where individuals fail to act as they say they should and where they consistently miscalculate the costs and benefits of their choices. We will begin with a discussion of why people tend to not follow through on their plans and tend to discount the future too highly.
Time Preference and "Irrational" Choices
Would you give up $100 today for a promise to receive $100 a year from today? Would you do it for $104? for $120. There is no right answer and since people possess different rates of time preference - the rate at which they would trade something today for something in the future. I may be willing to trade $100 today for $120 next year, while you are willing to forego $100 this year for $105 next year. We simply differ in terms of our rate of time preference. I tend to discount the future more than you do.
One of the concerns of researchers studying individual behavior is there seems to be a significant difference between what people say they want to do and what they actually do when it comes to choices between today and the future. This discrepancy, however, raises questions about the "rational" decision-making model that economics is based upon if people are not doing what they want to do. For example, a sample of students were asked which of the consumption profiles depicted below they wanted for the rest of their life. The one on the left gave them a constant level of consumption spending over their lifetime, where there would be no increase in the standard of living as they got older. The right-side diagram, meanwhile, depicts a rising standard of living. The lifetime income in the two situations will be about even. What researchers found was the majority of students picked the earnings profile on the left, suggesting they valued future consumption more than today's consumption. It also suggests people care not only about the current situation, but also the direction in which things are headed. Unfortunately for the proponents of the "rational" decision-maker, what we find out is people do not save so there is a disconnect between what they say they want and what they actually do.
A possible explanation for this disconnect would be the existence of positional goods, what economist Fred Hirsch called goods you can never get enough of to satisfy yourself. If you have a car, then it will always be compared with a car with more features and better lines. The same will be true for the schools you attend, the clothes you wear, the vacations you take, and the homes you live in. As a result, this "keep-up-with-the-Jones" effect associated with positional goods will tend to increase the rate of time preference - people will save less. This has prompted some to suggest that Social Security should be considered forced savings needed to overcome the effect of positional goods.
Closely related to this is the problem of self control - or more precisely, the lack of self control. The difference between what people "want" and what they get will differ if they lack self-control, the ability to trade today off for tomorrow. This is at the heart of the self-help literature that focuses on the task of implementing the plan rather than the formulation of the plan. If you want to get those A's on your transcript, then you may very well have to move yourself away from the noisy dorm and into the quiet library, away from your party friends and to your studying friends. If you want to quit smoking, you may want to stay away from situations where there will be smoking. This is also what drives people to enroll in Christmas clubs with the forced savings each week or month.
Before we move on, let's review the IRS question. [Assume that you know that a year from now you will need to write the IRS a check for $1,000 to pay your income taxes. Would you: a) decide to deposit $20 a week for 50 weeks into a savings account that would give you $1,100 in one year or would you increase your federal income tax withholding each week for 50 weeks by $20 so that you would not need to write the check at the end of the year?] Think of how many of you willingly gave up $100, which is what you did when you chose the greater withholding. This makes no "rational sense" since you would never choose to give way $100 which is precisely what you did - unless this was your way of dealing with a lack of self control. Maybe you were afraid of a few extra dinners out or a mini vacation keeping you from your real goal of saving the $100.
Asymmetric value function
Economists' rational choice model is based on the premise that the level of utility (satisfaction) depends upon the level of consumption. An alternative view has been proposed by Kahneman and Tversky (K&T), two psychologists who have done considerable research in this area. They set out to explain two phenomena. The first is that people tend to treat gains and losses differently. You gain less from earning $100 than you lose when losing $100, even though the dollar value is a wash. The second is that people identify events first and then add the value of the events rather than add the events and evaluate the net outcome. If you win $100 and lose $80, then the K&T model says what matters is the value of $100 combined with the value of -$80, rather than the value of $20. It is the second of these that cause the rational choice people problems.
To understand the issue, let's look at the Asymmetric value function proposed by K&T which appears in the diagram below. There is a positive relationship between the amount of wealth you have ($s) and the value you attribute to it, precisely what you would expect with utility analysis. If wealth increases by $250, value will increase by 100. Similarly, a loss of $250 will reduce value by 300. The asymmetry comes in because you treat losses and gains differently, which is why the slope is different for gains and losses. In this case, if you were presented a fair game - one where the chance of gain was equal to the chance of loss - you would not play.
With this asymmetric value function in mind, let's return to the question concerning medical plans.
