How Memory Shapes Our Choice
Consider a traveler at an airport who is thinking whether to purchase water. In standard economic theory, this decision only depends on how thirsty she is and on the price of the water bottle. But as Bocconi Professor Nicola Gennaioli and coauthors point out in a recent paper in The Quarterly Journal of Economics, a crucial and often ignored factor – memory – shapes a decision as simple as this one. Drawing from psychology, the authors formulate a novel theory of how memory affects choice. The model shows that seemingly irrelevant factors like location and past experiences play a key role in choice.
To see this, consider again the traveler. Even before she enters the store at the airport, she forms memories of buying water in the past. But this estimate needs not be accurate, for experiences are selective. For instance, if the traveler has never been to the airport before, she would be surprised by the high price of water compared to the usual price she pays downtown. Her attention would focus on the high price, and prompt her not to buy, even if very thirsty. On the other hand, a frequent traveler, armed with many similar experiences, would find it normal to find expensive water at the airport, and so would be willing to buy. In standard economic models, these considerations are irrelevant. They instead become relevant when we rely on memory to form norms for prices and when attention focuses on price surprises relative to the memory norm. This approach helps understand why otherwise identical people with different past experiences make different choices in the same situation.
In another paper, recently published in Psychological Review, Prof. Gennaioli and co-authors conduct experiments to understand better how context influences recall. Their study reveals that one in which our brains determine what past experience is recalled when faced with new information is interference, i.e. the fact that recall of a particular memory is weakened by the presence of other more similar memories. These effects help explain a wealth of puzzling evidence. For instance, consumers are more likely to buy convertible cars on sunny days or to overspend on warm clothes during unusually cold winter days. In China, days with unusually high air pollution see a soaring increase in the purchase of health insurance, which is subsequently cancelled when pollution turns back to normal. From the vantage point of selective memory, the cause of this puzzling behavior is clear: current weather or pollution conditions cue recall of similar weather conditions or of the health hazards of pollution, causing consumers to overestimate the value of these items.
"Whether we perceive a value, say the price or quality of a good, as high or low," Professor Gennaioli summarizes, "depends on subtle factors that cue us to think about past experiences influencing decisions, even when these aspects are totally irrelevant to the decision at hand."
This principle can also be used to think about advertising. For example, the ads of Budweiser beer cue friendship to create an association with good experiences that subsequently enhances the valuation of the product or the attention devoted to it. Thus the authors offer a richer model of the process of decision making founded in psychology, which can be used to better explain behavior that critically departs from existing economic models.
Bordalo, P., Coffman, K., Gennaioli, N., Schwerter, F., & Shleifer, A. (2021). "Memory and Representativeness." Psychological Review, 128(1), 71–85. DOI: https://doi.org/10.1037/rev0000251
Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer, "Memory, Attention, and Choice," The Quarterly Journal of Economics, Volume 135, Issue 3, August 2020, Pages 1399–1442, DOI: https://doi.org/10.1093/qje/qjaa007