(), Mark Voorneveld
() and Jörgen W. Weibull
Lars-Göran Mattsson: Department of Infrastructure, Postal: Royal Institute of Technology, SE-100 44 Stockholm, Sweden
Mark Voorneveld: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Jörgen W. Weibull: Department of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Abstract: It is not unusual in real-life that one has to choose among finitely many alternatives when the merit of each alternative is not perfectly known. This may be the case when an individual chooses school, doctor or pension plan, or when a firm chooses between alternative R&D projects. Instead of observing the actual utilities of the alternatives at hand, one typically observes more or less precise signals that are positively correlated with these utilities. In addition, the decision-maker may, at some cost or disutility of effort, choose to increase the precision of these signals, for example by way of a careful study or the hiring of expertise. We here develop a model of such decision problems. We begin by showing that a version of the monotone likelihood-ratio property is sufficient, and also essentially necessary, for the optimality of the heuristic decision rule to always choose the alternative with the highest signal. Secondly, we show that it is not always advantageous to face alternatives with higher utilities, a non-monotonicity result that holds even if the decision-maker optimally chooses the signal precision. We finally establish an operational first-order condition for the optimal precision level in a canonical class of decision-problems, and we show that the optimal precision level may be discontinuous in the precision cost.
22 pages, First version: March 9, 2004. Revised: September 13, 2006. Earlier revisions: April 21, 2004, July 6, 2004, March 14, 2005, September 13, 2006.
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