Preference Reversal

CHALLENGING ECONOMICS

Preference reversals have an important place in the history of the conversation between psychologists and economists. The reversals that attracted attention were reported by Sarah Lichtenstein and Paul Slovic, two psychologists who had done their graduate work at the University of Michigan at the same time as Amos. They conducted an experiment on preferences between bets, which I show in a slightly simplified version.

You are offered a choice between two bets, which are to be played on a roulette wheel with 36 sectors.

Bet A (the riskier “L” bet): 11/36 to win $160, 25/36 to lose $15

Bet B (the safer “H” bet): 35/36 to win $40, 1/36 to lose $10

You are asked to choose between a safe bet and a riskier one: an almost certain win of a modest amount, or a small chance to win a substantially larger amount and a high probability of losing. Safety prevails, and B is clearly the more popular choice.

Now consider each bet separately: If you owned that bet, what is the lowest price at which you would sell it? Remember that you are not negotiating with anyone—your task is to determine the lowest price at which you would truly be willing to give up the bet. Try it. You may find that the prize that can be won is salient in this task, and that your evaluation of what the bet is worth is anchored on that value. The results support this conjecture, and the selling price is higher for bet A than for bet B. This is a preference reversal: people choose B over A, but if they imagine owning only one of them, they set a higher value on A than on B. In general, about half of subjects state prices that are inconsistent with their choices.

What drives the reversal is a compatibility effect. When a response scale is compatible with a particular attribute—in this case, pricing is expressed in money, which makes the monetary payoffs especially salient—that attribute is overweighted in single evaluation. In the pricing task, the large possible win in bet A ($160) looms larger than the high probability of a modest $40 in bet B, because the money scale pulls attention toward dollar amounts and away from probabilities. In choice, where the two bets are compared directly, the difference in safety becomes the most prominent feature, favoring the safer bet. The compatibility of the pricing response with the payoff dimension thus produces the asymmetry: the weight of the dollar amounts is amplified in isolation but diminished in joint evaluation.

The same dynamic can be described in terms of the two systems of thinking. In this account, System 1 is more likely to dominate single evaluation, where the vivid dollar prize can serve as an anchor. Direct comparison can invite the more effortful assessment associated with System 2, though comparison does not guarantee careful reasoning. Here it makes bet A’s lower chance of winning more salient, while pricing directs attention toward the prize.

One striking demonstration of the compatibility mechanism comes from a study that examined preference reversals with monetary versus nonmonetary outcomes. When the bet outcomes are not expressed in monetary terms—for example, winning a dinner or a book—the compatibility between the pricing scale and the payoff attribute is weakened. Under those conditions, the frequency of preference reversals drops substantially (from around 41% to 24% in one experiment). The pricing response no longer draws disproportionate attention to the prize amount because the payoff is not naturally denominated in dollars, making the single evaluation less distorted by an overweighting of that dimension. This finding underscores the central role of compatibility in producing the reversals, and it also helps explain why the phenomenon is so robust with standard monetary bets: it persists even in the presence of monetary incentives designed to promote consistent responses and has been observed on the floor of a Las Vegas casino.

The preference reversal can be confirmed in a within-subject experiment, in which subjects set prices on both bets as part of a long list, and also choose between them. Participants are unaware of the inconsistency, and their reactions when confronted with it can be entertaining. A 1968 interview of a participant in the experiment, conducted by Sarah Lichtenstein, is an enduring classic of the field. The experimenter talks at length with a bewildered participant, who chooses one bet over another but is then willing to pay money to exchange the item he just chose for the one he just rejected, and goes through the cycle repeatedly.

Rational Econs would surely not be susceptible to preference reversals, and the phenomenon was therefore a challenge to the rational-agent model and to the economic theory that is built on this model. The challenge could have been ignored, but it was not. A few years after the preference reversals were reported, two respected economists, David Grether and Charles Plott, published an article in the prestigious American Economic Review, in which they reported their own studies of the phenomenon that Lichtenstein and Slovic had described. The introductory paragraph of Grether and Plott’s article was unusually dramatic for a scholarly paper, and their intent was clear: “A body of data and theory has been developing within psychology which should be of interest to economists. Taken at face value the data are simply inconsistent with preference theory and have broad implications about research priorities within economics.… This paper reports the results of a series of experiments designed to discredit the psychologists’ works as applied to economics.”

Grether and Plott listed thirteen theories that could explain the original findings and reported carefully designed experiments that tested these theories. One of their hypotheses, which—needless to say—psychologists found patronizing, was that the results were due to the experiment being carried out by psychologists! Eventually, only one hypothesis was left standing: the psychologists were right. Grether and Plott acknowledged that this hypothesis is the least satisfactory from the point of view of standard preference theory, because “it allows individual choice to depend on the context in which the choices are made”—a clear violation of the coherence doctrine.

You might think that this surprising outcome would cause much anguished soul-searching among economists, as a basic assumption of their theory had been successfully challenged. But this is not the way things work in social science, including both psychology and economics. Theoretical beliefs are robust, and it takes much more than one embarrassing finding for established theories to be seriously questioned. In fact, Grether and Plott’s admirably forthright report had little direct effect on the convictions of economists, probably including Grether and Plott. It contributed, however, to a greater willingness of the community of economists to take psychological research seriously and thereby greatly advanced the conversation across the boundaries of the disciplines.