The first plan pays all medical expenses for a fee of $800 a year. The second pays all expenses above $300 for the year for an annual fee of $400. Which plan would you chose? What we find is some people choose the first plan even though it will cost more than the second plan. The first plan costs $800, while the second will never cost more than $700. The $400 in cost savings, which shows up as a gain, is weighed less than the possible $300 expense, which shows up as a loss, so this plan would appear to be inferior even though it has to cost less.
If you accept the asymmetric value function of K&T, then economist R. Thaler suggests that how you frame a choice will have a significant impact on the choices made.
Let's look at some choices.
It should be clear from the questions the expected value of the two choices are equal and the rational choice model would say an individual should be indifferent between the alternatives. That you end up with $150 matters, what should not matter is how you ended up with it. But it does appear to matter as people continue to treat these options differently. When confronted with the situations above, the framing of the information matters. In the case of the first three questions, people preferred the separate gains and the packaged losses. In the fourth and fifth example people wanted the combinations - a small gain with a large loss and a small loss with a larger gain. Based on results similar to these, Thaler concludes that there are four strategies for framing the questions.
Sunk Costs
One of the "rules" of the rational model is that sunk costs should not affect a decision. The idea is simple enough. By choosing a certain option, if costs are sunk, then these costs will not vary with the decision and thus they will be the same regardless of the choice. If these costs do not vary, then they should not enter the decision. Behavioral research, however, has shown that decision makers often act as if the sunk costs matter. But you already know this. Just think of how often you have heard the phrase: "We must continue because of all that we have spent on this project." In this example, future behavior is being influenced by sunk costs which is a result at odds with the rational choice model. For another example, let's look at the situations facing the tennis player, the owner of the uncomfortable shoes, and the basketball fan.
In the case of the tennis player, the rational expectations model predicts the decision to play on the outdoor court is the "rational" decision since it costs no more to play outdoors. The choice should have not be dependent upon whether or not the hourly fee had been paid, but the results indicate that those who paid the fee are less likely to play outdoors.
The response of the owner of the uncomfortable shoes, meanwhile, generally depends upon where the shoes came from. People were much more likely to wear the uncomfortable shoes if they had purchased them, despite the fact that the costs and benefits of wearing the shoes were identical in the two situation.
And finally there is the basketball dilemma - to go or not to go. The rational choice model would tell us to expect the decisions should be the same regardless of how one came upon the tickets. The benefits of the game should be weighed against the costs of getting there, and the source of the ticket should not enter into the calculation. Once again though, the answers were not the same, as students were more likely to go to the game if they had bought the ticket.
In each case what we appear to be seeing is people factor into their decision sunk costs, although the rational model would say these are irrelevant. If costs are truly sunk, they cannot be recovered regardless of the choice, a decision should not be influenced by them. As we saw here though, this is often not the case. Very often we find people include in their decision the $15 fee that had already been paid for the court despite the fact it will not be refunded regardless of where you play. We also find those people who bought the shoe are more likely to wear them, even if they are uncomfortable. And finally, we tend to find students who have already paid for the ticket are most likely to go to the game despite the bad conditions.
Let's look at one final question. You have bought a ticket to a concert for $20. On the way there you find that you have lost the tickets. Do you buy new tickets and stay, or do you return home? Would the answer be different if you had waited to buy the tickets at the door and on the way to the performance you received a $20 ticket on your way to the concert? The rational choice model would say there should be no difference, they are both $20 poorer as they contemplate the decision to buy the ticket. In terms of the consumer choice model, both couples have experienced an inward shift of their budget constraint and we should expect they will behave in similar ways. What repeated studies find, however, is that individuals confronted with this choice do not behave the same, do not behave as the rational choice model would suggest. Kahneman and Tversky conclude that people do not think of their money as a pool of resources, but rather place it into separate "accounts." In this case, the lost $10 came from the general account and the lost tickets came from the recreation account. In this case $10 is not $10.
Opportunity costs
Decision makers thus appear to sometimes build into their calculations costs that should not be included. It can also be said that there are instances where costs that should be included in the decision-making are systematically excluded. The problem is decision makers possess a tendency to miss some implicit (opportunity) costs in their calculations. To see the importance of implicit (opportunity costs) in decision making, let's return to the following questions.
What surveys have revealed is there are people who will not give up the Super Bowl tickets or the wine, but this is against what the rational choice model would have suggested.
In the case of the Super Bowl ticket, the decision to go to the Super Bowl means spending will total $250 for the ticket. By not going to the game and selling the ticket, you could earn $2,250 [$2,500 - $250]. The difference in the financial situations would be $2,500, which should be considered the opportunity cost of going to the game. Although this person would never pay more than $250, in this case they spent $2,500.
In the case of the wine, to drink the wine will cost $5 out of pocket. A decision to take the offer and sell the wine would produce a profit of $95 [$100 -$5]. In this case the net financial position would be $100 higher when selling the wine. What this means is the opportunity cost of the bottle of wine is $100 since this is the difference in the two financial positions, but this is far more than it was worth.
Biases and rules of thumb
It is now time to briefly examine a few additional "irregularities" in decision-making identified by Kahnman and Tverskey. They have suggested that individuals, as a way of dealing with choice situation, tend to come up with rules of thumb. Three simple rules-of-thumb that people use to guide their choices - all of which lead to non optimal behavior - are availability, representativeness, and anchoring. Availability pertains to the ability to recall information. It turns out not all information can be recalled equally. Researchers have found patterns in what people can recall. Individual's ability to recall is influenced by the frequency of the information, the time since the information was heard, and its graphic nature. It turns out, not surprisingly, that people are more likely to be influenced by information widely disseminated, heard recently, and more graphic. Think back to yesterday and what is it that you recall.
There is also the problem of representativeness associated with how people answer questions such as: What is the probability a certain object belongs to class A? It turns out that people are influenced by representativeness. For example, think about how you answered the question: John is 6' 10'' tall. Is he more likely to be a professional basketball player or a salesperson? Many people are tempted to pick the professional basketball player since this is where you see the highest concentration of tall people. The problem is there are very few professional basketball players and a lot of sales people so it is very possible the odds of the person being a basketball player are very low. For example, if there are 400 professional basketball players in the country and 20 million sales people, and 20 percent of the basketball people are taller than 6.7, as are 1/100 of a percent of salespeople, then the number of 6.7 + basketball players is 80 and the number of 6.7+ salespeople is 2,000. Based on these data it is far more likely that the 6.7 person will be a salesperson despite the fact that most assume that he is a basketball player.
A second example of this representativeness bias is the regression to the mean effect. What happens if someone does exceptionally well today? What is likely to happen tomorrow after someone has been praised for her efforts? The law of averages suggests performance will return to the mean, so tomorrow should not be as good as today. Similarly, what happens if there is a bad performance today. After the person is "scolded," you should expect the behavior will improve tomorrow - again just because of the law of averages. The problem is that people tend to forget about the law of averages and attribute influence to their policies. The policy of praise did not breed continued superior performance, while the "scolding" of bad performers was followed by a better performance. This regression to the mean could also help explain the Sports Illustrated jinx, but we will talk more about that in class.
A third problem has to do with the psychophysics of perception. It turns out that people's ability to identify differences in a signal is directly related to the intensity of the signal. For example, you might be able to distinguish a 10 from 20 watt light bulb, but not a 100 and a 110 watt bulb. To see how this effect works, let's look at the shopping question. Did people shopping for the radio tend to alter their shopping more or less that those shopping for the TV? The rational choice model would say that there should be no difference - if you were willing to move for a $5 saving, you should do it both for the radio and the TV. What we find, however, is that the difference seems to matter less as the price rises (signal intensifies) and the $5 becomes less important in the decision.
Conclusion
Economists have increasingly turned their attention to extensions of / alternatives to their narrow view of behavior. One strain of this thinking that can be traced to the work of Gary Becker has been the extension of the utility analysis to provide economists with the basic tool to extend their insights into other, traditionally non economic decisions such as having children or getting married. By adopting the expanded framework economists have been able to explain the choice of family size as the result of a rational choice. A second, very different strain, has borrowed heavily from the field of psychology and extended the analysis to explain 'irrational' behavior. Here, we have looked at a number of the latter category of "extensions" of the rational choice model. Some of the behavior, it turned out, could be explained as rational in an environment of limited information and uncertainty. Other behavior that cannot be explained away by limited information and uncertainty, meanwhile, appears to be explainable within the asymmetric value function framework. There are also some systematic "flaws" in decision-making - inclusions of "sunk" costs that should not be considered and the exclusion of "opportunity" costs that should be included. Finally, there are instances where limited recall ability, imperfect statistical sense, and imperfections in perception can lead to non optimal choices. The rational choice model of individual behavior remains a powerful tool, but anyone interested in explaining behavior will need to move beyond this simple model. Now we will move on to a discussion of decision-making for firms.